Why We Can't Reconcile 40% Of Monolithic Power's (MPWR) Revenue After An Investigation Of Its China Presence

Summary

MPWR is a U.S. listed and HQ'ed semiconductor company, but we estimate 90% of its production and 58% of its sales are in China.
China tax filings show a $262m revenue discrepancy and margins almost 20% lower than reported in SEC filings. Inventory is bloated at 180 days vs. 106 days for the industry. Minimal inventories in China were reported.
MPWR has a remarkable ability to rarely miss financial results, and gross margins are stable and grow with remarkable consistency. A former employee we spoke to raised concerns about inventory dealings with distributors
MPWR dismissed its auditor in March 2019. It shared the same engagement partner as Super Micro, which is delinquent in its filings and investigating revenue recognition issues.
MPWR trades at the highest multiple in its industry on the belief: 1) Its financials are accurate, 2) 20% sales growth is sustainable, and 3) It's a takeout target. Our research challenges each assertion.

Report Entitled: "Powering Down Fab-U-Less Earnings”

Spruce Point is pleased to issue a unique investment research opinion on Monolithic Power Systems, Inc. (MPWR or "the Company"), a designer and manufacturer of power management solutions. The report outlines why we believe shares face 75% - 85% downside risk to approximately $21 to $35 per share.

Despite being headquartered and publicly listed in the U.S., MPWR operates largely as a foreign company with ~90% of its production, and 58% of sales reported in China. After a close on-the-ground and forensic financial investigation, Spruce Point finds evidence that suggests $245 - $265m (~40%) of its China sales being irreconcilable.

The full contents are available on our website . We will have exclusive content and updates on Twitter @sprucepointcap

Irreconcilable Revenue And Worrisome Inventory Bloat:

MPWR, a company citing two material weaknesses immediately preceding its IPO, claimed $335m of its 2018 company-wide revenue (58% of total) to be domiciled in China. However, the tax filings of its three Chinese subsidiaries show revenue of only $73m and gross margins of 35.9% – materially below the 55.6% documented in its consolidated financial statements. Notably, these tax filings show almost no inventory domiciled in China at year end 2017-18 despite its China-centric production footprint and large number of Chinese customers. The magnitude of the disparity between these two sets of statements is highly unusual and suggests that at least one is likely to be inaccurate. MPWR inventory days have also ballooned to ~80% above the industry average – a red flag that has foreshadowed two accounting scandals in the semiconductor industry (Sipex Corp and Vitesse Semicondutor). We believe that these concerns should give investors significant pause as to the potential risks involved in owning MPWR shares.

Large Undisclosed Customer Relationship Appears To Be On Shaky Terms:

Our analysis suggests that 17% of MPWR’s revenue is tied to Microsoft ( MSFT ) – a relationship which isn’t explicitly disclosed in its financial statements, despite the potentially material risks it may pose to the company. Based on disparaging public comments made by CEO Hsing directed at the “gaming” industry, MPWR does not appear to respect the Microsoft relationship, and could stand to lose the business over time as Microsoft looks to diversify suppliers. Our analysis suggests that Microsoft has single-handily kept MPWR’s consumer segment afloat in recent years, amplifying the risks facing MPWR as its relationship grows increasingly tenuous.

A Culture Of Weak Financial Controls And A Suspicious Auditor Dismissal:

Our interviews with company formers reveal that MPWR’s CEO Hsing has little patience for financial and audit professionals. Both roles have seen meaningful turnover since the IPO, and the circumstances surrounding these exits (including the recent dismissal of its auditor of 20 years in March 2019) should be cause for investor concern. MPWR shared the same audit engagement partner with Super Micro (OTCBB: SMCI ), a company that is undergoing and investigation, and delinquent in filings. We worry that poor financial oversight, combined with questionable capital allocation decisions – notably, expensive real estate purchases – could pose a serious threat to the financial health of the business.

Governance Not A High Priority According To Our Research. Key Board Members Linked To Controversial Companies:

Founding Shareholder and Board Member Chang Kuo Wei (Herbert) Chang : MPWR’s largest shareholder at IPO, Herbert rapidly cashed out but remains on the Board. His involvement with prior public companies, including Oplink Communications (OPLK), BCD Semiconductor (BCDS) and Marvell Technology (MRVL) all merit significant scrutiny. Chang entities and associates have been linked to offshore companies in the Panama Papers

Audit Member Douglas McBurnie : Served on MPWR’s Board 2007-2014, and failed to disclose in his biography that he was Chairman of Sipex Corp (Nasdaq then Pink Sheets: SIPX), a California based semiconductor company. As noted earlier, Sipex restated revenues 35% lower from aggressive revenue recognition accounting choices, and gross margin was revised from -8.9% to -24.8%, or 1,590bps lower

First Audit Chair Alan Earhart left under questionable circumstances : According to former executive we spoke to: “Michael (CEO)doesn't like people asking questions he doesn't like. And Alan was doing his job as audit chairman and sort of rocked the boat too much.”

Victor K Lee : Alan was replaced as Audit Chair in 2009 by Victor K. Lee. Lee also served as CFO of Leadis Technology (OTCPK: LDIS), a fabless semiconductor company that failed and was delisted. The Company settled a shareholder lawsuit, without admitting, that it misled investors

Poor Alignment With Shareholders And Unattractive Risk/Reward:

As MPWR’s stock has risen in recent years, MPWR’s insiders have slashed their ownership from 37.5% at IPO to just 3% today (and CEO Hsing to just 1%). Analysts project that MPWR will generate 19% and 27% sales and EPS growth, respectively, in 2020, but we believe that MPWR’s eroding technological edge and growing challenges in maintain margin and growth in China make such results unlikely, and that its Chinese tax filings throw into question its financial status as a whole. MPWR also trades at nosebleed valuations of 10x sales and 37x EBITDA – a substantial premium to semiconductor takeout multiples of at 3.3x sales and 17.5x EBITDA – and industry peers ( NXPI , ADI , MXIM , ON , POWI , SMTC , OTCQX:IFNNF , OTCPK:RNECF ) despite a reportedly reckless managerial culture which, per our conversations, would make it a poor fit with more conservative industry players. Based on our belief that MPWR’s Chinese tax filings may be a credible indicator of potential financial misstatement, we see 75% - 85% downside to MPWR shares.

Thank you very much for your continued interest in our investment research.

Disclaimer

This research note and our presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation Monolithic Power Systems, Inc. (“MPWR”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.

This research note and our presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US Dollars, unless specified otherwise.

To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of MPWR or other insiders of MPWR that has not been publicly disclosed by MPWR. Therefore, such information contained herein is presented “as is,” without warranty of any kind –whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. You should assume all statements made are our opinions, unless sourced as facts where practical.

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