Despite a very low valuation, ams OSRAM (OTCPK:AMSSY) (“ams”) still can’t buy a break. The expected loss of 3D sensing business at Apple (NASDAQ:AAPL) has been confirmed, but that hasn’t really brought any relief, as the ADRs of this sensing and lighting semiconductor chop around $10 and have lagged the SOX index since my last update.
While I do think the current valuation undervalues the potential of the business, whether management is up to the task of realizing that potential is very much up for debate. Front-facing 3D sensing adoption has been slow with Android OEMs and it looks as though both the behind-OLED (or BOLED) and LIDAR-on-VCSEL programs are behind schedule. This isn’t the first time that ams has had operational stumbles, and it raises questions about how smoothly the integration of OSRAM will go and how effectively the company can leverage design and product synergies.
All of that pessimism and more seems to be in the shares now. While I could argue for a fair value as low $8 on the basis of weak near-term margins, I think fair value is more in the low-to-mid teens assuming just 3% long-term revenue and lackluster long-term margins.
An In-Line Quarter And Stable Guidance Don’t Sway Opinions
ams didn’t report a particularly strong second quarter, but inline-to-slightly-better results and stable guidance (Q3 revenue and margins around expectations on an adjusted basis) should have gotten a little more positive attention.
Revenue declined 3% sequentially, with the Semiconductor business declining 5% qoq and the Lamps & Systems business down 1% qoq. Overall revenue was slightly better than expected, with better Semiconductor performance offsetting weaker Lamps & System.
Gross margin declined about two points sequentially to 33%, beating by more than two points. Operating income declined 24% qoq, with margin down 240bp to 8.8%, with operating income beating by 3%. Guidance for $1.5B in revenue and margins of 8% to 11% was basically in-line with where the sell-side already was.
What’s Next For Sensing?
3D sensing has gotten a lot of the attention at ams for a long time, but it’s well worth noting that it’s a much smaller piece of the puzzle now after the OSRAM deal. That said, it’s also one of the better growth opportunities on the immediate horizon for the company, so it still matters quite a bit.
Management acknowledged the loss of 3D sensing (to STMicro (NYSE:STM), as far as I can tell), at Apple, but has gone to some lengths to reiterate that they still have ongoing business with Apple and ongoing design activity. We won’t know until we see the second half financials, but I would estimate that 3D sensing was about a third of the company’s business with Apple, with the rest coming from applications like ambient light sensing and noise cancellation.
On the negative side, I do think there’s a risk of further socket losses at Apple. STMicro has been gaining share with its own ambient light sensor (including the iPad Pro), and it may be difficult for ams to compete with STMicro on a price/performance basis.
Beyond Apple, ams has continued to struggle to gain much traction with front-facing 3D sensing solutions with Android OEMs, as most companies are sticking with fingerprint-based sensors. BOLED has been tapped as a potential game-changing technology, but it sounds as though those timelines have slipped even further; not a complete surprise given the engineering challenges involved.
On the positive side, BOLED is delayed, but not dead, and I think this technology will have its day (“when” is an entirely different question). I also believe ams is gaining share with world-facing ToF technologies for camera enhancement (1D) and AR/VR applications (3D).
Other Opportunities Beyond Sensing
Given that ams now has significant leverage to auto, medical, and industrial markets through the OSRAM acquisition, I believe more and more product development will be focused in this direction. The company has scored some notable LIDAR-on-VCSEL wins in the auto sector. Unfortunately, with the pandemic and other issues, the ramps of these wins won’t likely happen until after 2022.
Further down the road, ams will look to harnessing its own sensing technology and OSRAM’s emitter technology to develop more advanced sensing offers for markets like secure access (facial scanning for entry), machine vision and human-machine interfaces (allowing robots to better sense their environment and respond appropriately), driver monitoring and in-cabin gesture-sensing, and medical imaging.
The Outlook
“Further down the road” is part of the issue. I don’t think any investor would object to the general notion that there is a market out there for better machine vision for robots (cobots in particular), secure entry, and so on, but how quickly these opportunities will become real products with real market share is an open, and relevant, question.
So too, then, with the margin story. Management has goals of double-digit revenue growth and EBIT margins in the 20%’s. While the target addressable markets could support that revenue growth, ams really needs some wins (and revenue ramps) before the Street is going to buy into the story. Likewise with margins, as it will take meaningfully better gross margins than the mid-30%’s the company is generating today to drive 20%-plus operating margins.
Can ams achieve these goals? Yes. I believe the market opportunities are real, and I believe ams has credible technology. But whether they can leverage those technologies into marketable products and compete effectively head to head with Infineon (OTCQX:IFNNY), ON Semiconductor (NASDAQ:ON), STMicro, and Texas Instruments (NASDAQ:TXN), among others, is still very much up for debate – and why, I believe, the shares trade at such low valuation.
As I said in the open, it doesn’t take much to drive a higher fair value. Just 3% revenue growth from 2020 onward with low double-digit FCF margins would drive a fair value in the low teens. Double-digit growth would clearly drive substantially more value, and especially if that 20%-plus operating margin target proves attainable.
Margin-based valuation likewise reflects low expectations. Near-term gross margins in the mid-30%’s and operating margins in the 10% to 12% range support a fair value in the mid-teens, and by the harshest analysis (the lowest the market has paid for a given level of GPM/OPM) would still give me a fair value of $8 – below today’s price, yes, but again we’re talking about the lowest valuation I can call credible.
The Bottom Line
Clearly the market is saying that the OSRAM integration will not go well and/or that ams will struggle to develop the sensor packages (light sources like VCSEL, optics, image sensors, and so on) to generate real revenue in those auto, consumer, industrial, and medical markets that management has identified. This management team has a lot of work to do to rebuild its credibility with the Street, but expectations are at such a low level that more aggressive, risk-tolerant investors may want to take a closer look.
