Is Globetronics a value trap?

Value Investing Case Study 73-1: A fundamental analysis of Globetronics Technology Bhd showed that it is undergoing a turnaround. But it needs to rediscover its product development mojo to deliver the turnaround.

In the fast-paced world of technology, companies rise and fall with remarkable speed. Few stories capture this tension better than that of Globetronics Technology Berhad (Globetronics or the Group).

Founded in 1991, the company soared to new heights, becoming a prominent player in the Malaysian semiconductor industry. But fast forward to today, and the narrative has shifted dramatically.

With a decade of declining revenues and increasing competition, one must ask: Is Globetronics poised for a triumphant revival, or is it trapped in a cycle of stagnation? The Group is undergoing a turnaround.

In this article, I will exploring Globetronics meteoric rise, the challenges it faces, and the critical factors that could determine its future. Join me as I uncover whether Globetronics can reclaim its former glory or it is destined to become just another cautionary tale in the tech world.

Sad to say, to turn around its performance, the Group needs to re-discover its ability to develop products that would be in great demand in the next 5 years. The jury is still out on whether management can do this.

Should you go and buy it? Well, read my Disclaimer.

Company background

Operating performance

Financial position

Valuation

Conclusion

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Company background

Globetronics was started in 1991 by 2 entrepreneurs to provide integrated circuit burn-in services. It quickly grew and was listed on Bursa Malaysia in 1997. Today, the Group designs, manufactures, and distributes semiconductor-based products and services. These products cover:

Semiconductor Devices. The Group produces a variety of semiconductor components, including light-emitting diodes (LEDs) and sensor devices.

Optoelectronic Products. This includes high-performance LEDs used in various applications such as automotive lighting and general illumination.

Microelectromechanical Systems (MEMS). The Group develops MEMS devices for applications in consumer electronics and automotive sectors.

Integrated Circuits (ICs). Globetronics manufactures ICs that are essential for various electronic applications.

The products are used in various industries, including consumer electronics, automotive, industrial automation and medical devices,

One of the key characteristics of the semiconductor sector is continuous new product development due to rapid technological advancements. This is acknowledged by the company as exemplified by the following:

“…over the last five years or so…engaging ourselves in the energy-saving…LED-lighting market and ICT markets with crystal-devices…” 2010 Annual Report

“…into the next five years…the growth areas…products/components that support smartphones, medical electronics, automotive, tablets… wearable wireless products...” 2013 Annual Report

“…Group’s major product platforms were transitioning from their matured platforms into their next generation platforms...” 2016 Annual Report

“…successfully developing and ramping new sensors…pursued…third-generation light sensors, bio/environment sensors, 5G telecommunication module…” 2019 Annual Report

“…launched a new generation of light sensor and gesture sensor…expect…expansion…into new applications of augmented / virtual reality, wearable devices, LED…” 2022 Annual Report.

As I will point out later, Globetronics' revenue decline over the past decade can be traced to not being able to develop enough new products that match the changing technology landscape.

Operating performance

Globetronics experienced declining performance over the past 12 years. Refer to the left part of Chart 1.

Revenue declined at a compounded annual rate of 6.9 % with a corresponding 4.0 % compounded annual decline in the PAT.

Gross profitability (gross profit/total assets) declined from an average of 24 % in 2012/13 to an average of 19 % in 2022/23.

Globetronics’ revenue decline is in contrast to the growing revenue from the global semiconductor industry as illustrated in the right part of Chart 1. If nothing else, it meant that Globetronics lost market share.

Chart 1: Performance Index and Semi-conductor industry revenue

You can see that the Group experienced 3 revenue dips – 2016, 2019 and 2023. These are in line with the declines in the worldwide semiconductor revenue. According to POE, these declines were due to global economic conditions, market dynamics, and geopolitical influences.

2016

Market Saturation: The smartphone market, a major driver of semiconductor demand, experienced saturation, leading to decreased sales and reduced demand for chips.

Inventory Corrections: Many companies faced excess inventory from previous years, prompting cuts in semiconductor orders to balance supply and demand.

