If you look at enough companies, you will find good ones, make money, and cruise towards financial freedom. But every so often, you’ll stumble across an investment that could really move your needle. A game changer, a wealth builder, dare I say a Rule Breaker? Silicom Ltd. (NASDAQ:SILC) is a low cost business, operating in a growing space, run by smart management.
For a business to be truly great, it needs to spot trends, develop solutions to capitalize on those trends, and sell the bejesus out of its product portfolio. And Silicom has been doing that for years. It doesn’t matter if its rising internet traffic, big data, virtualization, or the cloud, Silicom Ltd. (NASDAQ:SILC) has an answer for just about everything. You need a flux capicitor? Forward the request to these guys, they can probably build it.
The product portfolio
Whether it’s a multiport or bypass server adapter, intelligent switches, security acceleration, or wire speed software, Silicom Ltd. (NASDAQ:SILC) has computer connectivity covered. Its also developed a patented server to appliance converter, or SETAC for short. SETAC rocks because it takes a standard reliable server and modifies it so you can more easily connect to the front of the machine. Prior to SETAC, you could only get this flexibility from hardware appliances that weren’t as well made.
But don’t take it from me, here’s what CEO Shaike Orbach had to say,
“Initial market reaction to our unique Nano Time-Stampers has been overwhelming, demonstrating how hot the networking monitoring arena has become in the Big Data era and how outstanding our solution is.”
The deal
Here’s how this business works. Management spots the next big thing. It then tasks its engineers to build something fresh and innovative, to meet a customer’s evolving needs. Once Silicom Ltd. (NASDAQ:SILC) gets its foot in the door, it cross sells other solutions. The best part? It has never lost a customer. Ever. Capiche?
Silicom services more than 90 original equipment manufacturers, most of which, are industry leaders. And while management won’t say who those customers are, there’s no harm in speculating on the types of businesses that may be attracted to Silicom Ltd. (NASDAQ:SILC). In fact, all these heavyweights could potentially eat Silicom for lunch.
1. Cisco Systems, Inc. (NASDAQ:CSCO) is a $120 billion tech titan that offers everything from data center management to security to hardware like routers and servers. Essentially it wants to be a jack of all trades for everything tech. Don’t laugh, Cisco has the cash and industry presence to make it happen.
Now it wouldn’t be surprising to see Cisco Systems, Inc. (NASDAQ:CSCO) buy Silicom Ltd. (NASDAQ:SILC) at a premium to todays price, as its cloud and virtualization solutions could benefit from many of Silicom’s products. If Cisco were to acquire Silicom, just the seamless integration of SETAC onto a Cisco server would generate significant cost efficiencies. Think about it, adding the Silicom hustle to Cisco’s muscle could be transformative for both.
2. Riverbed Technology, Inc. (NASDAQ:RVBD) is a $2.65 billion market leader in WAN optimization. In networks that span wide areas, it’s important to get efficiencies in data transfer. The key here is Riverbed is always looking for ways to increase connectivity and bandwidth.
Since 2009, Riverbed has acquired 7 tech firms whose specialities range from software that analyzes the performance of networks to a satellite optimization provider. For Riverbed Technology, Inc. (NASDAQ:RVBD), Silicom Ltd. (NASDAQ:SILC)’s best in class network appliances and lesser known wire speed software could be on its wish list.
3. Symantec Corporation (NASDAQ:SYMC) books nearly $7 billion a year in revenue and provides security solutions to businesses and companies all over the globe. It’s getting more and more into code signing which makes the software between a provider and customer tamper proof. It also provides a time stamp option that helps indicate when the code was signed.
Look further downstream. What if Symantec Corporation (NASDAQ:SYMC) were to offer big data and network monitoring customers a best in class, state of the art, nano second time stamper? In five years, time stamping may become synonymous with Symantec. When you think security, you should be thinking of time stamping. When you think about time stamping, think Silicom Ltd. (NASDAQ:SILC).
4. Dell Inc. (NASDAQ:DELL) is a mess right now. Whether it’s Michael Dell looking to take the company private or Carl Icahn attempting to force a leveraged recapitalization, there’s not a lot of visibility regarding the future. But one thing is for certain, Dell will continue to exist, it will continue to provide tech solutions, and it will probably make money doing it. We’re just not sure who’ll be cashing the checks.
It’s also a safe bet that Dell Inc. (NASDAQ:DELL) is a Silicom Ltd. (NASDAQ:SILC) customer. How do I know? Go to the Silicom website, look up its products, and you will see a Dell server outfitted with SETAC technology. Once possession of the company is settled, it’s possible Dell may look into building better machines by getting a little more familiar with Silicom.
The hand that guides
CEO and President Shaike Orbach is a very smart dude whose been leading the charge for more than a decade. How smart? Check this out.
During Silicom Ltd. (NASDAQ:SILC)’s infancy, Mr. Orbach realized his customers would prefer to deal with a company that’s financially strong. In May 2007, Silicom privately offered 875,000 shares at $20.50 per share raising about $18 million.
17 Months later, the housing bubble burst, the market got crushed, and Silicom traded for $2.87 per share. Whether Mr. Orbach foresaw a market correction or just stumbled upon some luck, the fact is, Silicom had $40 million in cash with a nonsensical market cap of around $20 million. Despite the times, customer confidence was probably as high as it could be.
Fast forward to present day. Silicom Ltd. (NASDAQ:SILC) has grown into a low cost business, with plenty of working capital, and high profit margins. In a very shareholder friendly move, Mr. Orbach decided to issue a dividend of $0.55 per share or $3.9 million payable this past April. Have you ever heard of tech micro-cap doling out that kind of cash?
Now the numbers
Silicom is a serious growth stock with wicked strong financials. It has increased sales 237% and upped its bottom line by 375% over the last 3 years. Its margins are expanding, costs are contracting, and it has over $50 million in cash on the balance sheet.
Taking its cash into consideration and using a conservative $8 million in free cash flow, Silicom Ltd. (NASDAQ:SILC) needs to grow 11% over the next 5 years, then 6% during years 6-10, before settling into inflation for today’s price to be fair. When you factor in time stamping, SETAC, and the fact that it grew its top line by almost 50% last quarter, those targets seem easy to beat.
A word about risk
Silicom is domiciled in Israel so there’s obvious political risk. And while unlikely, management could suddenly lose touch, miss trends, get dropped by customers, and wreck a good thing. But I think the real risk here is a company like Cisco Systems, Inc. (NASDAQ:CSCO) coming along and scooping up Silicom Ltd. (NASDAQ:SILC) during the early stages of its growth cycle. If that were to happen, investors would miss out on years of outperformance and compounded returns.
The bottom line
Hot markets like Virtualization, Cloud, and Security, are where Silicom lives, breaths, and does business. Management has a track record of identifying trends, building well received devices, and cross selling customers. The end result is a financially strong, low cost business, that’s attractively priced with plenty of room to run. For investors, it doesn’t get much better than this.
The article Smooth as SILC originally appeared on Fool.com and is written by Wade Michels.
Wade Michels is long Silicom. The Motley Fool recommends Cisco Systems, F5 Networks, and Riverbed Technology. The Motley Fool owns shares of F5 Networks and Riverbed Technology. Wade is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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