Why The Virtual Reality Biz Likely Won't Become Himax Technologies' (HIMX)Reality

by Sonya Colberg, Senior Editor - 4/11/2016 11:18:28 AM

As virtual reality fans geek out over the latest goggles hitting the market, Himax Technologies (NASDAQ:HIMX) stock is shooting over the moon.

Himax shares have rocketed as much as 45 percent in the last couple of months. This rally came in lockstep with mass hysteria over the late-March shipping date for the "Oculus Rift" virtual reality goggles and the preorder date for "Microsoft HoloLens" goggles.

Taiwan-based Himax is a chip company focused on the driver IC used in TV and cell phone panels. The hype is tied to its second-tier product, a display piece used in virtual reality and augmented reality (VR and AR) headwear.

Yet when investors understand how Google Glass hype failed Himax previously - and how many other issues are chewing at the company - this stock could quickly get booted back to reality.

Investors may find other viewpoints here. Meanwhile, TheStreetSweeper presents the top eight reasons Himax shares are  so risky:

*1. Rift: Weak, Largely Unpromising Sales Impact

The opportunity presented by Oculus Rift is extremely weak and of little financial significance to Himax.

The Himax product used by Rift is the timing controller. Other Himax components could conceivably be used but the most prevalent piece by far is the timing controller, a chip that sells for about $1 apiece.

Some analysts estimate that 12.2 million virtual reality headsets may be shipped in 2016, according to Fortune.

Let's assume the unlikely scenario that Oculus Rift sold all of those headsets and Himax provided the timing controller for each one. The best gross revenue would be ~$12 million or a mere 1.75 percent of 2015 sales. Considering the current 3.64 percent profit margin, then, Rift would be worth less than half a million in net income to Himax.

And some analysts say that scenario is highly optimistic...

(Source: oculus.com)

In fact, primarily thanks to issues explored in "Product Reviews" below, some analysts expect only around 3.6 million Rift sales in 2016.

Again applying the company's low profit margin, that would make the Himax opportunity unworthy of a mention at somewhere around $131,000 - yes, $131k - for the entire year.

So the case for a reality check goes deeper yet as we consider ...

*2. HoloLens: Too Expensive

The company's opportunity with HoloLens is also limited and very speculative.

Himax provides two LCOS display engines at $25 apiece and an array lens at about $100 apiece for HoloLens. However, Microsoft is uncertain about the mass market and few applications exist for the headset. So Microsoft is selling only a prohibatively expensive edition for developers... Indeed, the headsets sell for a whopping $3,000 apiece.

Too rich for most folks. And that price tag is reminiscent of Himax's snake-bitten Glass experience.

*3. Lesson Learned: Google Glass Gone

Himax remembers the Google Glass experience all too well. The good news for Himax was that it supplied LCOS microdisplays for Google Glass. The bad news is that Google Glass has shattered.

In one click of the Google Glass website, investors can quickly grasp that the "smart" eyewear, as we knew it, is gone:

(Source: Google.com)

That's right. Despite Glass appearances on actors on the red carpet, on models in Vogue fashion spread and in the imaginations of fans who thought the devices would inexorably change their lives forever - everything fell away in one horrid swoop.

Glass faced massive criticism and legislative efforts aimed at safety and privacy concerns. But the final blow came in the form of a viral video of a middle-aged, not-all-that-fit-looking tech blogger wearing Glass ... as he took a shower.

Gasp! Glass is for geezers??

Now Glass is gone ... merely a footnote at the toe of a pair of chewed up, canary yellow athletic footwear.

The New York Times ran a piece in February 2015 on how Google Glass broke. Here's how the story began:

(Source: The New York Times)

The Glass hype and final fiasco hurt Himax. Now the company must consider uncomfortable parallels between Google Glass and Microsoft HoloLens, including:

*The eyewear is isolating in both cases. And they make the wearer stand out ... not in a good way.

*Both offered limited applications.

*Both tech giants offered their experimental augmented reality device only to developers.

*Both products carry hefty price tags beyond the average Joe's reach. Glass was $1,500. HoloLens is double that.

*4. Some Bite: Product Reviews

Though no one really knows whether the Rift and HoloLens will reach any degree of success, product reviews offer some insight. Generally, reviewers note both positives and bumps in the virtual road, including:

*Expensive: The HoloLens (AR) headgear costs $3,000 and is available only to developers and businesses. The ~$600 Rift (VR) headsets are less expensive but must be used with high-end systems (costing ~$1,500) and two power plugs.

*Limited uses: Applications are limited to games.

*Awkward: The headgear is considered bulky, glitchy and prone to making some users nauseated.

*Limited interest: Only serious gamers would likely invest in the headgear and required systems.

Let's look at highlights of reviewers' issues with both the Rift and HoloLens headsets that represent Himax's low-tier market opportunity.

The Wall Street Journal's reviewer found the Oculus Rift headgear heavy, awkward and not ready for the mainstream. While he had fun, the reviewer noted concerns as he tried to move around in virtual space...here. The reviewer stated:

"The most awkward part isn’t nausea—it’s a 13-foot cable snaking from the back of your head to the PC, a tether eerily similar to one in “The Matrix.” To avoid tripping, you must keep track of this cable’s location like a never-ending game of Pin the Tail on the Donkey."

The Fortune reviewer wrote, here, that some people called Oculus Rift "magic." Others called it "clunky."

"The Oculus Rift is proving to be about as divisive as virtual reality itself. Tech critics love the headset, but reviews from mainstream outlets are far less flattering," wrote the reviewer.