Economic Slowdown: A slowdown in global economic growth, particularly in key markets like China, contributed to reduced consumer spending on electronics.

2019

Trade Tensions: Ongoing U.S.-China trade tensions created uncertainty, impacting business investments and consumer confidence, which in turn affected semiconductor demand.

Weakness in Key Markets: The downturn in the smartphone market continued, alongside sluggish demand in other sectors like personal computers and data centres.

Inventory Adjustments: Companies continued to adjust inventories in response to previous overproduction, leading to reduced orders for semiconductors.

2023

Post-Pandemic Adjustments: Following significant growth during the COVID-19 pandemic, demand normalized as consumers returned to pre-pandemic purchasing patterns, leading to a drop in semiconductor sales.

Economic Uncertainty: Rising inflation and interest rates created a challenging economic environment, leading to decreased consumer spending and reduced investment by businesses.

Geopolitical Factors: Ongoing geopolitical tensions and supply chain disruptions, particularly related to China, affected market stability and semiconductor supply.

Technological Transition: As industries transition to new technologies (e.g., AI, 5G), there may be temporary lags in demand for existing semiconductor products.

But as can be seen from the right part of Chart 1, the revenue for the global semiconductor industry recovered the year following each decline and continued on its growth path.

While Globetronics also recovered in the respective following year, there was an overall declining trend. I posit that this was due to its failure to develop new products that matched customers’ expectations.

The key challenge in valuing Globetronics then is figuring out whether it has found a way to address the decade-long poor product development trend.

Returns

Despite the declining profits, the return picture did not look too bad. Refer to the left part of Chart 2.

Except for the 2016/7 dip, both the 2023 ROIC and CFROIC were better than those in 2012.

The ROE in 2023 was worse than that in 2012. The discrepancy between the ROE and ROIC and CROIC was due to the tax rate. 2023 was the end of the pioneer status for the sensor subsidiary. As such the 2023 effective tax rate was 22.1 % compared to the 2019-2022 average effective tax rate of 5.3 %.

The other positive sign can be seen from the right part of Chart 2. The contribution margin post-2019 seemed to be higher than those before 2019. There are several reasons for this:

The Group embarked on its Industry 4.0 Implementation Plan in 2019 “…to achieve manufacturing excellence…to further automate, link and use live data to improve further the efficiency of our operations.”

In 2019 the Group also conducted “an operational efficiency review on one of its production lines and this resulted in changes in the expected usage of certain plant and equipment…” The effect is a reduction in the depreciation expenses for 2022 to 2024.

In 2020, the Group invested in the “…latest technologies to achieve a fully automated or “lights off” factory for some of our key product lines within the next three years.”

Chart 2: Returns and Operating Profit

Note to Op Profit Profile. I broke down the operating profits into fixed costs and variable costs.

Fixed cost = SGA, Depreciation & Amortization and Others.
Variable cost = Cost of Sales – Depreciation & Amortization.
Contribution = Revenue – Variable Cost.
Contribution margin = Contribution/Revenue.

Efficiencies

Given the focus on productivity/efficiency, there was an improvement in the gross profit margin from an average of 26% in 2012/13 to 40% in 2022/23. This is reflected in the improving contribution margin stated earlier.

But when I looked at other capital and operating efficiencies metrics, there were mixed results. Refer to Chart 3.

Operating efficiencies. While the operating profit margin improved, the operating expense ratio got worse. But this could be due to declining revenue. Inventory turnover improved from 2012 to 2020 but then declined so that the 2023 value was just a bit better than that in 2022.

Capital efficiencies post-2018. Unlike operating efficiencies with mixed results, there were no improvements in all 4 capital efficiency metrics.

Chart 3: Operating and Capital Efficiency Trends

While improving operating efficiency is positive, a decline in capital efficiency suggests that the company may need to rethink its investment strategies and ensure that its capital is working effectively to support its operational goals.

Deteriorating capital efficiency, despite operational improvements, can signal potential financial instability, making it critical for the company to address these issues to avoid future challenges.

