IQE’s licence agreement with Translucent has the potential to accelerate its developments and secure key IP in the high-growth GaN on silicon market. While at the revenue level the company’s transformation to a more diversified compound semiconductor business still has some way to go, its pathway is becoming clearer. With continued execution along this path, we believe the share should rerate upwards from its lowly 9x P/E rating.
IQE’s H1 results were as expected. Revenues grew by 2% y-o-y to £53.2m, suppressed (as flagged) by a delay of shipments at a wireless customer from Q2 to Q3, which is now underway, but supported by 28% y-o-y growth in Photonics to £7.4m. Adjusted PBT and EPS both grew by 5% to £5.9m and 0.9p, respectively. The balance sheet is looking more solid, with net debt reducing to £31.1m and deferred consideration to £17.9m – a trend we expect to accelerate over the next two years, especially as the RFMD wafer discount agreement comes to an end in mid-2016. Our estimates have not significantly changed with some additional contingency for the risk in the Chinese handset market offset by a £2m licensing payment related to the setup of the CSC joint venture.
The company’s licensing agreement with Translucent, a subsidiary of ASX-listed Silex Systems, provides IQE with a means to accelerate the development of Gallium Nitride (GaN) – a key enabling technology for the next generation of power electronics devices. Capital outlay is modest (max $1.5m committed, $6.5m if the technology is bought outright, while the process uses MBE reactors, for which IQE has significant excess capacity). It also secures key IP, which management believes covers the entire GaN on silicon wafer manufacturing process – reducing the risk of IP disputes in a domain that has attracted significant patent coverage due to its high growth potential.
Despite the strong recovery over the past six months, IQE’s rating is undemanding and remains at a substantial discount to its peers. If the business progresses to plan, we should see its revenues continue to diversify, cash conversion improve and the balance sheet strengthen. We believe that these factors would justify a rerating upwards in the shares, with a low- to mid-teens (35-40p) share price not looking out of the question.