Sell-Off Provides Opportunity to Buy Best-In-Breed Semiconductor Company

The recent sell-off in printed circuit board manufacturer TTM Technologies is most likely due to the company's upcoming $220 million convertible bond offering.

However, any potential dilutive impact is reduced by hedging. Moreover, management intends to use a majority of the net proceeds to repurchase approximately $131.6 million of its 3.25% convertible notes due in 2015. This refinancing results in a lower interest rate and extended maturity.

TTM Technologies has three competitive advantages that should enable it to benefit from growing end-user demand. First, it has an extremely diverse customer base in multiple fast-growing industries such as networking, tablets, and smartphones. For example, market research company IDC projects annual smartphone and tablet unit growth of 20.5% and 29.8%, respectively, through 2016.

Second, its one-stop manufacturing solutions (e.g., engineering support, prototype development, and production) allows customers to bring products to market faster, and reduces the number of service providers used. As a result, it can steal market share from companies without these capabilities and gain valuable long-term customer relationships.

Third, the company's ability to rapidly respond to increasing demand for improved component performance and deliver custom-fabricated printed circuit boards in a short time period provides strong pricing power and cross-selling opportunities. For example, in the quarter ended in September, revenue (excluding the sale of a plant in China) rose 8% sequentially, driven by high demand for smartphones and tablets as well as higher average selling prices. Net income rose 51%.

Going forward, there are three value drivers. First, a lower cost structure resulting from the closure of an unprofitable manufacturing plant and a 50% decrease in Asian Pacific labor expense should drive margin expansion.

Second, the sale of a plant that manufactured conventional printed circuit boards generated $85 million, and provides greater exposure to the fast-growing advanced technology printed circuit board market.

Third, a large manufacturing presence in China should enable the company to benefit from the projected ~60% of global printed circuit board production that will be generated from China, Hong Kong, and Taiwan next year, according to N.T. Information.

Peer comp
TTM Technologies compares favorably to its closest domestic competitors, Viasystems and Sanmina on multiple levels, as shown in the chart below.

Source: SEC filings, based on trailing 12 months.

Although TTM Technologies has a relatively higher debt load than Sanmina, the margin is almost three times higher, which deserves a significantly higher valuation, rather than a slight discount.

Moreover, TTM Technologies is even cheaper than Viasystems, despite a modestly higher margin and significantly lower debt. The benefit of a low debt load should not be overlooked, given that the industry is highly cyclical with high fixed costs, which results in a higher than normal degree of financial risk.

Although both TTM Technologies and Viasystems reported the same 8% sequential revenue growth in the quarter ended in September, there were several negative factors. First, Viasystems claimed ongoing budget issues negatively affected its military and aerospace market. However, TTM Technologies actually benefited from its exposure to this market and expects stable fourth-quarter revenue. This highlights the fact that not all companies in an industry are affected in a similar manner by an overriding factor. The strongest companies maintain or grow market share during challenging times. Second, although EBITDA for Viasystems rose 7% sequentially, the margin contracted 20 basis points to 10.6%, while EBITDA for TTM Technologies rose 8%, and the margin expanded 90 basis points to 12.5%.

Sanmina projected lower than expected revenue and earnings for the upcoming quarter due to seasonality and a slower-than-expected ramp up of new programs. However, TTM Technologies reported increased revenue due to strong seasonal demand for printed circuit boards used in tablets. Again, just because one company is struggling with a particular issue does not necessarily mean everyone else is, too.

Although there is opportunity here, there are also industry and firm-specific risks. The industry is highly cyclical with intense competition, has high fixed costs, and is dependent on global end-user demand for electronics, which would most likely decline in a period of lower economic growth.

The industry is also subject to rapid technological change, which results in low visibility and requires continual investment in new production processes if companies are to remain competitive.

In addition, TTM Technologies has a high debt load of approximately $545 million.

Bottom line
While many investors hope for pullbacks in their favorite stocks, the pullback always seems to overshadow the longer-term positive outlook. Investors should focus on fundamentals like low valuation, wide moats, and growing demand, while placing less emphasis on short-term fluctuations.

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