Peer comparison

As of Sep 2024, there are 18 Bursa companies in the semiconductor sector. To identify the peers for comparison, I selected the main board companies with 2012 revenue similar to that of Globetronics. These are listed in Table 1.

Only one company – Unisem – had a bigger revenue than Globetronics in 2012. But by 2023, Globetronics was ranked the smallest in terms of revenue. Over the past 12 years, only Globetronics had a revenue decline.

Table 1: Peers

I looked at the trends of 4 metrics to get a sense of how well Globetronics performed compared to its peers – return on capital, EBIT margin, Free Cash Flow margin, and EPS. Refer to Charts 4 and 5.

Overall, while Globetronics demonstrated strong early performance in key financial metrics, recent trends indicate a decline in return on capital and EPS performance. The ability to maintain EBIT margins and leverage free cash flow suggests some operational resilience, but the challenges faced in the last two years are of some concern.

Globetronics had the better return on capital and EBIT margin in the early part of the past 12 years. But while its return on capital declined to be the average as time went by, it seemed to be able to maintain its EBIT margin position.

Except for 2019, Globetronics was among the better performers when it came to levered Free Cash Flow margin.

Globetronics was also one of the better EPS performers in the early part of the past 12 years. But it became one of the worst performers over the past 2 years.

Chart 4: Bursa Peer Return on Capital and EBIT Margin

Chart 5: Bursa Peer Levered Free Cash Flow Margin and EPS

Financial position

I would rate Globetronics as financially sound.

As of Jun 2024, it had RM 145 million cash. This is equal to 44 % of its total assets. It did not have any borrowings.

Over the past 12 years, it generated positive cash flow from operations every year. During this period, it generated RM 918 million cash flow from operations compared to the total PAT of RM 597 million. This is a very good cash flow conversion ratio.

From 2012 to 20243, it had a negative Reinvestment. I defined Reinvestment = CAPEX + Acquisition – Depreciation & Amortization + increase in Net Working Capital. The negative value implies that the amount spent on CAPEX and/or the increase in Net Working Capital was smaller than the Depreciation & Amortization. This is a good position as it meant that the company did not have to allocate funds to support its growth.

It had a good capital allocation plan. Refer to Table 2. The cash flow from operations was sufficient to fund its CAPEX and the excess was returned to shareholders as dividends.

Table 2: Sources and Uses of Funds 2012 to 2023

Valuation

This is a Group that needs to turn around its product development efforts to generate products that will enable it to grow its revenue.

Thus, in valuing Globetronics, I looked at 2 Scenarios.

Scenario 1. This is a conservative approach where the Group’s revenue and operating performance would remain at the 2023 level. I assumed that revenue would grow at 4% and the contribution margin and capital efficiency (revenue/total capital employed) would be the 2019 to 2023 averages.

Scenario 2. I assumed that the company would be able to turn around and continue to develop products that its customers want. I assumed that the revenue would be the average 2019 to 2023 revenue and grow at 4%. However, because of the higher revenue, the margins and capital efficiencies would decline to the average 2012 to 2023 level.

In both cases, I assumed that without the pioneer status, the tax rate would be the nominal rate of 24%.

Table 3 summarizes the intrinsic values compared to the market price of RM 0.61 per share. You can see that there is only a margin of safety under Scenario 2.

Note that under both Scenarios, cash accounted for about RM 0.22 per share of the value.

Table 3: Valuation Summary

Notes

a) 2023 revenue. Others are average 2019 to 2023.

b) 2019 to 2023 average revenue. Others are average 2012 to 2023.

Valuation model

In valuing Globetronics, I based it on the operating profit model shown in the right part of Chart 2. I valued it based on the single-stage Free Cash Flow to the Firm model.

FCFF = EBIT(1 – t) X (1 – Reinvestment rate)

EBIT = Revenue X Contribution margin – Fixed cost.

Value to the firm = FCFF X (1 + g) / (WACC – g)

Reinvestment rate was based on the fundamental growth equation of g = Return X Reinvestment rate.

