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Investment Thesis
Buying the common share of AXTI, Inc (NASDAQ:AXTI) today for $6.31 offers a massive margin of safety because the pre-IPO share price of AXTI’s subsidiary Tongmei is $16.6. Due to delisting risk, the market has penalized AXTI with a price drop of more than 60% in the last 12 months. If AXTI is delisted to OTC, the downside is protected by a liquidation value of $2.96 and the company’s economic moat.
AXTI first announced the details of its Tongmei IPO in November 2020, and its share price reached a high of $15.75 by Feb 2021. In late March 2021, the SEC announced its plan to delist China base companies whose auditors cannot be fully inspected by the Public Company Accounting Oversight Board (PCAOB). Although AXTI has continually been audited by accounting firms that comply with the PCAOB, its share price has drop alongside with the other non-PCAOB compliant Chinese companies. This is a strong indication that the share price of AXTI can easily reach the Tongmei IPO price without delisting risk in the US.
Company Overview
AXTI was last written on Seeking Alpha by Small Cap Chap and Brandon Ferro, who provided an in-depth discussion of AXTI’s business. In the past four years, AXTI has successfully executed its plan to become a global leader in the production of alternative wafers by using the most advanced technology from the US, and strategically building a reliable supply chain through ownership of raw material companies. The company also has a long, low-cost production history in China.
Products
1. Indium Phosphide (InP) Wafer
InP Wafers are used in Biometrics, Data Centres, and 5G networks. InP Wafers benefited from the expanding 5G users in China. According to Global Times China, China now has the most 5G users worldwide, with only a 41.7% adoption rate. According to verified market research, world production of Inp Wafer in 2021 was $108 Million. On the most recent Earnings Call, AXTI accounted for more than 50% of the market share in producing InP Wafer, with a 2022 Q1 Sales Volume of $15.1 Million.
As stated in AXTI Investor’s Presentation, AXTI is one of the three leading producers of Inp Wafer, and the other is Sumitomo and Japan Energy. The Inp Wafer accounted for 38% of AXTI’s total Revenue.
2. Gallium Arsenide (GaAs) Wafer
The applications of GaAs Wafer include LED Lighting, Industrial Laser, and 3-D sensing. AXTI is also a leader in GaAs Wafer production. According to market watch, the global production of GaAs Wafer was $273 Million in 2021. AXTI captured 17.6% of this market, 2022 Q1 Revenue from GaAs Wafer totaled $12 million, accounting for 30% of Total Revenue.
3. Germanium Wafer and Raw Material
Germanium Wafer is used mainly in Satellites and Drones. AXTI also owns raw material companies. These products of AXTI generated $12.1 Million Revenue in 2022 Q1.
Economic Moat
1. Low-Cost Producer
As claimed by Investor Presentation, AXTI has a long manufacturing history in China, dating back to 1998, allowing the company to develop a stable and satisfactory working relationship with the Chinese Government. In contrast, the company’s Inp Wafer main competitors, Sumitomo and Japan Energy, are both based in Japan. Furthermore, its GaAs Wafer competitor Freiberger is based in Germany with much higher labor costs.
2. Superior Access to Raw Material
As of 2022, AXTI owns ten raw material companies in China. This strategy has allowed AXTI to better secure raw material needed to produce wafers and gives AXTI the most up-to-date information on its input. Moreover, during the Earnings Call, Dr. Morris Young commented that AXTI’s lead time is only eight weeks compared to its competitor of 6 months.
Valuations
1. IPO in China (Price Target of $16.6)
Chinese companies listed on OTC in the US with the same level of short-selling restrictions in China have an average arbitrage spread of 4.4%. The Law of One Price holds in China-based dual listing companies, making the IPO price of Tongmei a suitable price target for AXTI.
| Ticker US | Market Cap in the US | Ticker China | Market Cap in China (Converted to US Dollars) |
Shortable in China |
| ACGBF | $118 Billion | SS:601288 | $156 Billion | No |
| ALBHF | $9.5 Billion |
HK:0241 |
$9 Billion | No |
| JDCMF* | $99.5 Billion | HK:9618 | $93.7 Billion | No |
*(OTCPK:JDCMF) trades on NASDAQ under the symbol (JD); JD was called out by the SEC for potential delisting.
