Magnachip Semiconductor Corporation (MX) Earnings Call Transcript & Summary

Okay. Welcome to Day 1 of Citi Virtual Technology Conference. My name is Atif Malik. I cover U.S. semiconductors and equipment stock here at Citi. It's my pleasure to welcome YJ Kim, CEO of MagnaChip; as well as Young-Soo, CFO at MagnaChip. I'll open it up with my questions first, and then we'll have the audience type in their questions via Zoom chat. Welcome, YJ.

YJ, MagnaChip completed the sales of Foundry Services Group last week. Can you remind us with the financial details of the transaction?

Yes, thank you. So we announced the successful completion of Foundry business and fared for sale on September 1. The purchase price, approximately $350.6 million including working capital adjustment of approximately $5.9 million. Buyer assumed all severance liabilities of approximately $100 million relating to the transfer of the employees. We also announced our plan to use $227.4 million of the net proceeds to fully redeem all of its outstanding 6.625% senior notes due 2021.

Great. YJ, it's a truly transformative change to sell foundry business, which will help unlock significant earnings power for the company in the long run. And how does it look like once the impact is fully reflected?

With our new sharp focus as a pure-play product company with fabless and fab-light model and an improved balance sheet, we are repositioning the company that will deliver sustainable and profitable growth. From 2020 to 2023, our goal is to achieve double-digit CAGR growth in revenue, above 30% gross margin and above 10% adjusted operating income margin. In addition, by Q1 of 2021, we will eliminate $21 million of interest expense. We have been communicating some pro forma items as we gain visibility quarter after quarter. We will continue to do so in the next earning call. By the Analyst Day, we plan to share key pro forma metrics and details on strategies.

Great. And Young-Soo, one for you. It looks like that you can pay off the debt and your business model can generate a steady cash flow. What is the plan on capital allocation?

Currently, our board and management are evaluating all available options to maximize our shared value, whether it is investing in the organic growth or adding inorganic growth opportunities and returning to shareholders. We are starting the cash use with delevering our balance sheet. And also, we are establishing our Fab 3 with some capacity expansion. And we will share more details of our plan, how we are going to use the cash during our Analyst Day, which is scheduled on November 12.

Great. And YJ, if you could add more color on growing at double-digit compound annual growth rate from 2023 and what are the biggest drivers of that growth.

Suppose our Display and Power business are well-positioned in the attractive markets where secular growth trend is a tailwind. For display, the OLED, DDIC, Sam is projected to grow at 15% from 2020 to 2023, driven by continued OLED adoption in smartphones and OLED penetration into new applications such as automotive, TV, wearables and PC and tablets. For the power business, we plan to further expand high-growth applications including industrial, automotive with our premium products. Also, there is a tremendous opportunity in China as our market share is only less than 2%. In addition, we are open for any options to layer additional growth opportunity. We may consider inorganic growth options that are synergistic and gross margin and EPS-accretive if the right opportunities present itself.

Okay. And maybe let's start with your Display segment first. What do you see in the smartphone market today as we recover from COVID-19 from both supply and demand disruption? Are you seeing an impact from second and third waves of COVID-19 to your customers' demand? Or is the worst behind us?

I mean I cannot tell how the market will shape, especially with COVID-19 second waves or so on. But I can assure you that as a socially responsible global corporate citizen, MagnaChip has implemented critical measures to protect employees' well-being and secure our supply continuity for our customers. In terms of smartphone demand, in July, we said we experienced an upswing in demand, which is outstripping our supply capability in Q3 because of insufficient lead time. Our standard OLED DDIC lead time is 2.5 to 3 months. Typically, Q3 is the peak season, followed by a softer Q4. However, if this rise in demand continues, we may see a stronger than typical Q4. We will see how it progresses for the next few months.

Okay. And then speaking about the smartphone demand, how do you see the recent Huawei export ban or the U.S.-China trade tensions in the semiconductor impact your business at all. Over the weekend, we heard that the U.S. might put SMIC on the entity list, which will prevent it from getting equipment. So how does the China dynamics impact your business?

