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Netlist Looks Overvalued Based On Fundamentals
Jul. 05, 2021 4:52 PM ETNetlist, Inc. (NLST)GOOGGOOGLHXSCF1 Comment
Summary
In 2020, Netlist reached a settlement with SK Hynix worth $40 million, which has led to optimism that it could reach a similar settlement in its lawsuit against Alphabet.
There could be significant retail investor interest as Netlist is popular on several social media websites.
I think this one looks like a sell, but the short borrow fee rate stands at more than 40%.
Unless you have a very high risk tolerance, it may be best to avoid Netlist for now.
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Investment thesis
U.S. high-performance SSDs and modular memory subsystems maker Netlist (OTCQB:NLST) got its second wind in 2021 based on retail investor interest and optimism regarding the outcome of lawsuits against SK Hynix (OTC:HXSCF), and Alphabet (NASDAQ:GOOG). However, the company’s market valuation stands at over $1 billion as of the time of writing and I just don’t think the fundamentals are there to justify such a high number.
Quarterly net sales are below $15 million and the company is unprofitable and I think we might be witnessing irrational exuberance.
Overview of the business
In its own words, Netlist is a provider of high-performance SSDs and modular memory subsystems to enterprise customers in diverse industries. On its webpage, you can find enterprise NVMe SSD, embedded flash, and DD3 and DDR4 DIMMs products.
(Source: Netlist)
Netlist specializes in hybrid memory (DRAM plus NAND) and it has a next-generation storage class memory product named HybriDIMM, which is aimed at real-time analytics in Big Data applications, inmemory databases, high-performance computing, and advanced data storage solutions. The company also manufactures a line of specialty and legacy memory products.
Netlist has manufacturing and testing facilities in the city of Suzhou in China, which located near Shanghai.
(Source: Netlist)
As I’ve explained in several articles on Micron (NASDAQ:MU) (example here). The global DRAM market is dominated by three companies, namely Samsung (OTC:SSNLF), SK Hynix, and Micron.
(Source: TrendForce)
The situation in the NAND market is similar, with the top five players accounting for over 90% of revenues.
(Source: TrendForce)
Overall, I view Netlist as too small to be able to invest enough in research and development and compete with the major players like SK Hynix, and Micron. You can see this reflected in the company’s financial results. In Q1 2021, Netlist generated net sales of just $14.9 million and posted an operating loss of $3.9 million.
(Source: Netlist)
Note that most of the revenues of the company come from the sale of products of other companies and those have low margins.
(Source: Netlist)
Overall, sales are stagnant, margins are worsening and the balance sheet doesn’t look pretty. As of April 3, Netlist didn’t have much in terms of assets and the main reason that shareholders’ equity was positive was a share issue carried out during the quarter.
(Source: Netlist)
(Source: Netlist)
The financials of the company look poor in my opinion and there is no clear path to profitability. Yet, the share price has been soaring for months and has started going parabolic lately.
(Source: TradingView)
Netlist has more than 100 patents and has been suing SK Hynix, Alphabet, and Inphi over patent infringement. In April 2020, Netlist surprisingly settled with SK Hynix and the latter is paying a fee of $40 million. However, Netlist will receive much less than $40 million as TRGP Capital Management funded $11.9 million in legal expenses in 2017 and 2018 (page 34 here).
The settlement with SK Hynix has led to optimism among investors that the company could win a Markman hearing in its case against Alphabet, thus achieving another settlement. However, this could take some time as the Markman hearing has been scheduled for March 9, 2022 (page 14 here).
Overall, I find it nearly impossible to justify a market capitalization of $1 billion for Netlist. I view the company’s business as close to worthless due to its low sales and lack of profitability which means that the company should get around 25 times more in a settlement with Alphabet compared to SK Hynix in order to be valued this high.
In my opinion, the main reason behind Netlist’s recent share price increase could be retail investor interest. There are a significant number of posts about the company on websites like StockTwits and Twitter. On YouTube, Netlist is being covered by several channels, including Best of Us Investors, Kennedy Grimes, Insider Financial, Atlantic Trading, and ClayTrader Video Charts. The most popular video on the company is from July 3 and it has over 9,000 views as of the time of writing. It’s titled "Netlist Could Be Your Next 15x Stock / Next Week". Note that the company isn’t doing the promotion of its business or shares itself, but this is being done by a significant number of private investors and traders.
I think this retail investor interest is unlikely to last and I’m bearish on Netlist. I don’t like the fundamentals and in my view, the company is unlikely to receive much from a settlement with Alphabet. This one looks like a sell and investors can take advantage of this by short-selling the shares. However, according to data from Fintel, the short borrow fee rate stands at 41.65% as of the time of writing. So, unless you have a very high-risk tolerance, I think the best course of action would be to avoid Netlist for now.
Investor takeaway
Netlist is a small memory company that receives most of its revenues from selling products from other firms. The business is unprofitable and assets are low and I think the company shouldn't be worth much.
In 2020, Netlist reached a settlement over a patent infringement with SK Hynix, which has led to optimism that there could be a similar settlement with Alphabet. However, the company’s market valuation has risen to levels that are almost impossible to justify and it seems that the reason behind this could be retail investor interest.
Overall, I think this one is a sell but the most prudent action might be to avoid its shares as the short borrow fee rate stands at over 40%.
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I have been investing in stocks for 13 years now, most of the time in my native Bulgaria. I have a bachelor...
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Contributor Since 2015
I have been investing in stocks for 13 years now, most of the time in my native Bulgaria. I have a bachelor's degree in Finance and a Master's degree in International Business and I like reading Pratchett and Michael Lewis. Regarding the opportunities that I cover, please take into account that I'm an admirer of legendary fund manager Peter Lynch so I tend to follow a lot of his investment philosophy.
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Additional disclosure: I am not a financial adviser. All articles are my opinion - they are not suggestions to buy or sell any securities. Perform your own due diligence and consult a financial professional before trading.
