This research note is provided by Alpha Deal Group LLC. Alpha Deal works for buyside clients on special situation deal intelligence in select regional capital markets on mispriced equity idea generation, deal sourcing and deal networking introductions.
Based in Israel, Silicom Ltd. (SILC.O) makes high-end computer server networking cards for a range of servers and server based systems. Designed primarily to increase data center efficiency, Silicom’s solutions dramatically improve the throughput and availability of networking appliances and other server-based systems. “Connectivity” is the watchword for Silicom’s products. We take a look at whether cloud computing trends and “big data” needs will connect to higher profits for Silicom.
Silicom’s products are used by a large and growing base of OEM customers, many of whom are market leaders, as performance-boosting solutions for their offerings in the Application Delivery, WAN Optimization, Security and other mission-critical segments within the fast-growing virtualization, cloud computing and big data markets.
Silicom’s product portfolio includes multi-port 1/10 Gigabit Ethernet server adapters, Intelligent Bypass solutions, Encryption accelerators and a variety of innovative Smart adapters. These products are available for incorporation directly into their OEM customers’ systems, or provided as part of Silicom’s patented SETAC (Server To Appliance Converter), a unique approach to the provision of high quality standard platforms with modular front connectivity.
In the initial due diligence call with Alpha Deal Group, Silicom Chairman Avi Eizenman said all market leaders are customers of Silicom: “They buy from Silicom every quarter. Having a strategy of serving OEMs successfully really affords us a few benefits. The first benefit is leverage. Whether we sell 100 or 1,000 cards to Cisco, our OPEX remains about the same. So as we grow our revenue, we really grow our operating profits at a faster rate. Our gross profit is 40%, which is quite high, and it has been so for the past 4-5 years. However, at the same time, our operating profit has grown from 15% to about almost 25% right now.”
Chart 1: Comparative ratios for Silicom Ltd.
Source: Eikon/StarMine
Good cash base
The company’s strong market position is equally matched with a strong cash position which provides it with the resources to take advantage of potential strategic acquisition opportunities to continue to accelerate the growth curve of the business. Good cash reserves give the company the ability to acquire key intellectual property toward software-defined network architectures and virtualized cloud-based data centers.
Larger and larger data center servers are increasingly run in these types of virtualized environments, with each server gaining a significant performance advantage with Silicom’s technology. Continued key technology acquisitions and strategic capabilities can significantly increase Silicom’s total addressable market and fuel bigger profit opportunities over the long term.
Chart 2: Valuation Ratios comparing company, industry, sector
Source: Eikon/StarMine
Leveraging partner relationships
Silicom’s continued focus on innovation as well as trusted associations with industry leaders not only ensures leading edge products but also a stable revenue stream as the same players who develop the products with Silicom later buy them.
Further, longer lead times as well as trusted relationships with partners also augurs well for the company. Typically, it takes up to 18 months of collaboration with a customer before a “design win” takes place. Then, up to 12 months lapses before the client’s product reaches the market. Such wait times result in significant barriers to entry for future competitors. Silicom has secured significant “design wins” and established relationships with a significant number of industry leaders. It may be noted that the company is yet to be replaced in any of its relationships by a competitor.
Silicom’s Q3 2013 financial results broke all previous records in revenues, operating income, net income, and earnings per share.
Chart 3: Silicom share trading volume
Source: Eikon/StarMine
Look to the cloud
With the continued proliferation of big data demands for cloud-based data centers and data related services over associated products, Silicom has positioned itself for continued growth. Moreover, Silicom’s association with large scale market leaders also ensures continued innovation and leading edge products which could translate into the sustainable growth of increasingly higher revenue opportunities and higher profit potential for years to come.
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