Fructivore Investments

I find that the stocks I like seem to come in pairs. I liked oil and gas producers Linn Energy and Breitburn; I liked phone companies Windstream and Qwest, and now in the contract manufacturing sectors, I liked Keytronic and now I like Amkor Technology (AMKR).

Amkor produces semiconductor packaging for other manufacturers, and also performs testing services. Most of their operations are in Asia. Based on today’s prices, I would estimate their P/E ratio at a little over 7. I shall go into more detail on that later.

On the downside, Amkor has significant debt; $2.7 billion in total assets and $2.2 billion in liabilities, producing a price/book ratio of around 2. Although they have significant R & D expenditures, and, following Damodaran, in Damodaran on Valuation, I have advocated capitalizing these, their interest coverage is still hovering around a little over 2x, firmly in junk status, although their credit rating was recently raised a notch to BB-.

Furthermore, some of that debt is convertible at various prices, ranging from $14.59 per share to $250 million in notes at $3.02 per share (the price as of Monday’s close is $5.61). As a result, there is a significant gap between normal and fully diluted earnings. The $3.02 convertible notes do deserve further attention; they were sold to the company’s chairman in April 2009, and the conversion price is actually lower than the price of the stock was at any time during the month. Most convertible notes are issued with a conversion price that is at a significant premium to the current stock price. Now, I know that April 2009 was still a time of economic crisis and was only a month after the market hit bottom, and as a result financing was hard to come by, but even so this level of blatant self-dealing should be a black mark against the firm.

Amkor is a cyclical company, and as a result sales for 2009 were no higher than they were in 2005. However, apart from a goodwill writeoff in 2008, the firm has been profitable every year since 2006. The recent improvement in the semiconductor device market has given the firm some improvement in their results as compared to last year. Turning now to earnings, in 2009 they reported earnings of $156 million, but because of operating losses, instead of paying taxes it worked out that the government actually owed them. If their tax liability had been normal, they would have earned only $80 million that year. They took $300 million in depreciation and amortization, and made $235 million in investments, producing free cash flow of $155 million. In 2008 the figure was $275 million, and in 2007, about $220 million.

Year to date 2010, they have reported earnings of $104 million, which is again propped up by tax effects so the correct figure would be about $67 million. Depreciation year to date has been $154 million, and capital expenditures $143 million, producing free cash flow of about $78 million, or $156 million on a full year basis. The firm also disclosed in their SEC filings that they typically see better results in the last two quarters of the year, and also that they intended to front-load a significant amount of capital expenditures for the year, so it is possible that the full year’s results will be even better. Furthermore, they have $300 million in net operating loss carryforwards to burn through as well.

I think the main drag on Amkor’s valuation is their significant debt levels, and although they have not made significant movement towards paying their debts down lately, which I would have preferred them to do, they have at least been refinancing at lower rates. During the last quarter, they borrowed what amounts to $133 million at a variable rate, currently 4.5%, to be paid down by 2013, to replace $125 million of 9 1/4% notes due 2016 (I assume some of the difference went to loan costs and the rest they kept). They also issued $345 million of 7 3/8% notes due 2018 (which they intend to replace with publicly traded notes by the end of the year, otherwise they will be liable for more interest), to replace their existing notes due 2011 and 2013. These transactions cost them $17.8 million, which is theoretically nonrecurring, but since the company has a large variety of debt outstanding and therefore has to engage in these operations frequently, and also since 2009’s results include a $16.8 million gain from similar transactions, I would not say that these costs are nonrecurring enough to eliminate from consideration. Pity they won’t give the notes convertible at $3.02 this kind of refinancing treatment.

As an aside, I will note that their 10-K is a thing of beauty. Very clear writing and a lot of easily digestible subheadings.

In the final analysis, I do think that the company is offering a very good return on investment and is capable of managing its debt load.

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Investing by grocca