Buy an Unstoppable Trend at an Unbeatable Price

I don’t always have to like a particular trend or the products driving it to accept the inevitability of its progression. As a value oriented investor, my focus is on finding undervalued businesses with exceptional future prospects, so I can purchase them today at a substantial discount and sell in a few years at a handsome profit.

As an older investor, smaller devices that are popular with the younger set are always becoming more difficult for me to use due to lessening dexterity in my fingers and worsening eyesight that makes it increasingly difficult to see the smaller and smaller displays. However, just because it doesn’t work well for me doesn’t mean that there is not an excellent investment opportunity to be found in this rapidly evolving sector.

An Opportunity

Today, I have found an excellent example of this situation in the products and shares of Tessera Technologies, Incorporated (TSRA, Financial). Tessera is a holding company whose subsidiaries develop, license and distributes semiconductor packaging and interconnect solutions for mobile computing and communications. They also provide products for memory and data storage as well as 3-D integrated circuits to OEM’s, integrated device manufacturers and manufacturers of original designs. They are also involved in supporting the technology transfer related to these functions.

Founded in 1990, the company's software solutions for mobile imaging technology includes FaceTools, which provide face-oriented imaging technology, such as face detection/tracking, smile/blink detection, red-eye removal, face recognition, and face beautification; Face Beautification that allows users to enhance portraits; and FotoSavvy, a solution that enables the novice user of a smartphone camera to take pictures like a professional photographer. Its mobile imaging technology also include FacePower, which enables the camera of a smart-phone to be a low power sensor, in order to save battery power; Panorama that enables users to automatically create panoramic images in a single step without a PC or editing software; and Image Stabilization, which corrects for motion blur and shake induced during video capture. The company is currently based in San Jose, California.

Tessera’s business operations include:

• Tessera, Inc. pioneered chip-scale packaging solutions, which it licenses to the semiconductor industry.
• Invensas Corporation develops and acquires interconnect solutions and intellectual property in areas such as mobile computing and communications, memory and data storage, and 3-D integrated circuit technologies.
• Tessera Intellectual Property Corp. manages our intellectual property licensing efforts, including for Tessera, Inc. and Invensas.
• FotoNation develops embedded image processing solutions that include FaceTools, face beautification, red-eye removal, FacePower, FotoSavvy, High Dynamic Range, panorama and image stabilization products.

They are moving aggressively to expand the use of their products and technology in the laptop, tablet and smartphone industries.

In short, they are involved in moving us forward toward increasingly smaller and less wired communications and information devices that are more difficult for me to use. The business is diversified across a range of products that provide desirable characteristics to its customers and the end consumer of mobile devices and services. Just because the products and trend do not benefit me in terms of function, does not mean in any way that I should not profit from investing in it.

More Than Just An Irreversible Trend

From all appearances, Tessera is an integral participant in an irreversible trend. However, it takes more than a good business in a growing market to make an excellent investment.

Excellent investments are made when those previous attributes are combined with a history of performance that exceeded expectations. There are few things in the market that can hammer a stock’s price as fast as disappointing the analysts with earnings below expectations. As shown in the table below, this has proved to be of little concern for Tessera over the past four quarters where they have exceeded expected earnings between 8.7% and 82.4%.

Even though the track record of outperformance in the past is no guarantee of the same level of performance in the future, it does give us some level of reassurance that the analysts covering the stock tend to be a bit on the conservative side in their evaluation of the prospects for the company.

We can also look at the more recent and current projections of the analysts covering the stock to see if the most recent adjustments to their outlook for the business have been favorable or unfavorable. In this case, we are seeing positive adjustments to the earnings forecasted for Tessera for not only the next two quarters but also for the 2015 and 2016 year end results.

The table above shows this recently improving trend and reveals an increase in projected earnings of 6.78% and 11.17% for 2015 and 2016 respectively in just the last 90 days. Given the company’s recent history of over performance against expectations and the current and recent trend of rising expectations, new investors can add just a bit of confidence to their consideration of the projected numbers for Tessera.

Based on the current consensus estimates for 2015 earnings of $2.36/share, Tessera is trading at a very reasonable price to earnings multiple of 13.97 times earnings. This is a very reasonable ratio for a good business in just about any conditions other than an advanced bear market.

Future Profits Are About Future Growth

While the numbers we have already seen indicate that the business is currently priced at a reasonable valuation for a well-run company, profiting from investments is about making educated guesses as to what will happen in the future. As previously discussed, I like to find businesses that are part of an existing and unstoppable trend.

