Gamble of the week: struggling chip-maker with improving prospects

By Paul Hill Feb 27, 2009

Paul Hill

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Wolfson is a specialist designer of high-performance audio chips used in thousands of consumer electronic devices, such as set-top boxes and computers. Yet despite at one stage supplying this technology for 90% of the world's MP3 players, including the Apple iPod, the firm has struggled of late in a highly competitive market.

Wolfson Microelectronics (LSE:WLF)

Wolfson recently lost the Apple account, and has suffered as customers have down-traded to cheaper alternatives. Revenues fell 48% in the last quarter after being savaged by the de-stocking that has afflicted the entire electronics eco-system. This has affected order books and forced Wolfson to withdraw its 2009 guidance due to a lack of visibility.

I reckon the outlook will stay ugly for the rest of the year, but at some point better days will return, and Wolfson's prospects should improve. The firm should also be far leaner and technologically well placed. At the end of December it had a $92m (£61m) cash pile (or 53p a share), which should be enough ballast to weather even the stormiest of waters. And as well as aggressively cutting costs, the chief executive, Mike Hickey, is developing the next generation of power management, ambient noise cancellation and sound chipsets. At some point the crippling inventory cull will end, which should boost volumes and perhaps even trigger a snap-back in orders.

The City expects turnover of £90m in 2009, rising to £98m in 2010, which is above the group's "cash break-even position of £85m". So once the bloodbath of the next two years is behind us, Wolfson should be able to achieve sales and operating profits (EBITA) of £110m and £10m by 2011. On this basis, using a 12% discount rate and a ten-times EBITA multiple, I estimate Wolfson is worth about 120p per share. What's more, the firm could be snapped up by a competitor at a price significantly north of 120p.

Admittedly, there are risks, not least the difficult macro conditions and the chance that a large customer may go to the wall. But with its sound balance sheet, support from the weak pound, and first-class technology, I believe the stock offers good value for the patient investor.

Recommendation: SPECULATIVE BUY at 80p (market capitalisation £93m)

• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.

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