The Bull Case for Monolithic Power Systems (MPWR)

With Quiver Quantitative’s recent institutional holdings data (MPWR Institutional Holdings (quiverquant.com)), we can see that hedge funds and asset managers have been increasing their holdings in Monolithic Power Systems Inc. (NASDAQ: MPWR). Firms such as Fidelity, Wellington Management, and Renaissance Technologies have all recently added to their MPWR positions. Most notably, Fidelity increased shares held by 34.99% (as filed on 9/30), bringing their total MPWR holdings to 3,583,803 shares worth around $2.3 billion dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Monolithic Power Systems.

In October, Monolithic Power Systems reported third quarter earnings results for FY23. Highlights of the quarter included revenue of $474.9 million dollars (up 7.6% QoQ but down 4.1% YoY) and GAAP operating income of $135.6 million dollars (up from $112.3 million dollars in the second quarter of FY23). Another large milestone during the quarter was the business’ new share repurchase program. During the quarter, Monolithic Power Systems’ Board of Directors authorized a new share repurchase program that authorized the repurchase of up to $640 million dollars worth of common stock over the next three years. This is huge, as this helps offset future share dilution from stock-based compensation and other equity-based compensation practices for management. In regard to the buyback, Monolithic Power Systems’ CFO Bernie Blegen had this to say on the Q3 about the buyback going forward, “Yes. So I'd like to comment on that very quickly is that when we looked at doing the buyback, we were demonstrating confidence in our free cash flow over the next 3-year window. And the goal here is to offset dilution that will naturally occur during that period of time. So we're going to apply a go-to-market strategy that is both opportunistic but also programmatic. So we don't have a timetable necessarily for how to implement it during that period, but it will reflect both existing market conditions as well as a systematic program.” Essentially, this excerpt from the CFO means that this buyback program is not only programmatic (which means the business buys back shares in a consistent manner, usually to offset dilution), but opportunistic. This means that management, in the future, will look towards repurchasing shares when valuations are low. This is a great sign of strong capital allocation (we believe that share repurchases should largely be opportunistic), and this should make investors comfortable going forward, knowing that management practices strong capital allocation measures to create shareholder value.

Monolithic Power Systems is a leading fabless semiconductor company, specializing in high-performance power electronic solutions. Founded in 1997 and headquartered in Kirkland, Washington, Monolithic Power Systems operates globally, employing over 3,200 people across Asia, Europe, and the United States. The company's core strengths lie in deep system-level knowledge, semiconductor expertise, and proprietary technologies in semiconductor processes, system integration, and packaging. Monolithic Power Systems’ innovative solutions, known for their high integration, compact size, energy efficiency, and cost-effectiveness, are widely used in various sectors including storage and computing, automotive, industrial, and consumer applications. Through continuous product innovation, Monolithic Power Systems generates revenue by addressing the growing demand for energy-efficient and high-performance semiconductor solutions in diverse industries.

The semiconductor industry, fundamental to electronic systems and equipment, is highly competitive and cyclical, with Monolithic Power Systems specializing in the high-performance analog and mixed-signal IC markets. These markets are distinguished by longer product life cycles, diverse end markets, and a focus on integrating higher levels of functionality, efficiency, and precision. Monolithic Power Systems faces stiff competition from major players like Analog Devices, Infineon Technologies, NXP Semiconductors, ON Semiconductor, Power Integrations, Renesas Electronics, ROHM Semiconductor, Semtech, and Texas Instruments. The industry is marked by rapid innovation, frequent new product introductions, and declining average selling prices over a product's life. Monolithic Power Systems’ ability to remain competitive hinges on continuous product innovation, particularly in offering smaller, highly integrated ICs with lower energy consumption and high performance at competitive prices, in an industry prone to market fluctuations and significant consolidation.

Management is solid, and their capital allocation priorities do a great job of creating long-term shareholder value. Monolithic Power Systems doesn’t have a long history of share repurchases, however, as mentioned above, the business’ Board of Directors recently authorized a new share repurchase program. This is huge, as this repurchase authorization will help reverse the dilutive effect of stock-based compensation going forward (along with other forms of equity-based compensation). Dilution is terrible for investors as it essentially makes your stake in the business smaller. When dilution occurs, shares outstanding rise, but your stake stays the same (assuming you are a passive shareholder that isn’t purchasing more shares over time). Additionally, dilution can hurt EPS growth (since EPS = Net Income / Shares Outstanding). Essentially, we think that this repurchase program is a step in the right direction for the business, adding lots of value to shareholders over time while showing that management is a solid capital allocator. In addition to this new share repurchase authorization, Monolithic Power Systems has a history of paying cash dividends on its common stock, another form of returning cash back to shareholders and creating shareholder value for the long-term.

In terms of management incentives, management is incentivized well, with a compensation structure that does a great job of aligning shareholder and management interests, while also doing a great job of retaining executive talent over the long-term. The compensation structure includes a base salary, short-term cash incentives, and long-term equity incentives. During FY22, the short-term cash incentive payout was based on a predetermined non-GAAP operating income figure for all NEOs. This short-term cash incentive incentivizes management to meet financial metric goals that are important to the business. In FY22, this metric threshold was easily met, showing the power that compensation incentivization has on management and their ability to complete strategic goals and tasks. The long-term equity incentives, since 2016, have been tied to rigorous performance conditions like revenue goals, business operating goals, and stock price targets (this condition is the ultimate incentive that links management and shareholder interests in our eyes). In Monolithic Power Systems’ proxy statements, we can see that these incentives clearly work, as the business consistently tops TSR (total shareholder return) among peer groups. We believe that the compensation structure for management is solid, with various predetermined financial metric and business performance goals that help drive maximum TSR for shareholders over the long-term.

