Friday, August 8, 2008

From the Mailbag: Trident Microsystems

One of our readers asked about my thoughts on Trident Microsystems (Nasdaq: TRID). Trident is an electronics company that designs and manufactures integrated circuits for different digital media products such as digital television and liquid crystal displays.

I have looked at several electronics companies in the past and I have to say, the profit margins have been razor thin. Trident seems to be made from the same stuff, as their operating earnings over the past 7 years do not paint tranquil picture. During the past 7 years, Trident has had 4 years of negative operating earnings and 3 years where they had positive operating earnings. Their average operating margins over the last 7 years are negative and imply that if this trend continues they will lose value for shareholders. With the majority of their revenues coming from just 2 customers, I would classify their business model as very risky.

Another clue about lack of earnings is provided from the shareholder's equity section of the balance sheet. The bulk of the shareholders equity is in the form of additional paid in capital and very little retained earnings. Shareholders have been contributing capital for the common stock, but the company has not been earning much on this capital. It's possible that large dividends have been paid out to shareholders and that is why retained earnings are so low but I found this statement in the annual report:

"Our present policy is to retain earnings, if any, to finance future growth. We have never paid cash dividends and have no present intention to pay cash dividends."

There is approximately $200M in cash on the balance sheet. What is this cash doing except earning a poor rate of return? Trident doesn't need to accumulate this amount of cash (imho) to operate their business (there is almost no debt). This cash was essentially all contributed by shareholders since they paid $203M of additional paid in capital.

In addition to not wanting to pay out dividends to shareholders, Trident has massive quantities of stock options outstanding. There is approximately 16% of the entire shareholder float in the form of stock options outstanding. Why such an excessive dilution of shareholders interests? It's certainly not to reward stellar company profits.

So if you were thinking of investing in Trident, a few ways that shareholders might get paid is 1) through stock appreciation, 2) have a major shareholder get active in the company's affairs and change policies to be shareholder friendly or 3) another company wants to acquire Trident and shareholders can sell to the acquiring company.

Based on a free cash flow analysis, I don't see a rosy picture for Trident's future stock price. As well, there doesn't appear to be a strong white knight shareholder working to make reforms on shareholder policies. Lastly, this is not an ideal market for acquisitions. The financing for deals is getting a lot harder with the troubles in the financial sector. For the time being I would hold off on looking at TRID as an easy asset play.

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