Foolish Forecast: High-Def Profit Picture at Silicon Image

Fire up that big screen! Tonight its time for a third-quarter report from Silicon Image (Nasdaq: SIMG  ) , the company behind the HDMI and DVI standards in your high-definition connectors. Check out last quarter's earnings miss, then come back to decide whether history will repeat itself today.

What Fools say:
Here's how the company's CAPS scoring rates against some of its peers and competitors:

Market Cap

Trailing P/E Ratio

CAPS Rating

Texas Instruments (NYSE:TXN)

$44,910

18.4

****

Broadcom (NASDAQ:BRCM)

$17,690

113.2

***

Analog Devices (NYSE:ADI)

$10,270

21.1

***

Conexant Systems (NASDAQ:CNXT)

$593.7

N/A

****

Silicon Image

$511.4

12.8

*****

Data taken from Motley Fool CAPS Nov. 1.

The bears in CAPS don't say much -- not that there are a whole lot of them, but still. The main argument against Silicon Image has been a lack of share price appreciation.

The bulls are plenty vociferous, though. One all-star player calls this an "undervalued stock with great fundamentals in a growing field of HDMI transmission which looks to have more upside than down at this point." Some players call the stock undervalued, and others would apply that tag to the digital media market or the whole semiconductor sector.

What management says:
"Silicon Image Names Covert CFO," said a recent Forbes headline. No, it's not a top-secret, undercover financial chief position -- the new CFO is Hal Covert, who comes from the same position at Openwave Systems (Nasdaq: OPWV  ) and Adobe Systems (Nasdaq: ADBE  ) .

"With [Hal's] extensive experience as CFO for technology innovators, including software and computer systems companies, he is an important addition to our management team," said CEO Steve Tirado. That Covert might help the company avoid further scandals like last year's stock options review was left unsaid, but you could hear it anyway.

What management does:
Profit margins aren't very stable, which is understandable for a company with just $314 million in trailing revenues. The revenue growth trend is more instructive and points in a good direction, while the abrupt cash flow drop looks worrisome. The company used up some of its deferred tax and accrued liabilities balances around the last New Year, which overrides better cash conversion management in these trailing figures.

Margins

3/2006

6/2006

9/2006

12/2006

3/2007

6/2007

Gross

59.1%

58.8%

57.8%

58.9%

58.5%

57.4%

Operating

16.6%

15.4%

12.8%

14.3%

14.1%

12.8%

Net

15.5%

12.4%

10.7%

14.4%

14.1%

13.2%

FCF/Revenue

23.9%

19.0%

23.3%

11.0%

4.8%

3.8%

Y-O-Y Growth

3/2006

6/2006

9/2006

12/2006

3/2007

6/2007

Revenue

25.1%

30.7%

36.7%

38.9%

34.2%

27.2%

Earnings

45.9%

(12.3%)

(22.1%)

(14.3%)

22.0%

35.9%

Data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
When the stock fell through the trading floor after the last earnings report, I said, "Silicon Image beat its internal targets and guided to double-digit revenue growth and continued margin improvement in the next quarter. And for this, the stock price took a 31% fall in just two days."

The drop still doesn't make sense to me. Was a die-hard value hound babysitting the growth-stock sector for the day? Yes, fundamentals matter and so does valuation, but so does the business model. As long as the high-definition consumer market keeps growing, so will Silicon Image's profits -- and I'm pretty sure it's only just begun.

I dare you to find a competitor with such a tight focus on the wildly attractive HD market, or one with a more generous value proposition. The buying opportunity still stands, although it may get even better if the company only beats forecasts by a little bit again. In my humble opinion, the short-term difference will only change the magnitude of your long-term returns -- not the fact that you will profit. The writing's on the wall, in crystal-clear high definition.


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