Table 4 illustrates the calculation under Scenario 2. The WACC was based on the first-page result of a Google search for the term “Globetronics WACC” as shown in Table 5.

Table 4: Sample calculation – Scenario 2

Table 5: Estimating the cost of funds

Case Notes

According to Damodaran, intrinsic valuation typically assumes a company is a "going concern." This means that the company is expected to continue operating indefinitely. This assumption underpins most valuation models, which rely on future cash flows and growth expectations.

If there is a risk of failure, we cannot use the DCF method to account for it. He opined that one way to account for the risk of failure in a realistic manner is to estimate the value of bankruptcy. Then assign a probability to this and compute the value of the company as a weighted average value of a going concern and a failed business.

This perspective is particularly important in volatile industries or for companies facing significant challenges. What Damodaran suggested for risky companies is not a common practice.

What is wrongly done is to use a higher discount rate or reduce the cash flows.

If you are a newbie and looking at what others have done, it is useful to have some basic “theory” first. This will ensure that you do not follow the wrong approach.

As you can see, fundamental analysis requires expertise and time. That is why I created the Fundamental Mapper to shortcut the process. Download the Fundamental Mapper app now on Xifu to get investment insights into Bursa Malaysia companies.

Risks and limitations

One of the features of the tech sector is the short product life cycle. As such there is a need for continuous innovation and product development.

Based on what was reported in its 2010 annual report, the Group has to plan 5 years. Unfortunately, there is no guarantee that there will be great demand for the new products when they come on stream.

Globetronics revenue over the past 2 decades peaked in 2013. Until then, Globetronics seemed able to come up with products to enable it to grow its revenue.

I have posited that the revenue decline post-2013 is because it seemed to have lost this "mojo".

All tech companies face this changing tech issue. The difficulty is determining whether the Group is going the way of Nokia and Yahoo. Or will it be an analogy of Apple following the return of Steve Jobs?

The margin of safety under the 2 Scenarios reflects these 2 views. It is a qualitative challenge.

I am not sure whether management would be able to tell as well.

Reading the various annual reports, I get the impression that the Group's fabulous performance before 2010 was due to the then "7-star CEO, Dato Heng" (Source: 2020 Annual Report).

But was also the same CEO that saw the declining revenue. Dato Heng retired in 2021 and the CEO position was taken over by his daughter.

A younger CEO may have better insights into the products required for a different tech future. But this is conjecture at this stage.

Conclusion

Globetronics needs a turnaround. But it is more than improving efficiency or productivity. It is about developing products that will generate good demand when the products come on stream in the next 4 to 5 years.

The Group seemed to have been able to do this new product development process a decade ago. Somehow it lost this edge.

If it fails to rediscover this edge it will not be an investment opportunity but a value trap. The only way to avoid being a value trap is for the new CEO to rediscover this product development edge.

I am unable to tell at this stage which way the Group will go. As such while it is financially sound, I will put Globetronics in the "too hard" category and look for other opportunities.

Is this a value trap?

Globetronics has a rich history of innovation and strong market positioning within the semiconductor industry. It has previously successfully ventured into diverse product lines, from semiconductor devices to MEMS.

It has also shown resilience in generating positive cash flows over the years. The company's strategic focus on operational efficiencies, coupled with a solid cash position, reflects its potential to capitalize on future growth opportunities.

However, the persistent decline in revenue over the past decade is a significant red flag. This contrasts sharply with the overall growth trajectory of the semiconductor industry. This decline, coupled with mixed results in capital efficiency, raises concerns about Globetronics' current ability to innovate and adapt.

The valuation scenarios suggest that while there is potential upside under optimistic conditions, significant risks remain. The recent leadership transition and the uncertainty surrounding the new CEO's vision add another layer of complexity.

Ultimately, whether Globetronics is a value trap or an investment opportunity hinges on its ability to rejuvenate its product development strategy and align with market expectations. Until there is strong evidence of this, I would rate it as a value trap.

END

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