What do you do when you can’t find attractively-priced assets in one market? Try other markets. I’ve lamented the “too far too fast” performance of U.S. semiconductor stocks, but I’ve found some interesting ideas in other places – Renesas (OTCPK:RNECY) in Japan and Dialog (OTCPK:DLGNF) in Europe. While I thought Dialog’s valuation was “just okay” more than a year ago, around the time the company came to an agreement with Apple (AAPL) on its main PMIC business, the shares have noticeably lagged the SOX index since then, despite reasonably good performance.
To be sure, Dialog has work to do. The company has done very well winning new power business with Apple, but progress on non-Apple diversification and growth projects has been more mixed. While I see opportunities in areas like auto PMIC, high-voltage PMICs, and industrial IoT, I need to see actual execution here, and I think that’s a major key to unlocking more value in the market. As is, though, I believe Dialog is meaningfully undervalued on the basis of low-single-digit revenue growth and operating margins around 20%.
Respectable Results For The Second Quarter
Guidance has been a bit of a roller coaster at Dialog, with the company posting some recent beats, then pulling guidance due to COVID-19, then boosting guidance again. However they got there, second quarter results were solid versus expectations, with a 4% revenue beat, a 17% operating profit beat, and a double-digit boost to third quarter revenue guidance.
Revenue fell 10% yoy this quarter, but rose almost 22%, beating expectations by 4%, as the company outperformed on a core basis and added acquired revenue into the mix. The Custom Mixed Signal (or CMS) business declined 15% yoy and rose 22% qoq, beating by 9% and continuing a long run of beats. While main PMIC business with Apple continues to erode (they haven’t had content in the iPhone 11 or subsequent phones), declining 36% yoy, the company continues to benefit from wins in the sub-PMIC business (up 19%).
The Connectivity & Audio (C&A) business saw a 7% yoy revenue decline and a 27% qoq improvement, missing by 10%. The Advanced Mixed Signal (or AMS) business fell 1% yoy and rose 22% qoq, missing by 4%. Misses in these businesses have been commonplace over the last year, as the company continues to struggle to gain real traction outside of its relationship with Apple.
Gross margin improved almost a point from the prior year and about 20bp qoq; the main surprise here was that the company didn’t beat, as it had established a good run of quarterly beats. Operating income fell 24% yoy and jumped 89% qoq, beating expectations by 17%. Margin fell 380bp yoy and rose 730bp qoq.
Apple Continues To Drive Growth
The market was understandably freaked out when Apple decided to in-source the main PMICs for its phones, as that had been a huge part of Dialog’s business. Since then, though, the decline in the main PMIC business has been slower than expected, and Dialog has done a better than expected job of wining sub-PMIC business throughout the Apple ecosystem.
Not only is the company benefitting from Apple including more sub-PMICs in phones (they’re a battery-efficient way of powering dedicated hardware like face ID modules), but they’ve also won business in other products like AirPods. On top of that, the company recently won the battery management socket for the ’21 iPhone, adding to a string of wins with other phone OEMs. All told, management believes this could be a $250M business in 2023 that really wasn’t expected even a year ago.
… But The Non-Apple Business Needs Work
Dialog hasn’t had any meaningful success winning sub-PMIC business with other phone OEMs, and time will tell if the company can win meaningful business outside of its AC/DC charging and battery management segments (part of the AMS business).
I’ve also been disappointed at the lack of progress in the company’s IoT ventures despite a strong market position in Bluetooth-Low Energy chips. As I mentioned in the past, I thought the company’s lack of a more complete offering (including MCUs) was a limiting issue, and that may well be why the company has continued to underwhelm relative to other IoT-focused players like Silicon Laboratories (SLAB).
The company isn’t giving up, though. The company has made multiple acquisitions aimed largely at improving its position in IoT (industrial IoT in particular), including Creative Chips, FCI, and the most recent acquisition of Adesto. Dialog has struggled to maximize the value of past deals (Silego and arguably iWatt), though, so the jury is very much out as to whether Adesto’s capabilities in connectivity and embedded memory will shift the story.
On a more promising note, the company is working to leverage its existing technology into other addressable markets. The company doesn’t have a large presence in the auto market, but it has formed partnerships with Xilinx (XLNX) and Renesas to leverage its capabilities in power management. I’m particularly interested in the opportunities for Dialog to leverage PMIC/sub-PMIC chips into the driver safety/ADAS and auto infotainment areas. This is an area of strength for Renesas (including some large recent wins), and while Renesas is very strong in MCUs, they’re not very strong in power management. Not only do I see a meaningful potential opportunity for Dialog in auto ADAS/infotainment PMICs, but I wonder if there could be additional collaboration on IoT, as Dialog has good connectivity and power assets, but lacks MCU and sensor capabilities, and that’s an area where Renesas is strong.
I don’t model Dialog with an expectation of a significant inflection in IoT or auto, but those could be sources of longer-term upside. For now, I model Dialog largely on the basis of its sub-PMIC business, its audio businesses, and its charging/battery management assets, as well as the revenue coming in from Adesto in IoT (whether Adesto’s assets can be effectively combined with the other IoT assets to drive even stronger growth is yet to be determined). With headwinds from the main PMIC business, I’m only expecting low single-digit revenue growth from Dialog, but I believe the company can drive operating margins above 20% and generate mid-to-high teens FCF margins, supporting low-to-mid single-digit FCF growth.
The Bottom Line
Discounted cash flow suggests Dialog is priced for double-digit annualized returns, and I don’t think my revenue or margin assumptions are particularly aggressive. Dialog also looks meaningfully undervalued on the basis of its near-term gross and operating margins; there’s usually a pretty tight relationship between semiconductor margins and valuation multiples, but Dialog trades well below the norms. I can understand investor frustration with management’s slow progress growing the non-Apple business, and the risk of making more value-destroying acquisitions, but I believe today’s valuation is too low for a company leveraged to some meaningful near-term content growth trends and with longer-term potential upside in IoT and auto.
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.