International Quantum Epitaxy: Acquisitions Prove Their Worth

Solid H1, but short-term headwinds
International Quantum Epitaxy, (IQE) started the year solidly with acquisitions driving 84% growth in sales in H1 and EBITDA growing 162%. The company solidified its position in Wireless and brought CPV Solar closer to volume production. Adverse currency movements and the risk of disruption from poor performance at Blackberry and softening of the smartphone market in general, create headwinds for H2, prompting a 7% reduction in our FY sales estimate, although this is largely offset at the earnings level by lower costs. The medium- to long-term picture remains positive.

Acquisitions prove their worth
Revenue for H1 was up 84% to £63.0m as a result of significant contributions from RF Micro Devices (RFMD) and Kopin assets. Organically we estimate there was a decline in revenues, but this is likely largely due to shifts in market share to the acquired businesses rather than a decline in the overall market. The acquisitions should make IQE more driven by end-market movements rather than shifts in market share. EBITDA was up 162% to £10.5m and net debt is down to £37.7m from c £40m immediately following the Kopin acquisition. The RFMD deferred consideration discount was slightly higher than estimated at £6m, reflecting strong performance by RFMD. This is expected to decline over time as RFMD moves to new products with reduced discount, but a £6-7m discount for H2 is expected.

Wireless drives growth
Growth has been driven largely from the core wireless division, where the RFMD and Kopin transactions have projected IQE into a strong leadership position. IQE’s RF customers have also reported robust trading and outlook, but the uncertainty in the wireless supply chain, particularly given the situation at Blackberry, may well have an impact on trading. Adverse forex movements have added a further headwind, although this is offset by lower than forecast expense contribution from the Kopin and RFMD acquisitions. Our adjusted FY13 EPS therefore remain unchanged at 2.0 per share. The medium- and long-term opportunities remain strong, particularly with respect to CPV and optoelectronics.

Valuation: Discount valuation with scope for upside
IQE’s rating of 12.1x FY14 earnings is at the low end of its peers and does not price in the potential upside from CPV and opto-electronic opportunities. Synergies from the RFMD and Kopin acquisitions are still to be fully realised and should boost earnings further. We see progress in opto-electronics and CPV solar, and reduction of debt through organic free cash flows as being the key catalysts for upside.

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