Alliance Semiconductor: Investing In
A New Economy Asset Play
It doesn't own a single manufacturing plant, but Alliance Semiconductor's total investments in companies that do, top $1 billion. Its equity guarantees supply during lean times when competitors often cry "sold out," and the value of Alliance's portfolio suggests its current price may be undervalued, making it a rare New Economy asset play.
Alliance Semiconductor (NASDAQ : ALSC) supplies memory and logic products to the computing, communications, and consumer industries. Unlike many of its peers, however, Alliance doesn't own fabrication facilities-it's one of a growing number of fabless semiconductor companies that outsource manufacturing. Alliance, instead, chooses to invest in joint ventures that guarantee capacity, while it avoids the enormous costs of building and operating a manufacturing facility. What truly sets Alliance apart, though, is the quality of joint ventures and investments the company has made, including one that resulted in a $532 million after-tax gain in April. Alliance's investments and access to capacity in a time of increasingly short supply recently signaled several top-tier analysts that the time has arrived to invest in Alliance.
Lacking manufacturing facilities of its own, Alliance invests in leading fabrication plants around the world. The company currently holds 340 million shares of Taiwan's United Microelectronics, or UMC, and more than two million shares of Singapore's Chartered Semiconductor (NASDAQ: CHRT). It also has several manufacturing partnerships, including one with an undisclosed domestic foundry. In an interview earlier this week, Needham analyst Tad LaFountain, who recently upgraded Alliance to a 'strong buy', speculated that only two domestic foundries would have the ability and desire to partner with Alliance: privately-held WaferTech, or, more likely, National Semiconductor (NYSE: NSM). Despite industry-wide shortages, Alliance's various partnerships give the company access to enough capacity to grow to a $600-800 million company, management says. At the end of fiscal 2000, Alliance stated that it was using less than 50% of its capacity at UMC, about 80% at Chartered, and 50-60% at the domestic foundry.
"I think one thing's very clear," said LaFountain, and that is management's "ability to make investments is absolutely first rate." In addition to its manufacturing deals, Alliance invests in other leading technology companies. It holds 488,000 shares of Broadcom (NASDAQ: BRCM) and 852,000 shares of Vitesse (NASDAQ: VTSS). Through its three venture capital funds, Alliance has invested in a total of twenty undisclosed companies. All are emerging communications, networking, and Internet ventures. In a May report in which Prudential initiated coverage of Alliance with another 'strong buy', analyst Hans Mosesmann estimated the value of all these private investments at $130 million. Mosesmann also pointed to a hidden benefit: Alliance could potentially incorporate their "exciting intellectual property into its operations."
The market value of Alliance's public and private investments reaches nearly $1.4 billion, yet the company's market cap is only $915 million. Using a "sum of the parts" valuation technique by dividing the value of Alliance's investments by its outstanding shares results in a $33 share price-much higher than Friday's $20-22 range. Several analysts-notably Neil Druker in a recent Barron's article-maintain that Alliance's equity assets mitigate the risk of investing in Alliance. LaFountain, though, pointed out that Alliance's shares in UMC are subject to lock-up period staged over four years. He also noted that because Alliance and other investors own a considerable number of UMC shares, selling by any one of them could drive the share price down. Taking the lock-ups, market volatility, and illiquidity into account, though, Mosesmann assigns a $30 twelve-month price target on Alliance's stock. LaFountain mentioned one further risk associated with Alliance's Taiwan investment, saying, "We're just one Chinese missile launch away from a somewhat dramatic re-valuation of those (UMC) assets." While this week's passage of the China trade bill may herald a new era of Sino-American economic opportunity, investors in this or any other international venture must be alert to the potential downside.
When asked about the biggest challenges Alliance faces this year, LaFountain referenced the rapid pace of change in the semiconductor industry, stating that Alliance must "continuously replenish and refresh their product line, even if they don't go right to the leading edge." To that end, the company dropped its unsuccessful graphics business segment, and began to focus products on the networking, communications, wireless, and electronics end-markets. LaFountain further noted that to succeed, Alliance will have to "marshal some design resources," which could be easier said than done. The semiconductor industry faces the same talent shortage that's plaguing all high-tech sectors. As LaFountain sees it, "if you can spell 'Double-E' (as in electrical engineering), you've got a job offer."
Alliance, too, rates itself a strong buy. In a clear sign that it agrees with analysts who think the stock is undervalued, the Board voted in February to double the company's share repurchase program from two to four million shares. As of April, it had repurchased approximately 720,000 shares. Revenue growth looks optimistic. The company reported fiscal 2000 revenues of $89.2 million, an increase of 86% over FY1999. LaFountain and Mosesmann forecast revenues of $165-170 million for the year ending April 1, 2001, an increase of about 85%. Mosesmann further estimates that in FY2002, revenues will rise more than 55% to $265 million. Competitor Micron Technology (NYSE: MU) announced Friday that it will raise prices on its main memory product, which can only help Alliance. The company's share price may also get a boost if a rumored NASDAQ listing for UMC occurs this summer.
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