Source: Author’s Work
In the July 2022 press release, the company received IPO approval from the Shanghai Stock Exchange. Upon the final approval from China Securities Commission, the company expects to complete the Tongmei IPO in 2022. Moreover, the per-share value of pre-IPO price based on page 5 of 2021 Form 10K can be computed as follow:
Investors in China paid about $50 million pre-IPO capital to acquire 7% of AXTI; this computes to a total market value of $714 million. With 43 Million diluted shares outstanding, we arrive at a per share valuation of $16.6. This $50 Million is received by AXTI and recorded as Redeemable Non Controlling Interest on its balance sheet.
2. Liquidation Value (Expected Bottom Price)
Brandon Ferro last mentioned this topic on Seeking Alpha in 2016. I am using a similar approach here. We add Cash & Short Term Investment ($34.9 Million) to 50% of Account Receivable and Inventory ($108.6 Million) and Building at Cost & Construction in Progress ($146.5 Million) minus Total Liability, Redeemable Non-Controlling Interest from China and Preferred Share ($109.4 Million) to arrive at a liquidation value of $126.3 million divided by 42.6 million diluted shares to get a per share bottom liquidation value of $2.96. Including Building at Cost and Construction in Progress makes sense because China generally has a solid building and house market. In addition, the market value of its building is probably much higher than its cost, making this liquidation value estimate of $2.96 a conservative measure.
Financial & Stock Price Performance
AXTI’s financial performance is astonishing due to a tailwind of increasing demand for its products despite China’s Zero COVID Strategy.
| 2022 E | 2021 | 2020 | 2019 | 2018 | |
| Revenue Growth | 15% | 44% | 14% | (19%) | 4% |
| Net Profit Margin | 10% | 10.5% | 3.2% | N/A | 9% |
| EPS | 0.42* | 0.34 | 0.07 | -0.07 | 0.24 |
| Closing Price Per Share on December 1. | $5.86** | $8.81 | $9.77 | $4.35 | $4.35 |
| P/E | 14 | 25.9 | 139.6 | N/A | 18.12 |
* Forward P/E retrieved from Seeking Alpha on June 30, 2022.
**closing price as of today on June 30, 2022.
Source: Author’s Work
AXTI is currently trading at a P/E of 14, the lowest multiples in the past five years while AXTI is having its best year fundamentally. 2021 Revenue is at all times high of $137 Million and record Earnings of $14.1 Million. AXTI has invested a total of $112 million in Capital Expenditure from 2018 to 2021, and I believe we are now seeing the fruit of the investment. 2022 guidance shows a continuation of Revenue and Earnings growth in the range of 15-20%, and leverage risk is primarily eliminated by having a liquidation value of around $3.
How can AXTI investors in the US benefit from IPO on STAR
1. Buy AXTI today at a discounted price and wait for the spread to diminish
A more straightforward approach is to buy AXTI today and waits for the spread to diminish. The downside risk is protected by solid fundamental performance and a P/E of 14 compared to a P/E of 20 on the NASDAQ. The upside return is at least 163% because I expect the fundamental value to increase while I wait for this to play out. Using Luckin Coffee Inc. (OTCPK:LKNCY) as a case study, this company was delisted to OTC in 2020, offering a bargain entry of $1 compared to its IPO price of $17. In the past two years, LKNCY’s share price increased to a high of $17.5 in 2022. A whopping 17 bagger!
2. Wait for Cash Offer or Relisting
According to Nikkei Asia, the SEC announcement of potentially delisting more than 100 Chinese companies listed in the US due to auditing rules, “many China-based companies are exploring the strategy of going private in the US with the goal of re-listing in China.”
