MagnaChip :: MX 3.0 update
“Capital allocation is the CEO’s most important job.” -William Thorndike
Today MagnaChip held its conference call to update its MX 3.0 strategy and capital allocation plan. Before we delve into the call, I want to mention that the company recently announced the departure of its CFO at year-end 2021. The new CFO, Shinyoung Park, formerly served as the Chief Accounting Officer and has been with the company since 2014. We do not like to see senior executive changes, but in this case, the transition should be smooth with an experienced internal candidate filling the role.
The MX 3.0 conference call slide deck follows below:
The previously announced $75 million stock buyback includes a $37.5MM accelerated stock repurchase agreement with JP Morgan, which will be completed in the first quarter. In an ideal case scenario, given the absurd amount of cash on its balance sheet, MagnaChip would increase the amount of the stock buyback to $200MM. Today’s call gave no indication that management will increase stock buybacks.
MagnaChip is still dealing with serious supply chain challenges. The company mentioned “a severe wafer shortage” numerous times. The wafer shortage is expected to continue throughout 2022 and into 2023. Due to the shortage, management is prioritizing high-margin products. The company said something incredible on the call: Demand for some chips is 50% higher than they can produce. Management is working to secure additional wafer supply and increase production capacity this year. The company plans to increase capacity in its power semi business by 40% by year-end 2022. Management announced a major new (unnamed) OLED customer as a “top-tier panel maker outside Korea” that will add to revenue numbers later in 2022. Prior to the conference call, MagnaChip announced new automotive OLED products. It expects these new chips to be included in “2 premium European automakers” vehicles in 2023. This deal is an exciting new market opportunity over the long term.
MagnaChip did not provide any details on the current quarter’s financials. We will have to wait for its February earnings announcement to see those figures. The company did provide an update to its initial October 2020 MX 3.0 plan with the following slide (green shaded column):
As you can see, the company continues to execute well. Despite COVID and a revenue decline in 2021, management is confident it can achieve double-digit CAGR growth for 2020-2023. That means 2020’s $507MM of revenue is forecast to grow at least to $675MM in 2023 at a 10% CAGR. The company is achieving a higher gross margin and expects to consistently maintain gross margins above 30%.
Management shared these capital allocation updates:
Maintain $100MM cash on the balance sheet for working capital.
Authorized $75MM buyback.
Capital investments to address supply chain challenges and flexibility to make accretive tuck-in acquisitions.
Here are my thoughts. $100MM of working capital seems high to me given the strong business fundamentals, especially considering MagnaChip has no debt. If we estimate the company has $350MM cash at the start of 2022 and subtract $175MM for working capital and buybacks, that leaves another $175MM of excess cash on the balance sheet. This is a critical moment for management. In my view, that excess cash is best deployed in two ways: 1)increasing buybacks and 2)addressing supply chain bottlenecks. Management could add $125MM to the existing $75MM buyback for a total of $200MM. A $200MM buyback at $20/sh would retire 10 million shares out of 46.5 total outstanding, or approximately 21% of shares outstanding. This would leave the company with an extra $50MM to pursue acquisitions in addition to its $100MM in working capital cash reserves. My thinking here ignores the addition to cash reserves from ongoing business operations, which are cash flow positive.
If management implements an effective capital allocation strategy and executes its MX 3.0 plan, we think the stock could rise by 50% or more. We continue to view MX shares as attractive under $20/sh, and especially during periods of market weakness when shares have traded into the $17s.
REMINDER: MagnaChip is extremely volatile and is best suited for high-risk investors willing to accept a high level of stock price volatility.