Lemelson Capital
Management, LLC, a private investment manager, today announced that it has
taken a significant equity position in Kulicke & Soffa Industries KLIC, a global leader in the design and manufacture of semiconductor and LED
assembly equipment.
Lemelson Capital's acquisition reflects the firm's view that shares of the
company remain dramatically undervalued.
Lemelson Capital also announced today that it is urging K&S to initiate a
share repurchase plan and has delivered the following letter to the company's
management team, board of directors and other stakeholders.
April 22, 2014
Mr. Bruno Guilmart
President and Chief Executive Officer
K&S Corporate Headquarters
23A Serangoon North Ave 5 #01-01
Singapore 554369
Dear Bruno,
Congratulations on what can only be described as first-rate execution since
taking over as CEO of Kulicke and Soffa Industries in 2010.
The firm's focus on transitioning to copper wire bonding proved timely while
your and Jonathan's operational acumen appear to have contributed
significantly to K & S's sizeable war chest of approximately $556 million and
its near flawless balance sheet.
Additionally, your leadership team deserves much credit for achieving an
important shift in corporate culture that has fueled higher employee morale
while lowering turnover.
After following your progress over the years, Lemelson Capital on behalf of
its clients has picked up some 368,429 shares over the last 14 months,
increasing the positional size some 65 percent since YE 2013 alone, which is
indicative of a firm conviction that the market continues to radically
under-value the company and its future prospects.
Lemelson Capital intends to continue buying on behalf of its clients.
As you know, cash and cash equivalents now represent approximately 60 percent
of the company's market capitalization. The wedge bonder business remains
undervalued on the balance sheet and the flexible operating model that has
been adopted has reduced OpEx when needed. Also, the steady, high margin
expendable tools business combined with the absence of the convertible debt
that was paid off in 2011 have worked to minimize the correlation in the share
price to the overall semi-conductor industry cycles while "juicing" cash
flow. As a result of these changes, short interest in K&S has never been
lower.
At the same time, the thin analyst coverage the firm has received has been
either dead-wrong in its appraisal of the firm's value or significantly
under-estimated the Total Addressable Market going forward. All of this has
contributed to the shares remaining unappreciated for a curiously long period
of time.
However, the purpose of this letter is not only to recognize the recent
achievements of management but also to express to you directly (with the
expectation that you will in turn share this letter with the company's board
of directors) Lemelson Capitals unwavering belief the time is long overdue for
the company to authorize a sizeable (at least $250 million) share buy-back.
While it is appreciated that a substantial part of K&S's cash is held
off-shore, the company could easily use debt to finance such a repurchase at
very favorable interest rates.
Lemelson Capital considers K&S to be one of its most important commitments,
and to be abundantly clear is very much supportive of your leadership and
strategy. The sole criticism outlined in this letter stems from the
conspicuous absence of a significant buyback program.
There are two drivers of a share buyback, the first is that the current share
price is absurdly low in relation to the company's intrinsic value.
Time is of the essence. Vivid price/value disparities, such as that occurring
at the moment in the shares of K&S typically remain for but a short time, as
the market eventually comes around to more or less correctly weighing the
value of a growing balance sheet and an unusually high growth in per share
book value (K&S's growth in per share book value has averaged a remarkable
36.3% over the last five years[1]).
You have indicated in the past that you would like to reserve this abnormally
large cash position for potential acquisitions, but this argument is
increasingly losing merit, as the future of the company, which rests in large
part on advanced packaging, has already developed its own next generation
solution, with a commercially viable product, that is, by your own estimate
just six to nine months away. Meanwhile the underlying wire bonding business
has become a steady source of free cash flow that you acknowledge is easily
projected many years into the future.
K&S currently holds roughly $556 million in cash and cash equivalents, while
average free cash flow between 2010 and 2013 equaled 131 million. With 2014
EBITDA likely to approximate at least $85-100 million and future bonding
technology emerging as a home-grown solution, it is becoming increasingly
difficult to defend any further delay in initiating a large repurchase
program.
The forward PE ratio of the S & P 500 is about 15.7. After backing out net
cash, K&S trades at just 5.4 x conservative forward earnings estimates, this
does not account for the company's 10% tax rate, which is significantly lower
than that used by analysts in such calculations.
This (cash adjusted) discount becomes even more significant when viewed in
terms of projected free cash flow. If future cash flows approximate the
average of the last four years, then the cash-adjusted price to free cash flow
ratio is just 2.9x. That is to say the company arguably may generate enough
free cash flow in the next 2.9 years to cover its entire enterprise value.
With such a massive valuation gap and an inordinate amount of cash on the
balance sheet, it is difficult to understand why the board would not act now
to aggressively buy back stock by immediately announcing a tender offer for at
least 250 million (financed with either debt or a mix of debt and cash). K&S
generates more than enough cash flow to service such an amount.
For example, if the company decided to borrow the full $250 million to
commence a buyback at $12 per share, the result would be a reduction of 20.8
million or ~28% of the shares outstanding. This in turn would result in a ~38%
lift to earnings per share (based on 2013's anomalously low earnings), and a
commensurate 38% increase in the value of the shares. This conservative math
assumes no multiple expansion of the forward PE or the ridiculously low P/FCF
ratio outlined above.
In the not too distant future, if such a buyback were executed, today's
forward (and conservative) EPS estimates of just 89 cents per share would grow
to $1.23 based on a reduced ~55 million share count. It seems reasonable to
expect that with these enlarged figures the share price would appreciate
beyond $19 if the market prices the shares at approximately the same forward
multiple as the S & P 500 (a multiple at any rate substantially lower than the
company's peers).
The second driver of a share repurchase, is the perpetual dilution of
long-term owners in order to compensate management
Management teams that insist on holding large amounts of cash typically do so
out of a fear that they will not be able to effectively compete in the future
based on ability. This widely understood premise, when taken with
management's perpetual stock sales, is sending a message (perhaps wrongly) to
owners both existing and prospective.
It is also worth pointing out that management's shares sales have unfailingly
excluded management from participating in gains as the price of the shares has
risen steadily over the years. This pattern of share issuance and near
immediate selling (perhaps perceived as de-risking) is being done at the
expense of ongoing owners, indicating that while management's operational
ability is solid, it appears to have little understanding of how to properly
value a security. Needless to say, this has serious implications when
discussing an election to repurchase shares.
Delaying the execution of a buyback any further will only serve to validate
this point.
Ideally, management would keep its financial interests significantly
aligned[2] with that of long-term owners, particularly in light of the highly
undervalued nature of the shares. However, if management insists on selling
as quickly as options vest, then at a minimum the board must act quickly to
mitigate the resultant damage caused to long-term owners.
A significant component of the board's responsibilities is to be aware of
occasions to increase owner-shareholder value[3]. There are few things the
board could do at this time that would be more effective than to implement a
large and well-timed buyback.
Commencing the proposed buyback will likely result in considerable stock
appreciation of at least 60% for owners who choose not to sell into the
proposed tender offer. Lemelson Capital can be counted as first amongst those
committed to long-term ownership.
Sincerely,
+ Emmanuel Lemelson
Chief Investment Officer
Lemelson Capital Management, LLC
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