1 Little-known Fund Goes All In On Semi Stock

Prospect Capital Advisors isn’t a big name fund but it’s put almost 10% of its fund into a single stock, Silicon Motion Technology.

For a fund overseeing hundreds of millions of dollars, this is quite a bet. Why risk it all on a little-known stock when you can follow the herd into Apple, Tesla, Amazon and Alphabet, after all?

Well, it turns out there’s lots to like under the surface at Silicon Motion that may explain why Prospect Capital Advisors added another 2,200 shares in its most recent filing for a total of 279,600, amounting to a $22.6 million stake.

Key Points

• Prospect Capital Advisors has invested nearly 10% of its fund in SIMO, reflecting strong conviction in the company’s growth prospects.
• Silicon Motion is tethered to growth in AI-related markets, benefiting from rising demand for its high-performance storage solutions.
• Despite concerns over customer reliance and a weak retail SSD market, analysts see a potential 39.6% upside, suggesting overall market optimism.

Bullish Catalysts Driving SIMO

Silicon Motion is clearly benefiting from increased demand from smartphone OEMs (original equipment manufacturers). The acceleration in this segment points to a higher market share and a growing customer base, which may not be fully priced in by the market.

To talk specific numbers, sales of eMMC and UFS controllers increased significantly by 25% to 30% quarter-over-quarter (Q/Q) and 190% to 195% year-over-year.

Management mentioned that its new offerings with flash maker customers are expected to scale further throughout the year, and this aligns with Silicon Motion’s focus on highly differentiated controller solutions that deliver high performance, higher density, and lower costs.

It seems that Prospect Capital Advisors is betting on the fact that the market is underestimating these potential drivers on future revenue growth and margins.

Speaking of gross margins, they have been resilient even at a time when a softer retail SSD market has been evident. This steadfastness in gross margins suggests strong pricing power and cost management.

Gross margins for the second quarter of 2024 were 45.9% on a GAAP basis and 46.0% on a non-GAAP basis, both of which are at the high end of management’s expectations.

Where Does AI Fit Into All This?

So the margins and revenues look pretty good but what about the AI story, does one exist? It turns out that data centers, a key part of the artificial intelligence narrative fit into Silicon Motion’s core competence.

The company’s focus on customized high-performance SSD solutions for hyperscale data centers, industrial, and automotive applications represents a growing market that may sustain higher margins and more stable revenue streams.

Silicon Motion is also tethered to AI-at-the-edge applications because the design of its controllers are increasingly being tailored to use-cases that involve processing AI algorithms locally on edge devices, whether that’s in IoT devices or smartphones, or even other endpoints, as opposed to relying on cloud-based data centers.

For AI-at-the-edge to succeed, the solutions need to be high-performance, low-latency storage solutions and they must be able to efficiently handle data-intensive AI tasks. Silicon Motion’s offerings tick these boxes.

Another growth lever in the AI world stems from the company’s new programs with flash memory makers that are expected to scale throughout the year as demand rises for storage solutions that can handle the data requirements of AI workloads.

As AI continues to grow, the demand for advanced storage solutions, such as those that Silicon Motion specializes in, will likely increase and benefit the company’s long-term revenue and profitability growth.

It’s Not All Roses and Rainbows

While there is lots to like about Silicon Motion, the most recent filing noted noticeable “softness in the retail SSD market” that is evident across the industry.

A weak retail SSD segment could weigh on overall revenue growth, particularly if the decline is more pronounced or prolonged than anticipated.

It can’t be overlooked either that the company is heavily dependent on a few key customers and flash makers for a significant portion of its revenue. The latest quarterly report points out risks related to the “unpredictable volume and timing of customer orders,” which are not fixed by contract but vary on a purchase order basis.

Is Silicon Motion a Buy?

Only 9 analysts cover Silicon Motion but the consensus price target among them is for SIMO to rise to a whopping $88.33 per share, a 39.6% rise from present levels.

While 6 analysts did downgrade their earnings forecasts for the upcoming quarter, it seems the stock has largely priced in that pessimism and has material fundamental upside now.

Even after falling from $84 per share a few months ago, SIMO is up 18% for the year and it would probably be a bad idea to bet against a return to former highs when the next wave of AI excitement fuels the market.