1 Thing That's Hurting Silicon Motion Technology Stock

Markets Motley Fool

On July 30, Silicon Motion (NASDAQ: SIMO), a company that provides controller chips for NAND flash-based storage products, reported its second-quarter financial results.

Continue Reading Below

At a glance, the results weren't great: Revenue hit $132.7 million, representing a 6% year-over-year decline, and operating income dropped to $30.27 million, a reduction of 16.4% from the year prior.

During a conference call with analysts, management tried to explain why last quarter's results weren't that great, how long the negative impact is expected to last, and more.

NAND flash shortage hurting Silicon Motion

Silicon Motion CEO Wallace Kou explained that the market for NAND flash "continues to be very tight."

The executive went on to say that this shortage in NAND flash is a "temporary issue" as the major NAND flash manufacturers move from tried-and-true planar NAND flash to "new 3D [NAND] technology."

Continue Reading Below

This shortage, Kou indicated, is putting a lid on the growth that the company can deliver, even though the company says that it has a "strong pipeline" of design wins along with a "growing portfolio of unique solutions."

For some context, a modern flash storage device consists of, among other things, NAND flash as well as a controller chip that handles how data is read from and written to the device. Silicon Motion doesn't make the former, but it makes the latter.

Why, then, is a tight NAND flash supply environment bad for Silicon Motion?

In an environment where demand for NAND flash dramatically exceeds supply (as seems to be the case now), the NAND flash vendors naturally raise prices to try to bring supply and demand into balance.

This is good for the NAND flash makers because, even though they're not selling as much NAND as they could, they can charge more for a given amount of NAND, boosting their gross profit margins.

Unfortunately, the same doesn't hold true for a company like Silicon Motion.

If NAND flash is limited, then the number of solid-state drives incorporating that NAND flash sold becomes bottlenecked by that limited amount of NAND. This means that the solid-state storage drive makers will ship fewer drives than they would in a more relaxed supply environment, which ultimately means fewer controllers shipped by companies like Silicon Motion.

To make matters even worse for Silicon Motion, Kou indicated that this tight supply environment has led the NAND flash drive makers to shift more of their NAND flash supply toward their enterprise solid-state drives and away from their client-focused (e.g., personal computer) drives.

Silicon Motion's business is heavily exposed to the client solid-state drive market and currently has limited exposure to the enterprise solid-state drive market, further exacerbating the problem for the company.

And now, the good news

Kou said that the NAND flash shortage not only impacted the company's second-quarter results, but it's going to take its toll on the company's financial results during the second half of the year as well.

The good news, though, is that management expects its "growth to start to rebound" by the end of this year.

This rebound, he said, should be driven by a couple of factors. First, as 3D NAND flash makers start building 64-layer 3D NAND chips that can store 512 gigabits of data (a gigabit is 1 billion bits), twice as much as what the currently in-production chips can hold, industry bit supply should grow.

"And, in a few quarters' time, as the industry supply accelerates, this headwind should turn into a tailwind," Kou asserted.

Additionally, Silicon Motion CFO Riyadh Lai said that the company's board of directors has green-lit a new $200 million stock buyback program to take advantage of "a unique opportunity for [Silicon Motion] to repurchase [its] shares."

Even more interestingly, Lai said that Silicon Motion executives -- including Kou -- have "notified our company that we intend to buy our shares subject to compliance with relevant laws, regulations, and policies."

Time will tell if management is right about an imminent rebound, but at the very least it's putting its money where its mouth is.

10 stocks we like better than Silicon Motion Technology
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Silicon Motion Technology wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of August 1, 2017

Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.