So first of all, we sell drive IC to Korean panel makers who then embed our DDIC to their panels and provide them to multiple smartphone makers. Although Huawei is not our direct customer, it has a big part of smartphone ecosystem, which makes the near-term smartphone market even more uncertain. Consequently, we have seen reports forecasting other Chinese makers like Xiaomi, Oppo, Vivo to start gaining share in China and maybe in 2021 onwards. We also see Korean phone makers regaining the momentum. All of these makers are using panels with our chip for some of their smartphone models. The market will eventually adjust and balance with share shift. Beyond the near term uncertainty, the OLED smartphone market remains very attractive. And as a technology leader and long-term viable supplier, we are well-positioned to capitalize on the secular market trend.

Great. YJ, recent third-party report showed more than 30% share in the OLED smartphone, DDIC non-captive market, which is a first for MagnaChip. Can you give us more color on the market share data?

Sure. The most recent market data published by Omdia indicated we are #1 non-captive OLED smartphone driver IC maker in the unit basis in Q1 2020 with 33% market share. However, the #1 was Samsung, who took the majority number of -- majority market share, which leaves very little for the other makers. Now thanks to our strong relationship with the key customers, our share has been growing continuously: 24% in Q2 '19, 27% in Q3 and 32% in Q4 in 2019. In the dollar basis, though, our market share is lower than 33%, which provides us with additional growth opportunity in terms of dollar, if we get into better high-end models. With our market leadership and technology advancement, we can benefit from continued OLED adoption in the smartphones.

Great. What has driven your success in this market? What is MagnaChip's competitive advantage and -- in the OLED driver market, particularly? Because if I look at your history, you've had success in Korea in the past, but now you're making more inroads in China. And what makes it sticky this time?

Well, so as you said, we are the pioneer in the OLED DDIC since 2003. That's -- we're kind of Samsung and LSI internal supplier. And so we have a very strong record of technology. At the same time, because of our early lead and the design capability, we can design the analog portions more than anyone else. So what does that mean is that if you design the same chip in the same process node, our die is smallest, which turns to best power consumption. On top of that, the Samsung and MagnaChip have their own IP in terms of the process. So what this means is that when we actually qualify foundry externally, we actually send out process engineers to optimize the OLED process. We also understand the OLED panel manufacturing because we've been doing this for almost 20 years. And along with that, we have a patent granted by Korean government to be the best patent in 2015 that optimize the OLED design cell at the smallest level. So combination of 10 to 17 years of OLED technology, design know-how and customer relationship with superior engineering, that translate to our competitive advantages. And our success is definitely driven by clear mission that is empowering our customer by accelerating our technology advancement.

Great. You recently mentioned reestablishing your Fab 3. Can you provide some detail on what is required in terms of CapEx and what customers and outcome are you expecting?

So before we sold the Foundry business, our next-gen R&D and QRA lab was for -- in Fab 4, because we had share of the Fab 4 for both Foundry as well as product business. And at the same time, the data center was in the R&D building next to the Fab 4. Now we will be dedicating Fab 3 for our products, especially Power business. So as part of the separation, we now have to reestablish the data center and QRA lab for the Power business and also establish the Power process R&D to Fab 3. So that will require $21 million onetime investment this year. And adding the recurring maintenance level of about $13 million to $14 million annually, so total CapEx this year will be about $35 million. Next year, we plan to completely reestablish Power and Fab 3 for full and expansion of Fab 3 output. This will require special onetime investment of $22 million. And with the recurring CapEx, $13 million, $14 million, total CapEx next year will be also around $35 million. This investment allow us to pursue a revenue potential that equates to a payback period of less than 3 years. One of the key segments we are targeting is automotive, as you know. That also requires your own fab, and therefore, the Fab 3 is very strategic and critical. And customers expect us to have that fab for both the automotive as well as our premium Power Display product lines. In addition, we will consider external foundry services once we reach our full capacity as well as other product that is purely fabless like Power IC.

Great. YJ, a question on the pricing. We have been hearing that the panel pricing is going up perhaps because of the supply tightness. Can you talk about your pricing dynamics in terms of flexible drivers or rigid OLED? What are you seeing in the pricing dynamics?

We don't really monitor the panel prices. But I can say you that in July, we had more demand than what we can supply for Q3. So we've been working hard with our suppliers, try to meet some of the robust demand. So -- but as far as the panel prices of that, that's not in our domain. So -- but I can tell you what's happening to us.

Great. And then on the -- in terms of the drivers, I think one driver that you have highlighted in the past has been gaming in the smartphone market where you require 120 gigahertz speed. Can you talk about gaming being a driver for not only smartphone market but as well as OLED adoption?