2023-06-02 17:22:54 ET
Summary
- Immersion Corporation and its subsidiaries develop haptic technologies that let people use their sense of touch to interact with digital products.
- In Q1 FY23, IMMR experienced a 9.55% YoY decrease in EBIT, but net income increased by 63.1% YoY due to a significant tripling of net interest income.
- The net interest income was likely a one-off event. The market expects a sharp fall in EPS going forward. Since it's expected - it may be priced in.
- Assuming a next year's EV/EBITDA ratio of ~3x, IMMR looks significantly undervalued amid the historical norm of 6-7x, despite stagnant revenue growth.
- I assign the IMMR stock a Buy rating this time.
The Company
Immersion Corporation ( IMMR ) and its subsidiaries develop haptic technologies that let people use their sense of touch to interact with digital products. They provide licenses for their technology and patents, along with software development kits that enable the creation of tactile effects. The company also offers reference designs, and engineering services, and serves markets like mobile communications, gaming, automotive, and more. It was founded in 1993 in California and was reincorporated in Delaware in 1999.
IMMR's primary source of revenue comes from fixed-fee license agreements and per-unit royalty agreements. In terms of geographical distribution, Asia accounted for 84% of its total revenue for Q1 FY2023, while North America and Europe represented 12% and 4%, respectively.
The first reporting quarter of 2023 proved to be quite challenging for the company - due to a $0.5 million decrease in automotive licensing revenue, IMMR's fixed-fee license revenue decreased 30% year-over-year. Although per-unit royalty revenue increased slightly (+6% YoY), this wasn't enough to offset the overall negative effect:
At the same time, COGS, which in the case of the IMMR business equals OPEX, increased 293 basis points year-over-year - for some reason, management decided not to summarize the difference in the 10-Q . Well, I did it for them:
As a result of this decline in margins, EBIT fell by 9.55% YoY in absolute terms. However, net income increased by 63.1% year-on-year in the same period - why? Because net interest income more than tripled:
This income statement's item is all about dividend income from cash and cash equivalents, as well as gains from marketable debt and equity securities, short-term investments, and derivative instruments. As I see from the Notes to 10-Q, the significant increase above was mainly driven by 3 factors.
First, there was a $3.6 million rise in net gains from investments in marketable equity securities and derivative instruments. Second, IMMR earned $0.7 million more in interest income. And third, last year's expense of -$152 thousand turned to other income gains of $0.1 million thanks to net foreign currency translation gains and a decrease in interest expense.
As of March 31, 2023, IMMR's current cash balance amounted to $148.4 million, which is a decrease of $1.3 million compared to the balance of $149.7 million in Q4 FY2022. This small decline of -0.88% QoQ has by no means made IMMR riskier, as its cash-to-market-cap ratio is still above 50% despite a 35% rise in the share price over the past year.
As we can see from the cash flow statement, IMMR is a fully self-sustaining company in terms of CFO generation [at least over the last 3 years ]. In Q1 FY2023, IMMR spent a lot of cash on buying marketable securities and other investments, which pushed up the net CFI a lot, but this increase settled on the current assets' part of the balance sheet.
IMMR's 10-Q IMMR's 10-Q, author's notes
The company has a stock repurchase program in place, allowing them to buy back shares with a total value of up to $50 million [~21% of the total market cap]. Perhaps management will continue share buybacks, as this trend has already started in 2022:
In April, IMMR announced a license agreement with Motrex Co LTD, a manufacturer, and developer of automotive solutions - so maybe the drawdown in the fixed-fee license agreements was just a temporary headwind to the sales figures.
Other significant news is the lawsuit against several companies of the Xiaomi Group in Germany, France, and India. The lawsuits allege that Xiaomi's smartphones, including the Xiaomi 12, infringe Immersion's patents related to haptic effects in such smartphones. Immersion is seeking an injunction to prevent Xiaomi from selling the patent-infringing smartphones in Germany, France, and India, as well as compensation for damages and costs incurred as a result of the patent infringement. I expect that the litigation could drag on for years, and in that regard, this news isn't in itself a catalyst. But it's certainly worth following the progress of this litigation if you're considering buying IMMR stock.
Valuation & Expectations
Due to its small market cap of ~$240 million, IMMR has low coverage among investment banks. There is only one analyst who forms the final consensus on projected EPS and revenue numbers.
Seeking Alpha, IMMR, author's notes
As you can see, the same analyst expects the company to see an 11.36% year-over-year decline in EPS in FY2023 - in Q3 and Q4, earnings per share would have to decline 50% and 64.44% YoY, respectively, for this forecast to come to pass. I'm relatively calm about this - the interest income in Q1 is considered a one-time event that can't be easily extrapolated to future quarters.
Historically, the company's EPS has been highly variable with pronounced seasonality - Q1 has almost always been the peak, and the correction began in Q2. Today's forecasts predict exactly the same seasonal pattern, but smoother than in 2020-22:
Seeking Alpha data, author's work
As for a valuation, I suggest starting by looking at EV/EBITDA - with such historical variability in EPS as IMMR, it's almost impossible to take P/E multiples seriously. For comparison, I take 2 periods of the company's life - the period from 2014 to 2016 and the period from 2017 to 2018. As a "justification" for the valuation levels of each period, I look at YoY changes in quarterly revenues - in the first case they grow sharply, and in the second they fall sharply. As we can see, the variation in IMMR's valuations is enormous:
The only one analyst mentioned above forecasts that the company's quarterly revenue will decline by 2.77%, 19.3%, and 6.15% year-over-year in Q2, Q3, and Q4 of FY2023, respectively.
At the same time, the market estimates EV/EBIT for next year at 3.36x - we don't have data for FWD EV/EBITDA, but it must be even lower since IMMR's total D&A costs are ~2% of annual revenue. Let's assume that next year's EV/EBITDA ratio is currently ~3x - this is still very low and represents an underestimate of about 67-100% of the historical norm of 6-7x EV/EBITDA at the current even stagnating revenue growth.
But Morningstar Premium gives IMMR a far more modest price target:
The Bottom Line
There is a lot of risk in buying any small-cap company, especially one whose financial performance has already reached a historical seasonal peak and is planning another downward spike. No matter how cheap IMMR stock is, it can always get cheaper due to changing market conditions and the company's relatively low liquidity in the market. The company isn't immune to slowing its EPS growth of the past few years - anything can change in any quarter. The moat here is extremely low.
But despite the risks listed, I believe IMMR's cash cushion of > 50% of total market capitalization provides some level of margin of safety. The company's net debt is -$166.75 million, according to Seeking Alpha - no long-term debt on the balance sheet looks good given the macro headwinds and rising refinancing costs.
So given the identified undervaluation, I assign the IMMR stock a Buy rating.
Thanks for reading!
For further details see:
Immersion Corporation Is Still A Cheap Small-Cap Buy