In this press release, 58.com Inc. (WUBA), a leading online classified marketplace company, went private in 2020. WUBA paid US investors $56/share in cash, a premium of 20% to its trading price. As stated in Himalayas Research from Seeking Alpha, this $56 offer is already the highest possible based on the company’s historical valuation multiples. For instance, the P/E of the offered price is 17.5 compared to the historical average of around 18. Using 58.com Inc. as a case study, AXTI has a historical average P/E of 60 compared to the historical high P/E of 80 on STAR. With an EPS estimate of $0.42, as shown on Seeking Alpha, the going private cash offer could be valued at $25.2, providing a handsome return of 330%.
Investors can find another case study in DiDi Global Inc (OTCPK:DIDIY), recently delisted from the New York Stock Exchange to re-list in the Hong Kong Stock Exchange. DiDi’s share price has dropped more than 60% from its high, and it is still available for purchase via the OTC market.
The possibility of a cash offer in going private or re-listing is pure speculation for AXTI, but it is an expected trend mentioned on Bloomberg last year.
Insider Transactions
Evident by the 2022 Proxy Statement, the CEO, Dr. Morris Young, and the CFO, Gary Fischer, get paid mainly from stock awards. CEO received half a Million cash and close to $2 Million in stock awards, while the CFO received $0.3 Million cash and $0.7 Million in stock awards. The CFO and the four other directors held onto their awarded stock shares for the past two years.
The CEO is the only insider who sold a small position of 40,000 shares at around $9.7 in Aug. 2021 to fund the acquisition of 100,000 shares via awarded stock option at an exercise price of $3.06 in Sept 2021. I view insider transactions as a positive in AXTI because, overall, the insiders are holding onto their shares. Two other institutional investors are Dimensional Fund and Black Rock. Together they owned about 13.3% of AXTI’s common share, acting as activists in AXTI.
Risk
1. Value of Time
The SEC has set a deadline in 2024 to delist any non-compliant Chinese companies. As shown in the case of Luckin Coffee, it could take another two years for the share price of AXTI to reflect its true fundamental value if AXTI is delisted to the OTC. This trade could take more than four years, and there is no guarantee that this trade will work out at all. Nevertheless, I believe AXTI is suitable for a long hold due to its exemplary financial performance while waiting for this trade to work out.
2. Delisting Risk
Similar to other China-based companies listed in the US, AXTI could face the threat of delisting from the SEC. AXTI was penalized by investors for dropping more than 60% in price, a level that is seen in DIDIY. I would be glad to buy more shares of AXTI at an even more discounted price on the OTC as long as the company continues to deliver the same fundamental values.
3. Tongmei’s IPO Fails
Since the Shanghai Stock Exchange has approved this IPO, Tongmei has a very high chance of being approved by the China Securities Regulatory Commission, as mentioned by the management in the most recent press release. Even if this IPO fails, I believe AXTI deserves a P/E multiple of 22, as seen on the OTC. This translates to a target price of $9.24, which still offers an upside of 46%.
Catalysts
1. Successful IPO of Tongmei.
2. AXTI continues to deliver strong results by being the leading player in alternative wafer productions.
3. AXTI is delisted onto OTC and the spread between AXTI and Tongmei diminishes overtime.
4. SEC finishes delisting all delistable Chinese companies before 2024 and AXTI continues to trade on NASDAQ because the company continues to use PCAOB compliant auditors.
Conclusion
The current tensions between regulators in the US and China create an opportunity for bargain hunting among China-based companies, and I believe AXTI is in bargain territory. AXTI continues to benefit from a growing market of the alternative wafer, and AXTI continues to reinvest its earnings into expanding its economic moats. In the absence of delisting risk accompanied by Tongmei IPO price fully disgested in the US market, AXTI traded near Tongmei’s pre-IPO price of $16.6 in Feb 2021. This indicates the Law of One Price holds in AXTI. The 163% spread in AXTI and Tongmei is unusual compared to the 4% spread of other China-based dual listing companies without delisting risk. Even if AXTI is delisted to the OTC, the share price should reflect its stellar fundamental value in its OTC share price over time. The current price of AXTI at $6.31 is an attractive buy.
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