MoSys: Memory technology with an edge
MoSys Inc. (Nasdaq: MOSY)
Sunnyvale, CA
Website: www.mosysinc.com
Rating: BUY
Initial Coverage: $8.95 – April 17, 207
Recent Price: $8.05 – May 25, 2007
Price Target: $12.00
52-week low / high: $5.47 / $9.96
Shares Outstanding: 31.67 million
Market Capitalization: $256.9 million
Why We Like MoSys:
- High margin low cost intellectual property business model
- Growing applications with broad market and global appeal
- Demand for System-on-chip on a clear uptrend
- Superior technology of 1T-SRAM over SRAM and DRAM
MoSys develops embedded memory solutions used by the semiconductor industry, electronic product manufacturers, and foundries to develop complex integrated circuits. The company does not manufacture chips but operates a semiconductor intellectual property business model in which it licenses out its technology to chipmakers on a non-exclusive and worldwide basis. Without the need to maintain the high capital costs of manufacturing, MoSys operates a high margin business with gross margins generally in the 85% to 90% range or higher.
The company’s patented semiconductor memory technology, called 1T-SRAM, is designed for high-volume, low-power consumer applications. The end result is high performance at a reasonable cost. Its memory is embedded into advanced integrated circuits including the increasingly popular system-on-chip (SoC). MoSys’s 1T-SRAM places a large amount of local memory on the SoC chip, thereby reducing the need for two separate chips and reducing the overall cost.
The demand for SoCs is rising as the demand for smaller semiconductor building blocks, or transistors found in advanced consumer applications increases. The underlying concept behind SoCs is the integration of multiple elements such as microprocessors, graphics, memory, analog components and digital signal processors into a single integrated circuit, which in turn enables higher performance and less power consumption.
1T-SRAM technologies deliver key advantages versus traditional SRAM in the areas of density, power consumption and cost. Some developers have tried DRAM because of its greater density over traditional SRAM, but the slower speed of DRAM has proved a detriment. 1T-SRAM appears to be gaining in the marketplace. MoSys’s 1T-SRAM memories provide 3 or more times the density associated with comparative SRAM. The higher density translates into lower cost for the chipmaker. The lower power requirement of 1T-SRAM also results in longer battery life and lower costs.
Prior to 2004, MoSys manufactured memory chips based on its 1T-SRAM technology, but a strategic shift was made thereafter to stop making chips and instead license the technology. Revenues are currently derived from two major sources: royalties of 2% to 5% of the selling price (64% of fourth quarter 2006 revenues) and licensing fees of 10% to 15% of the licensing price (36% of revenues).
The growth potential for embedded memory technologies as an integral part of SoCs is evident. Advanced consumer applications employing SoCs include cell phones, game consoles, portable multimedia players, cameras, camcorders, digital TV, and networking products to name a few. As the technological complexities of consumer products rise, the demand for more complex SoCs will also rise. To date, MoSys’s memory solution has been embedded in over 110 million units shipped.
A major growth area is the cell phone. As the demand for advanced cell phone features rise, the significance of embedded memory in chips found in cell phones to run advanced applications will rise and should benefit MoSys. By 2009, cell phones are expected to represent the company’s second largest application after graphics and imaging.
Clients include the top echelon of the technology world including Nintendo, Hitachi, LG Electronics, Yamaha, Rambus (Nasdaq: RMBS), Broadcom (Nasdaq: BRCM), Sony (NYSE: SNE), Applied Micro Circuits (Nasdaq: AMCC), LSI Logic (NYSE: LSI), Fujitsu, Motorola (NYSE: MOT), and Microsoft (Nasdaq: MSFT). Another major client is Nintendo, which employs 1T-SRAM technology in the hugely popular Nintendo Wii game console.
MoSys holds 97 U.S. and 72 foreign patents and patents pending. To stay ahead of the technological advances, the company employs a stable of engineers that focus solely on improving the 1T-SRAM technologies.
Growth in the demand for memory cells/blocks such as those developed by MoSys grew at 46% from 2004 to 2005, according to market research firm Gartner Dataquest. And according to the International Technology Roadmap for Semiconductors, embedded memory on SoCs will continue to rise and be driven by more complex consumer applications requiring more local memory to be stored on the SoC.
To accelerate its growth, MoSys is aiming to make its 1T-SRAM technologies the standard for all large embedded memories in SoCs. To move toward this, the company will continue to license its technology worldwide. Key target markets include consumer electronics and communications.
