CEVA Inc. Looks Fairly Valued

Shares of DSP IP vendor, CEVA (NASDAQ: CEVA  ) reported its Q1 2014 results on April 30. The results for the quarter were actually quite good -- earnings per share of $0.16 beat consensus by $0.03, and revenue of $13.7 million beat consensus by $1.54 million. However, guidance of $10-$11 million on the top line (down from $12.8 million a year ago) and $0.03-$0.05 on the bottom line (down from $0.15 a year ago) was a disappointment. Is it time to panic, or is this an opportunity?

The story should get better
For semiconductor IP vendors, there are two revenue streams to watch for: licensing revenue and royalty revenue. Licensing is the upfront amount paid by a licensee in order to be able to use that IP block (and in CEVA's case, these are DSPs) in a given semiconductor design. This is usually upfront per-design, although some IP vendors are willing to work out multi-device/multi-year agreements. One of the best predictors of future royalty payments (that's the amount an IP vendor receives as a percentage of each unit sold by the licensee).

In the most recent quarter, licensing revenue was up to $7.9 million, a 57% jump from the same period a year ago. At the same time, royalty revenue (reflective of licenses signed some time ago) was down 19% on a year-over-year basis. The explanation for the weak royalty revenue was the "inventory adjustment" among the handset vendors that use chips incorporating its DSP IP. This is expected to get better as new handsets launch by the end of the year, but this alone doesn't get CEVA where it needs to be -- the company needs its licensees to make it into these new handsets.

Samsung and Intel look like the heavy-hitters in mobile
Many of the latest LTE phones use Qualcomm (NASDAQ: QCOM  ) Snapdragon processors and Qualcomm modems. The content within a smartphone platform that CEVA typically captures is the DSP found inside of the cellular baseband processor. The bad news is that if Qualcomm is the primary beneficiary of the handset growth in the back half of the year, CEVA doesn't really benefit.

However, the good news for CEVA is that its DSP cores are found inside of Intel's (NASDAQ: INTC  ) latest XMM 7160 LTE modem (which is actually winning some real designs), as well as in Samsung's (NASDAQOTH: SSNLF  ) home-grown baseband chip (although it's unclear how aggressively Samsung plans to deploy this in its phones). In addition, many of Broadcom's (NASDAQ: BRCM  ) modems use CEVA DSP cores, so success on Broadcom's part against, say, Qualcomm is good for CEVA.

Growth drivers abound, but is it priced in?
At first glance, the stock looks pretty expensive at about 27 times current analyst EPS consensus for the year. However, there are two things to consider, here:

  • Lots of cash -- CEVA has about $6.36/share in net cash, so stripping this out leaves a stock trading realistically for about 15.36-times current year analyst consensus.
  • Growth ahead -- It is often a mistake to look at a company's trailing-12-month earnings without taking into consideration potential growth. With competitors to Qualcomm coming online in the LTE space soon, and with the continued growth of 3G chips at licensees like Spreadtrum, the company's best days are ahead of it

That said, though, if the company can hit the $0.55 sell-side EPS consensus for the year and grow the bottom line to the tune of a 10%-15% 5-year CAGR before leveling off to a high single-digit long-term growth rate, then the shares look to be anywhere from fairly valued to modestly undervalued. Of course, if the company can hop right on over these estimates (say, for example, its non-handset licensing business drives upside or if CEVA's handset customers gain 3G/LTE share), then the shares could have pretty dramatic long-term upside if there is reason to get more aggressive on those growth estimates.

Foolish bottom line
CEVA's story is an interesting one, and at lower prices (say in the $13 range), it would offer a very compelling risk/reward. However, for now, it's worth putting this one on the watchlist and keeping a close eye on the ramp of its royalty stream from basebands deployed during the second half of 2014 and whether its non-cellular baseband business can help drive some incremental growth.

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