AMS Osram - It is the hope that gets you
All,
Please find our updated model here.
AMS Osram has no upcoming maturities, and the credit is supported by strong market fundamentals in AMS’s underlying end markets. The equity markets concurs, valuing the Company at c.7.0x FY23 EBITDA and provides c. 3.0x of equity cushion beneath the bonds. Additionally, the Company is expecting to run out of capacity in in the coming years. This is partially behind the new facility, with new technology which could be a step change to the Company’s profitability. AMS continue to spend than this facility in FY23, with production ramp-up expected in FY24. All of this is expectation or hope.
However, the reality is likely to be different in the short term. Operational leverage is double-edged, and the current dampened demand will lead to weakening margins in FY23. The Company guidance, and our model points to deteriorating performance for H1 ’23, driven by dampened demand and high operational leverage which is behind the lower margin guidance for H1 ’23. This leaves AMS Osram a good short candidate.
Investment Rationale:
- We are not taking an active position in AMS Osram at the current time. At current yields, we are not encouraged to go long AMS Senior Notes. The yields, 8-10% range, are insufficient for the current headwinds AMS are experiencing, especially with the weakness in the consumer segment (mobile phones). However, we are comfortable with the growth opportunities within the business, and with its wide diversified segments, we don't foresee any major difficulties for the business.
- We expect that the earnings will disappoint for H1 23 but with the Company not reporting Q1 numbers until 2nd May it is a little early to short the bonds. We have diarised to re-examine our view at the end of March. Re-listening to the Company’s FY22 call and our subsequent call with management, we are confident in our model and leverage will increase throughout FY23 to 5.0x (including the cost of the Osram put). It is unlikely we will receive any concrete indication of a positive H2 23 at the Q1 results in May, with the Company currently guiding a weak H1 and hoping for improvement in H2.
- The documentation of the AMS debt structure could enable the Company to put in additional senior secured debt, but the relatively short-term nature of the bonds makes this unlikely. The Company may have to pursue a refinancing on a senior secured basis, but with a further 3x of market cap beneath the bonds, we would feel relatively comfortable.
Ratings Impact:
- Moody’s downgraded AMS to B1 from Ba3 last September but put the ratings on stable outlook. Moody’s commented that a ratings downgrades potentially on the cards if leverage does not improve, or with margins continuing to be weak. With the production outlook remaining poor over H1 ’23, there is no opportunity for AMS to improve its margin (via higher utilisation rates) and our model does not expect any improvement in margin or leverage stats in the coming quarters.
- S&P confirmed its ratings in October at BB-, Outlook Stable on similar concerns. However, we highlight the potential for upgrades mentioned by S&P in their report. Any upgrade is not expected until FY24, is predicated on the completion of the integration of Osram into the business, the lower integration/restructuring costs which should result in higher earnings. However, the main trigger for the turnaround at AMS is the launch of the 8” LED production facility.
8” LED Facility:
- As part of their Capital Markets Day in April 2022, AMS outlined its plans for a new 8in LED front-end facility alongside its existing LED fab in Kulim, Malaysia, adding significant capacity to support expected growth in advanced LED technologies and MicroLED. The new facility investment is expected to amount to up to around €800 million over the next 18-24 months.
- Although the Company has made progress with this project in 2022, it is unlikely to be in production mode until FY24. The plant is a step change in their production capabilities, and AMS will enjoy first-mover advantages over its peers.
- Note, there are some rumours that PlayNitride, a Taiwanese-listed manufacturer, is mulling building a similar plant, but we were unable to confirm this with the Company.
Management Changes
- AMS has grown historically from an aggressive acquisition strategy. This is still a potential risk, but with the recent changes in management, and focus on the 8” LED production facility, there is a sense that the focus for management has changed. The CEO Alexander Everke will step down as CEO in April, to be replaced by Aldo Kamper. Mr Kamper was the CEO of Leoni since 2018, but prior to that had spent 18 years in differing management positions within Osram.
Additionally, the current CFO, Ingo Bank, is not extending his contract beyond April 2023. His replacement has not been announced.
It is the hope that kills you:
- With expected worsening leverage stats driven by dampened demand, AMS bonds should be a prime candidate for shorting. At current yields, 8-11%, and ratings downgrade potentially ahead we are closely examining the potential to take a short position.
- However, underpinning the credit and equity story of AMS is the undoubtedly strong underlying potential in the markets where AMS operate. There are significant positive structural changes in the market, with significant growth expected in Consumer, Industrial & Medial and Auto in sensing, visualisation and illumination, all segments that AMS participate in.
- AMS is a top 3 player in optical semiconductors, (joint 2nd) and the only player covering all segments. This gives them a unique opportunity to partner with OEMs across all of their optical sensoring requirements.
- More importantly, the opportunity of the 8” production facilities has resulted in a customer agreeing to pre-payment agreements related to future deliveries, underpinning existing agreements. Note, this pre-payment has not been received yet as is not present in their accounts.
- Notwithstanding the underlying future positive catalysts, we are looking at AMS from the short side. At the current time, we are not going to open a short position, but instead, we will look to re-examine the name in late March/April prior to the Q1 results. We will continue to monitor the name and the equity cushion beneath the bonds in the meantime.
Happy to discuss.
Tomás