Data is the new oil. – Clive Humby
Let us start with a story about Inphi Corporation (IPHI), a global leader in high-speed big-data movement interconnects. In late 2015, when it was a small but growing company, it issued $200 million worth of senior convertible notes due 2020 at a conversion price of approximately $40.16 per share. At that time, its stock price was $29.75 and now, as of August 28, 2020, it is $112.55. In April 2020, when IPHI’s market price was $94.27, it issued 0.75% convertible senior notes due 2025 at a conversion price of approximately $125 – and the current market price is already close to this conversion price.
IPHI is an innovative and creative company that is growing at a rapid pace. Plus, the COVID-19 disruption has worked as a business multiplier and accelerator for the company.
I have been bullish on the whole communications sector since 2019 and still hold the same view. However, IPHI investors need to dig deeper. Here’s my analysis:
IPHI – Robust Business Prospects
IPHI thrives on three verticals – cloud, telecom, and its legacy business. Its cloud business contributed 44% to its Q2 revenues, while telecom contributed 38% and the legacy business 18%. The legacy business will phase out in a few years as technological obsolescence picks up speed.
The business verticals have witnessed exponential growth after the arrival of COVID-19. In Q2 2020, the cloud business grew 10% sequentially and 92% year over year; telecom grew 44% sequentially and 119% year over year; legacy business increased 39% sequentially and 101% year over year. Overall, the total Q2 2020 revenue grew 103% over Q2 2019, helping the company post excellent numbers. In Q2 2020, IPHI reported an EPS of $0.95 beating estimates by $0.29, and revenue of $175.29 million beating estimates by $25 million.
IPHI is not just another semiconductor-cloud-telecom company. IPHI is a niche company whose strength lies in developing semiconductor components and optical subsystems for use in the world of high-speed big-data movement within and between data centers. Their 10G-800G high-speed analog and mixed-signal semiconductor components are supplied to their networking OEM (original equipment manufacturer), optical module, and cloud and telecom service provider customers. And since 5G is the next big thing around the corner, and IPHI’s components are useful in systems required for 5G networks, this can push the company into a much bigger league.
Inphi’s primary data center interconnect partner Microsoft (MSFT) has been making very aggressive moves lately. It is building global data centers in Italy, India, New Zealand, and other countries. It also has won the U.S. defense cloud computing contract of $10 billion. MSFT is now focusing on winning cloud computing contracts for other governments. The IPHI-MSFT partnership can help boost IPHI’s fortunes.
IPHI – The Concerns
1. Insider Sales
Lately, company insiders have sold off small parcels of the stock between $113.35 and $121.90.
There’s more: Ford Tamer, the CEO, and John Edmunds, the CFO, have 10b5-1 plans which they had filed 6-9 months ago. They plan to sell shares in Q3 and Q4 2020 to diversify their personal investment risk. A 10b5-1 plan provides defense against charges of insider trading.
The question is that if the company is going to do great business going forward, why do the CEO and CFO need to diversify their risk?
2. The Chinese Connection
Source: IPHI’s SEC Filing
In Q2 2020, 58% of the company’s revenues came from China, including sales to Huawei. Only 19% of the company’s revenues were earned in the U.S.
The current U.S.-China semi-cold war has the potential to escalate into a full-blown cold war because what’s actually happening these days goes much beyond a trade war – it is a tech war. We cannot predict how it will pan out, but at this point, it doesn’t look good.
IPHI expects competition to intensify from Q3 2020 because alternate solutions will get qualified. It expects sales to normalize from Q3 2020 onwards. The company expects its operating margin to remain flat but its EPS to decline 10% in Q3 2020 on a sequential basis.
IPHI’s business prospects look very robust despite competitors entering the fray from Q3 2020 onwards.
The only niggles are the company’s reliance on China markets, potential U.S.-China cold war, and the forthcoming insider sales in Q3 and Q4 2020.
I do expect problems to be resolved in the medium term but would allocate my capital to IPHI like an ETF allocates its funds to stocks.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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