Ams-OSRAM AG: A Major Risk Has Materialized (OTCMKTS:AUKUF)

Just when ams-OSRAM AG (OTCPK:AUKUF;OTCPK:AMSSY) seemed to have found its footing, it was yet again hit by major bad news. One of the most important, if not the most important, projects was cancelled by the customer, thereby rendering a brand-new factory in Kulim, Malaysia virtually obsolete. To add insult to injury, ams appears to be stuck with substantial lease liabilities for the time being, after selling the buildings to investors in anticipation of a large contract to produce state of the art 8-inch microLEDs. The stock market reacted as one would expect it to react: by sending the stock tanking. At the time of writing, it still trades some 28 lower than when I last covered ams. In this article, I will assess how the recent developments impact the investment thesis.

Going forward, I will refer to the company as “ams” in the interest of brevity. Also, kindly note that all per share numbers are on a pre-split basis (the company has proposed a 10:1 reverse split, subject to shareholder approval at the general meeting on June 14^th; cf. item 7 of the agenda).

Malaysia Factory Rendered Obsolete

Following the cancellation of a “cornerstone microLED project”, ams wrote off €513 million of related to its almost completed Kulim facility. This, basically, is a polite way to say that the facility is a sunk cost. Instead of commencing operations later this year, the factory remains empty for the time being. On a more positive note, the company will at least save some capex that way. The (non-)customer in question is rumored to have been Apple Inc. (AAPL). Back in February, I warned, that “It would not be the first time for Apple to replace a supplier”. As it turns out, I may have been right to worry. I assume that it will be rather hard to come up with another party to sell the lease of the facility, too. There may, however, be a possibility for ams to claim damages from the customer in question and/or terminate the lease agreement. Unfortunately, I have no insight into any of the relevant contracts and can therefore not make any predictions in this regard. As of the release of the Q1 report, an exit was “being pursued”.

Valuation

Naturally, the aforementioned developments have a significant impact on ams’ future profitability and therefore, by extension, its valuation. The company had initially forecast an operating margin of 4 to 7 percent. The actual Q1 figure came in about the middle of that range at 5.2 percent. Revenue, too, came in pretty much in the middle of the estimated range of €800 million to €900 million at €847 million. Q2 revenue is expected in a range of €770 to €870 million. Annualizing these numbers, and under the assumption of an operating margin in line with Q1 – the previous 15 percent target is presumably off the table for the time being – I would expect an annualized EBIT somewhere in the vicinity of €190 million. As I have explained previously, I expect interest expenses to rise rather than decrease (from €187 million in 2023). In other words: most, if not all, of EBIT will presumably be eaten up by interest payments for the foreseeable future. Tellingly, ams underlines its expectation of positive FY2024 free cash flow excluding net interest paid. This is great – if you do not have to pay interest.

Absent the revenue from Kulim, ams also lowered its mid-term revenue growth targets to now 6 to 8 percent CAGR. If those targets are met and under the assumption of an improvement in operating margins to around 10 percent, annual net profits could reach €150 million to €200 million within two to three years. For that to happen, the interest expenses would have to not rise materially, which realistically requires the 0 percent convertible bonds maturing next year (outstanding amount: €447.4 million) to not be refinanced. So all in all, this is a very optimistic scenario. Based on these generous best case assumptions, the company would currently trade at a forward earnings multiple of 7 to 10 times in the mid-term. This would be a fair valuation. But once again: these are very optimistic assumptions.

Risk Profile

Back in February, I cited the “inability to land a big contract” as a major risk. That risk, obviously, has materialized by now. As a consequence, that also leaves the company more reliant on the automotive business. Parts thereof, in particular those relating to new vehicles, are inherently cyclical. Unfortunately, management has little influence on macroeconomic developments, and the car market is not exactly displaying a positive dynamic right now. There is also still the issue of execution risk. Ams cannot afford any major misses if it is to cover its interest expenses. One or two weaker than expected quarters may easily put the issue of an additional capital raise back on the table. Ams reported cash and equivalents of €1.1 billion as of March 31^st. This should suffice to cover 2025 maturities. It should, however, be kept in mind that even without the Kulim factory, there will be capex. For example, the company intends to invest a total of €558 million (200 million of which it hopes to bag in EU Chips Act subsidies) to expand capacities in Styria by the end of the decade. On the other hand, the company’s Passive Optical Components business was recently sold for €45 million. So, all in all, there is little room for error.

Conclusion

There is no way to sugarcoat it: ams is in trouble. With the growth strategy in shambles and operating profits barely covering interest expenses, there is little to no room for further misses. Yet another capital raise has become a good deal more likely, in my opinion. At the now lower price, the dilution would be even more punishing. Even under fairly optimistic assumptions in terms of performance over the next couple of years, the stock would not have much upside, merely justifying its current valuation.

Naturally, the company may come up with a new plan to generate significant growth going forward. If and once that is the case, the investment thesis would have to be reevaluated. It is also not entirely impossible that the rate environment shifts in ams’ favor by early 2025. But for the time being, I am downgrading my rating of the stock to a sell.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.