Reviewers wrote about similar issues with Microsoft HoloLens.

TechRadar, here, wrote about pluses but also noted that HoloLens is glitchy, difficult to adjust properly, and offers a short battery life plus only a limited field of view.

Numerous reviewers complained that the HoloLens is extremely expensive and offers even fewer uses than the Rift. A BetaNews reviewer, here, summarized the situation this way: 

"(If) consumers are underwhelmed by it, chances are HoloLens will quickly lose its appeal. If that happens, the whole project turns to dust."

Here's the deal with both the Rift and HoloLens opportunity: Neither is ready for prime time. Even with great success, the revenue opportunity would be just a fraction of the company's declining TV-smart phone revenue.

*5. Reality Check: Chief Chip Biz Is A Boring Commodity With Low Margins

Headgear excitement sparked the stock rally, yet ~80 percent of the Himax revenue comes from the drive IC, a commodity piece used in a TV or cell phone panel.

Himax will struggle mightily to try to grow its core business. With just 10 percent of the driver IC market, the company holds the third position in an extremely crowded, cut-throat market.

Additionally, the Himax gross margin rests under 25 percent and even suffered a drop last year.

CEO Jordan Wu told analysts, "2015 was a difficult year with different challenges every quarter."

Our chart below indicates the very real declines in the business, from revenue to margins.

(Source: Company SEC filing)

Our chart below shows more details on Himax's core business sales.

It depicts continual sales declines in TV components (large panel drivers). Smartphone components (small/medium panel drivers) dropped a stunning $100 million.

(Source: Company SEC filings)

Indeed, the driver chips have been facing what CEO Wu called, "tougher competition in mobile devices and TV."

Assuming Himax hangs onto the flat 10 percent market share, there's just one key avenue left to increase sales: Himax needs to lower prices.

That idea is difficult enough but analysts' expectations add even more pressure ...

*6. Impossible: Analyst Expectations

Revenue took its biggest drop in seven years last year. And the greatest percentage growth rate was 16 percent in 2012.

But Wall Street seems to prefer to ignore the trend as it unconsciously sets Himax up for failure.

Analysts at Morgan Stanley predict impossible growth, in our view, projecting that 2016 revenue could grow by an unbelievable couple hundred million or 32 percent ... despite the revenue history:

(Sources: Company SEC filings, here, here, here; Reuters for 2010, 2008-2009; analyst estimates)

Analysts there indicate the HoloLens AR component could account for the bulk of that revenue at $93 million, which would be about a million HoloLens sales this year. This is extremely unlikely, in our view.

We can look to the aforementioned Google Glass misstep for a sanity check here.

Many thought Glass would be selling 2.47 million units in 2015 and 3.7 million in 2016. But over 2 1/2 years only an estimated 720,000 units sold, according to our tech analysts' estimates. And today, of course, Glass is gone. Everyone is just waiting to see when Google will try a second version. So a million HoloLens shipments this year? Highly unrealistic.

*7. Stock Now: Outrageously Pricey

Along with that 62 percent earnings shrinkage, Himax now sports an unbelievable trailing price-to-earnings ratio of 75, more than three times the industry average. The forward P/E is outrageous, too, at more than 23.

Yet Himax operates within a highly competitive field and doesn't even get a one star rating from Morningstar.

Indeed, Himax net income is dwarfed by Taiwan Semiconductor and more than 20 other companies. In fact, Himax produces the second-lowest net income in the entire group:

(Source: Morningstar)

Even constructive sell side analysts seem concerned about the run-up in the stock price. Lake Street Capital Markets recently commented that shares are overpriced considering the absence of significant sales in virtual reality/augmented reality:

"HIMX (Buy, $9 PT) - Stk has been strong lately as there's been a lot of news/focus on AR/VR w/ the Oculus Rift shipping this week. Schmidt continues to think HIMX is one of the best ways to play this trend, but believes the P&L impact in the NT may be getting ahead of itself. The stk is trading at 26x consensus' `17 EPS of $0.46. Even if you believe there's 30% upside to this # (~$0.60), shares are still trading at 20x, which he views as rich in the absence of significant LCOS rev." 

*8. Aggressive: Himax Is Quick To Criticize

But analysts better be careful with any negative comments. Himax is silent on promotional comments that drive up the stock but not so much when it comes to negative comments. Consider this rather aggressive March 18 note from Himax Investor Relations emailed to fans:

"Valued Himax Investors,

Though we have received only a few investor inquiries regarding a report issued today by an analyst at UBS securities, we feel it necessary to share our response. We reiterated that the Company and its management team has not been contacted by, or spoken to the UBS analyst for a business update for the past five months.

"Sincerely,

"Himax Technologies (HIMX) Investor Relations"

*Conclusion:

Himax is a boring TV and cell phone panel component company trying to recast itself as a sexy virtual reality/augmented reality component provider.

This effort isn't surprising since the Himax core business centers on a declining commodity. And it's saddled by extremely low margins and wildly successful competitors. So Wall Street has placed impossible expectations on Himax, hoping it can perform in a new, virtual reality/augmented reality - a particularly nichy and uncertain business.

In our view, though, disappointment is a more likely reality for Himax. We expect the stock will soon get booted down to about $7, a very reasonable valuation.

* Important Disclosure: The owners of TheStreetSweeper hold a short position in HIMX and stand to profit on any future declines in the stock price.

* Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to scolberg@thestreetsweeper.org.

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