In the Q4 2023 issue of Hidden Value Stocks, Adam Buckstein shared his thesis for Israel-based Silicom Ltd (NASDAQ:SILC), a hardware manufacturer that makes networking and data infrastructure solutions. Silicom stock has tumbled 17% year to date and is off 15% over the past year. Nonetheless, Buckstein remains as bullish as ever, citing a return to growth as the foundation for his thesis.
Silicom announces design win
Silicom's solutions are aimed at boosting performance and efficiency in data centers and cloud environments. They're used as components in the infrastructures of major cloud companies, service providers, and telecom companies and in the infrastructure offerings of manufacturers.
Silicom announced a design win in December. At the full run rate, the design win is expected to reach $3 million to $4 million a year and lead to additional significant design wins going forward. It also should play a role in the turnaround Buckstein continues to forecast.
"The relationship we have built with this networking leader, with initial discussions leading step by step to their standardization on our products and the potential for future collaborations, confirms that our renewed sales strategy is working," Silicom CEO Liron Eizenman said in a statement. "It shows the value of the range of our products, the innovation of our concepts, and the rock-solid reliability of our delivery."
Israeli stocks
Of course, Israeli stocks in general had a challenging time in 2023 due to higher interest rates, controversial judicial reform and the war in Gaza. A year ago, Buckstein said he felt the relative underperformance of Israeli stocks created select opportunities like Silicom, which he had been following since 2008, when he first saw it on a screen.
More recently, things have started to look up as the Israeli stock market has thus far outperformed its peers, with the Tel Aviv Stock Exchange appreciating 27% year to date and on track to end the year with one of the best returns among global markets.
Many Israeli stocks trading on the U.S. stock exchanges have also roared higher, with names like Check Point Software popping 24% year to date. On the other hand, some Israeli names have not, like Mobileye, which has plummeted 58% year to date.
A year ago
Last year, Buckstein noted that despite the current challenges, Silicom had 18 years of continuous profitability and 22 straight quarters of on-track quarterly guidance with no misses. He added that there was a nice margin of safety and the potential for sizable upside with a return to growth. At the time, Silicom was also aggressively downsizing, having slashed its workforce from 310 to 240 employees.
"Bottom line: this is a turnaround story that is checking all the right boxes," Buckstein said in the year-ago issue of Hidden Value Stocks. "Aggressive buyback, Fort Knox balance sheet, aggressive cost-cutting, no debt. Lastly, there is a line of sight in the medium term for improvement in revenue/ earnings momentum, as well as a longer-term EPS target that makes the current stock appear ridiculously cheap."
Buckstein’s updated thesis
Today, Buckstein sees downside protection for Silicom, noting that the company has an $83 million market capitalization with $78 million in cash, giving it an enterprise value of around $5 million.
"At the current run-rate of $60 million in revenue, they are going to burn about $15 million next year, so on an adjusted basis, you are paying around a $20 million EV," he told Hedge Fund Alpha recently. "During the first three quarters of 2024, they repurchased more than half a million shares out of a total share count of 5.9 million. At around ~$14/share, you aren't paying a lot for the chance that they can hit their long-term guidance that was laid out on the Q3 24 conference call."
On that call, Silicom management said they are continuing to focus on reaching more than $3 per share in earnings as their revenues rise back to $150 million to $160 million per year. They also reported that they have "right-sized" their expenses, "investing as needed to achieve our strategic targets while retaining tight control of our outlays."
Inventory overhang nearing its end?
A key challenge for Silicom last year was a major inventory correction, meaning suppliers over-ordered between 2020 and 2022 because of the supply-chain chaos linked to the COVID-19 pandemic. As a result, they were working through that excess inventory and continued to do so in 2024. Buckstein did warn investors that the inventory overhang would continue to depress the company's performance in 2024.
However, Silicom could be poised for a breakout, as management said last year that things would turn back around in early 2025. In Q3 2024, they updated that comment, saying they expect an improvement in the inventory overhang in the second half of 2025 with a resolution by the end of the year.
"Given the company's historical profitability and steady progress in working through their customers' excess inventory, there's a good chance Silicom will generate great returns from here," Buckstein concluded.
Downside protection
Despite the drop in Silicom's shares over the past year, Buckstein observed downside protection in his thesis last year, saying that the stock was still trading "almost like a Ben Graham net-net." In addition to the cash, accounts receivable and inventory, Buckstein said Silicom's main downside protection is its long-term customer relationships.
Further, given the company's strong cash position, it also continues to buy back shares despite being (temporarily) unprofitable. On the Q4 2024 conference call, Silicom management announced plans to repurchase 1.6 million shares over the following two years, representing 24% of the outstanding shares.
They've been making good on that promise too, repurchasing half a million shares in the latest quarter, as mentioned above.
