Cheap, big margins, niche, growth, industry leading, aligned management and clean B/Sheet

Manna from Heaven?

NEW IDEA! This idea was sourced from a screen we built and since then I’ve only found 2 people on X talking about this…

Disclosure I and others I advise own equity in this business and nothing here should be taken as investment advice.

Summary

I think this business is worth at least 3x what it currently trades for (21st March 2024) and that’s on conservative estimates, with much lower future growth. Catalyst for value is likely to be growth in earnings or time, but could be taken out via M&A (no special insight on this).

About the business

Qualitau (QLTU) tests semiconductors to check for faults, using in-house patient protected machinery and class leading service staff. Their main operations are based in USA and serve the largest chip manufacturers in the world. They are listed on the TASE in Tel Aviv and founded and run by an Israeli team.

I see it as a picks and shovels play at the growth in chip requirements as the digital age takes hold. They provide testing units/ equipment that is patient protected, and the servicing and testing itself with highly trained technicians.

Why I like it

It’s cheap, fast growing, has big margins, a long runway for growth, operates in a niche market with few competitors, and has industry leading products and services.

Growing revenues 29% and 41% for FY21 and FY22 respectively.

Operating margins 20% and 35% for FY21 and FY22 respectively.

Trades at c. 8 P/E and cash adjusted c. 6.5 P/E, so is exceptionally cheap for a growing business with high margins and clean balance sheet.

It has net cash of $20m and market cap of c. USD90m, so very strong credit position.

In FY22 it had $28m in back order of business.

Big industry tailwinds with growth in semiconductors, which is what has fuelled the recent revenue growth.

It is a well run business with a long track record and aligned management.

Small market cap ($90m) and therefore big potential to grow and receive multiple expansion as it gets recognised by institutional investors.

Why I suspect it’s cheap

Flown under radar after decades of poor performance - The company has been listed since early 2000’s when it was spending a lot on R&D and marketing, making the net margins very low. Then it went through a period of much lower revenues until 2018, when demand for semiconductors started to increase again. It’s only in the last 5 years that operating margins have been much higher and revenue has been growing quickly. Growth and high margins are relatively new for this business. So it may be flying under the radar in that sense. Although high margins and growth look set to continue as R&D is much lower consistently and they don’t need to spend as much on marketing and sales, given they are already established with their main customers and most of sales are driven by in-house relationships.

Small market cap in a niche area - With a market cap of $90m currently and only $40m in Jan 2023, and $20m in 2020, it was far too small to be of interest to institutional investors and even most retail investors. This is because it’s not possible for a large fund to take a meaningfully large position size and difficulties around liquidity of shares. So this is a recent growth story and is only now becoming a size that will attract interest from larger investors. Volume of shares traded has meaningfully increased since 2021 and in particular in 2023.

Israeli - Not only is it listed on the TASE Israeli stock market, all it’s annual reports are in Hebrew with no translation available. We have translated their annual reports, but suspect both location and language barrier puts a lot of people off. (You can by Israeli stock via IBKR and other brokers, but some don’t allow it). TASE equities are underflowed generally. There are no analysts following Qualitau, and I’ve only found one writeup online by a well respected Israeli fund manager who also own’s a stake.

Downsides

Contract terms - The contracts it has with it’s customers are reviewable annually and have no exit costs. So it would be easier for customers to switch providers if they wanted. However they are unlikely to switch based on price for two reasons. The quality of testing is class leading and it’s worth paying up for the best testing. And the proportion of spend on testing vs the overall size of the semiconductors revenues is insignificant - we’re talking a few million for testing equipment generating billions in revenues for the business. So the main risk of customer loss is due to another business producing a significantly better offering. However the testing technology is not fast changing so this is unlikely, and Qualitau has a huge number of patients. The other mitigating factor is that the staff running the testing are far better trained that the rest of the industry, and the research team are world leading with very high salaries and equity to retain these key staff members.

Competition - Their largest competitor is FormFactor a large listed US business who acquired a couple of small semiconductor testing businesses over the last decade. They have full testing capability. It’s not clear what size of the market they have and I’m unclear what size of the market Qualitau has as well. FormFactor directly compete with Qualitau. The other competition are much smaller and more regional. Chiron is another business that has full testing capability, but focuses on Asia markets and hasn’t directly competed with Qualitau for any business recently. There are 3 or 4 other firms with some testing capabilities and focus on more regional areas.

From Qualitau’s FY22 Report: “To the best of the company’s knowledge, Qualitau has an advantage over its competitors in terms of technical knowledge it possesses, the variety of its products and the services it can offer in its field of activity, as well as in the array and ability of distribution, marketing and the specifications of the applications included in its products. However to the best of Qualitau’s knowledge, each of the main competitors described above has considerable financial resources and financial support from wealthy parties, so that despite Qualitau’s advantages, the company’s management treats its competitors very seriously.”

Cyclical - Semiconductors are a cyclical business. I personally believe we are in the midst of a big up cycle which looks set to continue. This is driven by the Automotive, data centres, IoT etc. which all have huge chip requirements.

China / Asia - A large portion of the revenue comes from China and Asia. However Qualitau have their main base in the USA. And they also provide services and equipment to EU. Reshoring of chip manufacturing in the US should prove a nice tailwind as more companies will require testing.

Valuation:

Given the rates of growth valuation will be very subjective as to normalised values. I’ve used a range of valuation methods to triangulate the fair value.

I used Greenwald’s EPV methods and also a DCF. I get fair value to be around $250 to $350m. Currently trading at $90m.

End

I’ll leave it for you to do your own research but I hope this has been a nice little intro to a business that you’ve never heard about.

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Thanks,

Joe and Swapnil

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@Joevalue and @swapnil00456809

Swapnil Singh

Disclosure I and others I advise own equity in this business and nothing here should be taken as investment advice.