Businesses situated in this way have already greatly reduced on of the big risks faced by investors which is owning shares in a business where the market goes away. Think of the buggy whip makers when the automobile came along.

I also like to find companies that will make good investments if the future performance fails to improve and only matches the past performance in terms of growth in sales and earnings.

The table above shows that over the past five years, Tessera has grown earnings at an annual pace of 22.25% and is only expected to approximately maintain that trajectory over the next five years with a projected growth rate of 20% annually.

Even more reassuring is the fact that the forward growth rate for the business is very closely aligned to growth rates for both its industry and sector. The business is also currently trading at a P/E ratio approximately the same as the S&P 500 while its projected earnings growth rate is about 183% higher.

So not only is this a business that would appear to be fairly valued in most market conditions, it is just plain cheap today compared to the broad market and its future projected earnings growth rates.

This Business Is Even Cheap Compared To Itself

One of the critical considerations in establishing a reasonable price target for a particular stock is to compare the current valuation against the historic valuation of the business. Different sectors can have wildly different “normal valuations” assigned to them by investors. For example, we typically expect to see much higher values assigned to a healthcare stock than we would see assigned to a heavy equipment manufacturer.

In technology related stocks, when the projections for future performance are similar to the history of past performance, I like to look at the current valuation assigned to a stock in comparison to what the value would be based on the historic norms for the actual business I am evaluating. This provides me with a good method by which to assess whether the business is expensive or cheap compared to how the market normally values it.

In the case of Tessera, the chart below illustrates the price of the stock were trading at it historic median P/E ratio (without non-recurring items) and the price it would be trading at based on its historic minimum P/E ratio. These numbers are based on the trailing twelve months earnings (TTM). If the range between the historic minimum P/E multiple share price and the historic median are used as a range of valuation, this table provides us with an excellent visualization of just how cheaply this business is currently valued compared to its own historic metrics of price to earnings valuation.

It seems pretty clear that this business it trading very close to the lower end of its historic range of valuation. For me, a condition like this provides a bit of a floor closely positioned under the current share price along with the potential for excellent profits should the stock simply return to its “normal” valuation in term of the median P/E ratio.

Always Looking For More Safety

Value oriented investors never seem to stop looking for additional margins of safety in the businesses to which we allocate our investment capital. Tessera is no exception. The search for additional safety indicators needed to progress no further than the balance sheet of the business.

As of June 30, 2015, Tessera was holding cash and short-term investments of $431,893,000 on their balance sheet with another $9,536,000 of accounts receivable. The total liabilities of the business were listed as only $26,177,000. This produces a net cash equivalent of $405,725,536 free and clear of all debt and obligations of the business. On a per share basis, this number equals $7.785 or 23.6% of the total market capitalization of the business! Now that is a number that should put a smile on the face of any value investor. That is especially true when the business already appears to be cheaply valued. When looking for safety in any investment, cash on hand is just hard to beat. If the cash on hand is deducted from the share price when calculating the current P/E ratio, the stock is trading at a level of only 10.63 times 2015 earnings while it is projected to grow at 20%/year for the next five years.

Final Thoughts And Actionable Conclusions

We are currently experiencing a pretty solid correction in the stock market and there is a great deal of anxiety on display day in and day out. These are the times in which spectacular opportunities will present themselves and we will be offered the opportunity to acquire great assets with limited risk and exceptional upside potential at bargain prices.

Tessera is a stock that could easily rise 50% and still carry a reasonable valuation. I believe prudent investors can open a position in this stock anywhere under $35.00/share and sleep well at night.

For those investors who just always insist on something better, you may wish to consider selling the $30 strike price October 16, 2015 expiration uncovered put options against the shares with a limit price of $0.60/share. This would obligate you to purchase 100 shares of the stock at $30.00/share for each contract sold at the option of the contract buyer at any time between now and October 16th. The $0.60/share premium collected would provide a 2% return on the $30.00 strike price of the option contract and would equal an annualized return on total capital required to execute the transaction if assigned of approximately 15% over the 47-day life of the option contract.

This approach would also result in acquiring the shares at a discount of about 9% from the current market price if they were to be assigned. Therefore, it produces a 15% return on total capital while waiting for a chance to open a position in this stock at a 9% discount. This is just for those who always want a better deal.