SoundView Capital

Missed MIPS

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Being pretty focused on mobile Internet, I’ve spent a good deal of time with Qualcomm and ARM Holdings but didn’t see the MIPS Technologies train leaving the station.  And based on our IV analysis, it looks like we are too late.  Still, the situation at MIPS is now one that we will have to watch and add to our coverage of the mobile Internet ecosystem.  The positioning of the company may encourage momentum investors to pile into this one and push it further past our own IV estimates. The company reported a good quarter last night and is indicated up another 10% this morning even after the strong run that it has had.

So what is the positioning?

MIPS has been around since the mid-1980’s when there was major debate around Complex Instruction Set Computing (CISC), with the Intel x86 architecture being the primary example, and Reduced Instruction Set Computing, which had a number of players, including ARM, which some might say eclipsed MIPS in terms of overall success.

Overall, one would have to say that the x86 approach has won out in desktop and server computing.  Apple was one of the last mainstream users of RISC architecture based on the PowerPC instruction set from IBM.   However, the market for processors outside of desktops, laptops and servers is massive and growing rapidly.  Processors are embedded in communication gear, TVs and set-top boxes, automobiles, medical devices, appliances, etc.  And there are now myriad companies making embedded processors for all of these markets.

The key is that all these chip makers need to decide on a standard instruction set so that their chips can be easily programmed and integrated into designs.  The market has boiled down to four: x86, PowerPC, ARM and MIPS.  Both ARM and MIPS can be viewed as “pure play” companies in the embedded market.  Both follow a licensing model whereby chip makers license the designs so that they can make devices that support the architecture and instruction sets that end-market customers require.

The rise of the smartphone has raised the stakes and the interest level in this market.  Up until recently, MIPS has been a fairly quiet and ignored player compared to ARM.  However, the company hired a new CEO from Cavium, a networking chip supplier that has become a very hot stock (sporting a $1.3B market cap and a 12x price/sales multiple as I write this.)  Cavium is a MIPS licensee so the CEO has gone in with both eyes open and a vision for the company.

Thanks to an improvement in the underlying business and some stated goals to become a major player in the smartphone market MIPS is being looked at differently.

Maybe we missed it, maybe we didn’t…

The first stop for me in looking at MIPS was to crank out a quick Intrinsic Value which came to $11.70.  Thanks to the strong report last night the stock should run past that figure today.  But I’ve upped it on our watch list within the mobile Internet segment of our ecosystem.

Looked at another way, though, it might be tempting as either a takeover target or a pairs trade (short ARM, long MIPS) here.   For example, ARM has a market cap of just over $8B and is trading at about 16x sales.  On a relative basis at least it makes MIPS look cheap with a $440M EV and a 5.6x TEV/sales ratio.  So a pairs trade here makes sense.  And for any player wanting to get into this market an acquisition of MIPS is pretty manageable and well under $1B at this point versus the possible $10B needed for ARM.  MIPS looks less risky with more upside for an a buyer on that basis.

[Disclosure: none at the time of this writing]

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