It's become a Halloween tradition here at the Motley Fool to present investors with several tempting treats that might sweeten their portfolios -- as well as a few devilish tricks that could wreak havoc and mayhem on the unsuspecting. Having just watched the holiday classic It'sthe Great Pumpkin, Charlie Brown, I felt like handing out a treat this year.
So what type of company constitutes a treat? Well, some might want to unwrap a financially sound company with a juicy stockpile of cash inside. Others might sift around the market's big bowl for a promising young company in a dynamic industry that's dripping with caramel-sweet cash flows. Of course, value investors will point out that such things are irrelevant, unless the shares are trading for mere peanuts.
How about a company that has all of these traits rolled into one -- like a plump candy apple?
Experimenting with new flavors
In this case, the company is Zoran (NASDAQ:ZRAN), a leading manufacturer of consumer electronic chips used to compress audio and video in a wide range of products.
The firm is primarily known as a heavy hitter in the DVD segment, where it commands a dominating 30% market share, but recent acquisitions have helped balance the revenue streams and provide exposure to faster-growing markets such as digital televisions and multimedia phones.
In fact, at this year's Consumer Electronics Show, more than 100 different cutting-edge products featured Zoran chips.
That's trillion, with a "T"
With semiconductor factories running at 95% utilization rates in anticipation of a busy holiday season, global chip sales reached a record high of $20.5 billion in August. That has put the industry on track to nearly crack the quarter-trillion dollar mark in terms of annual revenues, of which Zoran continues to capture a small but growing chunk.
For a moment, forget about the fierce, margin-crimping bidding war between Intel (NASDAQ:INTC) and Advanced Micro Devices (NYSE:AMD). Less than half of all chips these days will be installed in PC's anyway; most will find their way into digital cameras, MP3 players, and a growing assortment of other consumer electronics gadgets -- playing right into Zoran's strengths.
Low-calorie valuations
The small-cap company has been around for more than two decades, but it's only now hitting its stride. Over the past three years, revenues have doubled to $465 million, gross margins have expanded from 40% to 56%, and free cash flows have swung from a $1 million loss to a $100 million gain, which means that the firm is currently converting every dollar of revenues into nearly $0.25 of FCF.
And over the past three quarters, Zoran has remained debt-free, while increasing its cash position from $218 million to $280 million ($5.71 per share) -- which represents more than one-third of the company's $700 million market cap.
Since reaching a peak of $30 back in April, the shares have suddenly been cut in half. Much of that brutal beating took place earlier this month, when the stock was sliced like a hapless slasher-movie victim after Zoran posted soft third-quarter revenues and issued a cautious short-term outlook. Never mind that the company shipped a record number of DVD chips, reported record revenues from digital camera processors, and significantly improved its inventory turns.
Thanks to the recent slide, though, the stock is now trading at just seven times trailing FCF -- versus an industry average of more than 30 -- with a microscopic PEG ratio of 0.60.
Take a bite
Yes, sales may be somewhat stale over the next three months, but they should sweeten considerably over the next three years. By 2009, all television stations will be broadcasting digitally, and Zoran is well-positioned to cash in on the rapid transition from outdated analog technology to high-definition television (HDTV).
TV aside, no one knows what's in store next for the digital revolution, but I'm betting that Zoran will be right in the middle of it.
I'm leaving a whole tray of these goodies out, so feel free to nibble.
Intel is a Motley Fool Inside Value recommendation.
Fool contributor Nathan Slaughter still hasn't eaten all of last year's Halloween candy. He owns none of the companies mentioned.
The Motley Ghoul's Tricks or Treats represents the opinions of each Fool only and should in no way be taken as the opinion of either The Motley Fool, Inc., or any company in question, or as representative of anyone or anything other than that specific Fool's thoughts. So do your homework, and review The Motley Fool's disclosure policy .
