ISSI fishing for success in chip business

Benj Gallander and Ben Stadelmann
Tuesday, April 3, 2012

Benj took a trip to California this month to check out the turf of some of the companies in his stable and others of interest. No, Apple was not amongst them, but perhaps if they offered tours it would have been. The three that are in the President’s Portfolio are Bank of Commerce Holdings, Integrated Silicon Solutions and Yahoo! The one where he really gained additional knowledge was ISSI.

Integrated has been a Contra holding since 2008, when it was acquired at $5.76. Only briefly in April 2010 did this designer and marketer of circuits stock trade higher than the current share price of better than $11. Other than that, there have been a number of up and downs and lots of time kind of rolling over and playing dead.

However, the time might be nearing where a surge could push the shares to the Initial Sell Target of $18.89. CFO John Cobb, who has been with the company for four years, explained to Benj the major changes undertaken. He talked about how, a few years ago, the enterprise had about three-quarters of its 400 workers in California. Only 60 remain in that state, and a major reason is that state’s tax regime.

The system is partially based on the percentage of the enterprise’s employees residing in the state — the higher the percentage, the more taxes California demands. The tax levy of about 39 percent is not particularly attractive, especially given the other jurisdictions in which ISSI operates, which include China, with a rate of 25 percent, and Taiwan, Singapore and Hong Kong, sitting at about 17 percent. That makes those locales more tax-efficient for a profitable company.

Previously, ISSI was more concerned about making money than paying taxes, as losses were the norm. In 2006 the company decided a major corporate revamp was necessary; competing with the big boys had proven unfeasible. Quite simply, the cost structure at this outfit did not allow for the same economies of scale.

Recognizing this after losses in 2005 and 2006, management decided that, rather than going head to head with the goliaths, the enterprise would move to become a niche player and focus on, as Cobb stated, “high gross margin and legacy markets.” This meant a shift to fabless semiconductors, where the competition was less fierce and capital costs were much lower.

Results were not immediate, as two of the next three years were losers, but finally, in 2010, EPS sparkled at $1.56 per share; in 2011 it was even better, at $1.98. That has been eating up the tax-loss carry-forwards, which are just about exhausted.

While flat revenues are projected this year, 2013 is looking much brighter. Samsung is in the process of withdrawing from a $200 million SRAM market, opening a further opportunity for ISSI. Micron is also exiting some markets, creating additional opportunities. Both of these could easily provide seven to ten years of sales. Plus, Integrated is partnering with the latter on one of the most advanced DRAM products, which should boost both revenue and the bottom line.

Currently, revenues are at the $270 million level. The corporation boasts $94 million in cash, and no debt. Cash flow was positive even in the lean years, bottoming at $2.6 million in 2006 and pirouetting to $30.6 million in 2011.

Surprisingly, while institutional ownership is a robust 76 percent, insiders hold less than 1.5 percent. Recently, insiders have been selling more than we like to see, but one individual is selling because of that old bugaboo: divorce.

When asked about the possibility of ISSI vacating California altogether, Cobb did not think it was a possibility. “It is hard to replicate Silicon Valley,” he said. “There is lots of new blood, new thinking, and diversity here. People are easily accepted.”

But he did note that Apple has decided to expand its presence in Texas instead of his state, and he is convinced that the regulatory environment and taxes are two reasons why AAPL chose the Lone Star State for its new $304 million campus.

As he further noted, “It has become pretty easy to do business in other places and avoid the regulation of California. In most other countries, the company would not have to comply with regulations on light bulbs. Or have to put on the website something about not dealing with suppliers involved in slavery. That takes time and legal fees.”

But even as Integrated has scaled back in California, the Golden State will remain its home. And there is an excellent probability that this company will prosper in America’s most populous state.