Monolithic Power Systems is a very efficient business. The business currently operates at a LTM ROE of 25.9% and a LTM ROIC of 26.5%. With a WACC of 11.3%, the business operates at a ROIC to WACC ratio of 2.35x. This high ROIC to WACC ratio showcases the business’ ability to generate excess returns on capital relative to the business’ weighted average cost of capital. Businesses that operate with strong returns on capital are compounders, businesses that are able to rapidly compound earnings and intrinsic value over the long-term, much to the delight of long-term passive shareholders. Looking further, we can see that O’Reilly Automotive has had stellar sustained growth in operating income (EBIT), with strong EBIT margin expansion over the last ten years. Looking at operating income is important, as it shows the profitability of a business’ core operations. Since 2013, Monolithic Power Systems has grown EBIT at a whopping CAGR of 36.7%. This massive growth in EBIT can largely be attributed to expanding EBIT margins. In 2013, the business operated at an EBIT margin of 9.9% of revenue, compared to today where the business operates at an EBIT margin of 28.3% of revenue.

Analyzing Monolithic Power Systems’ income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2013, Monolithic Power Systems has grown revenue at a CAGR of 22.4%, with gross profit growing at a CAGR of 23.4% during that same time frame. This excess growth in gross profit relative to revenue during the last ten years can be attributed to expanding gross margins, which can hint towards the fact that Monolithic Power Systems benefits from pricing power. Pricing power is a business’ ability to raise prices without taking a large hit in the volume of sales, and pricing power can be established through tons of factors like strong brand recognition, superior products that add value to customers, and lack of competition / strong barriers to entry. Pricing power is a great way for a business to inorganically grow the top-line, and only the highest quality businesses possess this trait. In terms of earnings, Monolithic Power Systems has grown EBITDA at a CAGR of 32% since 2013, with EPS growing at a CAGR 31.4% during that same time period.

Looking at Monolithic Power Systems’ balance sheet, we can see that the business operates in solid financial health. The business currently holds around $1.04 billion dollars worth of short term investments and cash and equivalents on the balance sheet, with no short term borrowings or long-term debt on the balance sheet. Monolithic Power Systems is essentially debt-free, with a net debt of -$1.03 billion dollars (meaning that the business has an excess cash pile of around $1 billion dollars after factoring out all of the business’ small amount of debt). For a high quality compounding business like Monolithic Power Systems, it's a great trait to have little debt on the balance sheet. Instead of having to worry about paying down debt, management can focus on initiatives that create greater shareholder value, like reinvestments back into the business at high rates of return and share repurchases. As we’ve seen, Monolithic Power Systems is a very high quality business expanding quickly, with plenty of runway to continue to expand due to a very low debt load.

Analyzing Monolithic Power Systems’ cash flow statement, we can see some stellar sustained growth in net income and free cash flow over the last decade, showcasing the business’ increased operational efficiency during that time frame. Since 2013, Monolithic Power Systems has grown net income at a CAGR of 34.3%, with free cash flow growing at a CAGR of 26.7% during that same time frame. This growth in free cash flow can largely be attributed to expanding FCF margins. In 2013, Monolithic Power Systems operated at a FCF margin of 18.9% of revenue, compared to today where the business operates at a FCF margin of 26.3% of revenue. Expanding free cash flow margins act as a catalyst for future free cash flow generation. Strong top-line revenue growth and expanding free cash flow margins act as a “twin engine” for future free cash flow generation, and Monolithic Power Systems possesses both of those traits. With the business compounding free cash flow over the long-term, management can continue to reinvest cash back into the business at high rates of return, repurchase shares, and/or offer/increase a cash dividend, all of which provide immense value for shareholders.

After conducting a reverse discounted cash flow analysis, we can see that Monolithic Power Systems is trading at share prices that imply a 29.75% growth rate (CAGR) in free cash flow over the next ten years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 11.3% (Monolithic Power Systems’ WACC). As mentioned above, we believe that Monolithic Power Systems is a high quality business, with great future free cash flow generation potential. However, we further believe that this current FCF growth rate implied by current market prices is a little steep, offering little margin of safety. While past performance is not indicative of future results, Monolithic Power Systems grew FCF at a CAGR of 26.7% over the last ten years, and we believe that a growth rate of 18.7% (30% margin of safety from the 10-year FCF CAGR of 26.7%) is a fair valuation for the business. This 18.7% growth rate implies a share price of $322/share (49.8% downside). While there is a high likelihood that this valuation is too conservative and share prices will never touch this valuation again, we still believe that this is a comfortable level to enter a position into a very high quality business like Monolithic Power Systems. Please note that these valuations and projections are based entirely on our proprietary models, and we encourage all investors to do their own due diligence before entering into a position in Monolithic Power Systems.

Keep an eye out for MPWR stock’s latest news, data, and more with Quiver Quantitative (MPWR | Monolithic Power Systems, Inc. Stock Data, Price & News (quiverquant.com)).

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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