The huge market potential is there. About $50 billion of SoCs were shipped in 2005, according to MoSys. Applying the base 2% royalty on the selling price, this would translate into a potential $1 billion of royalty revenue.
Financial Results
Annual revenues have been inconsistent throughout the past 10 years. However, it is clear that the company’s key strategy shift in 2004 to change its focus from manufacturing chips to a royalty and licensing model has been panning out. The company reported its second consecutive year of year-over-year revenue growth in 2006, with revenues rising to $14.91 million from $12.28 million and $10.82 million for 2005 and 2004, respectively.
MoSys reported losses over the last three years from 2004 to 2006 as the company incurred added costs as it shifted its focus, but things appear to be looking brighter. The intellectual property model is picking up steam. The outlook for earnings is positive as MoSys squeezed out profits in the fourth quarter of 2006. Going forward, the profit picture is predicted to steadily improve with analysts predicting a return to annual profitability in 2007 and 2008, which could help drive the share price higher.
Revenues in the fourth quarter of 2006 surged to $5 million, up 108% from $2.4 million in the fourth quarter of 2005. The sequential growth was 25% from $4 million in the third quarter of 2006. The results were largely driven by strong growth in royalty revenue to $3.2 million in the fourth quarter, up 191% from a year earlier. MoSys recorded royalty revenues from 16 licensees, but the major royalty stream was derived from the popular Nintendo Wii console. The second source of revenues - licensing fees - grew 38.5% year-over-year to $1.8 million from $1.3 million in the comparative fourth quarter. Licensing revenues were derived from 12 chip development projects.
MoSys returned to profitability in the fourth quarter of 2006 on both a GAAP and non-GAAP basis as the company pared down its operating expenses by 40%. The non-GAAP earnings for the fourth quarter, excluding stock-based compensation charges of $816,000, came in at $1.38 million, or $0.04 per diluted share, a vast improvement over the prior year’s fourth quarter loss of $1.01 million, or $0.04 per diluted share. On a GAAP basis, earnings were $567,000, or $0.02 per diluted share, up from a loss of $1.08 million, or $0.04 per diluted share, for the year-ago quarter.
This is a high gross margin business as there are minimal capital costs. Gross margins in the fourth quarter were 88%, within the expected range of 85%-90%, but marginally below the 90% achieved in the year-ago fourth quarter. The decline in gross margins was due to higher costs related to product deliverables. Analyst firm Sanford Group estimates gross margins will rise to 92% in the first quarter of 2007.
The balance sheet is sound, with strong working capital, no debt, and cash and cash equivalents of $81.8 million, or $2.58 per share. This allows the company financial flexibility to grow its business without having to go to the capital markets.
Competition and Risk
Competition includes makers of traditional SRAM and DRAM, but MoSys’s 1T-SRAM technologies have key advantages and should enable the company to gain market share.
There is a risk of dependence as the company’s royalty revenue is presently derived largely from Nintendo, but MoSys is working at diversifying its client base.
A major market risk is the uncertainty of the semiconductor industry, but we feel MoSys is less vulnerable to swings in the semiconductor industry due to the growth in the embedded memory market as the demand for SoC rise. A risk, however, is if the SoC market stalls as competing technologies including System-on-a-Package, which combines multiple integrated circuits, gain ground.
Final Thoughts
With the demand for embedded memory to power consumer electronics rising, the demand for the memory developed by MoSys is on a strong growth trend and will be the key catalyst to drive growth in the years ahead.
Revenues are on a strong growth trend while earnings are estimated to accelerate this year and extend into 2008. Looking ahead, analysts estimate MoSys will report revenues of $25.2 million in 2007 for year-over-year growth of 69%, followed by 48% revenue growth in 2008 to $37.4 million. The consensus analyst estimate calls for MoSys to earn $0.20 per diluted share in 2007 followed by $0.38 per diluted share in 2008.
We are initiating coverage of MoSys with a Buy rating and price target of $11.00, which represents a pricing multiple of approximately 30X the forward year consensus EPS estimate.
Note: This article is from the April 2007 issue of Growth Report, a leading independent investment advisory focusing on uncovering small cap stocks with substantial growth potential. Growth Report provides individual investors with proprietary research and analysis on small cap companies that have yet to be picked up by Wall Street radar. Growth Report is published monthly with weekly updates and periodic special reports. Visit www.GrowthReport.com for more information.
