VERISILICON MICROELECTRONICS(SHANGHAI)(688521)：FRONTRUNNER IN SIPAAS INDUSTRY FOCUSES ON R&D

　　Investment positives

    　　We initiate coverage of VeriSilicon Microelectronics (Shanghai) Co., Ltd. (VeriSilicon) with an OUTPERFORM rating and a target price of Rmb58.00 based on 35x 2025e P/E discount. The firm is a leader in the silicon platform as a service (SiPaaS) space. We expect it to benefit from growing scale effect in the short term, thanks to synergies between its two main businesses as well as growth in its high-end processor shipments.

    　　Why an OUTPERFORM rating?

    　　First growth driver: One-stop silicon chip customization services and semiconductor IP licensing services facilitate customer conversion and should drive profit margin growth by strengthening economies of scale. In our opinion, VeriSilicon has a comprehensive intellectual property (IP) portfolio. It has six types of in-house processor IPs, 7nm advanced process technology for turnkey solutions (including chip design and mass production services), and relatively advanced technologies gained from IP licensing. We think the firm will continue to increase R&D investment to improve its competitiveness, as well as to facilitate customer and R&D resource conversion between its one-stop chip customization services and its semiconductor IP licensing business. We expect the firm’s revenue from these two main businesses to grow steadily and foster stronger economies of scale. The firm booked losses from these two businesses in 2021. However, we expect the businesses to gradually generate profit moving forward to offset the impact of a high P/E valuation in the short term.

    　　Second growth driver: High-end processor products have entered market and should accelerate firm’s revenue growth together with developing IP-based chip business. According to its 1H21 financial report, VeriSilicon has successfully taped out a high-end processor for final level caches (FLC) and has received the sample processor from its manufacturer. The corresponding operating system and software are running smoothly. We expect the new product to win recognition from the market, given VeriSilicon’s large IP portfolio and sound cooperation with large firms. As a third-party IP licenser, we think VeriSilicon will transform its IPs into chip products and sell chiplets as chiplet technology matures (chiplets help manufacturers integrate multiple circuit blocks into a large chip). We expect the firm’s high-end processors to penetrate diverse fields such as smart vehicles. At present, the firm’s revenue growth is around 30%. We expect its revenue to grow faster as its sales volume of high-end processors increases. If VeriSilicon sells chiplets, we think the positive correlation between revenue growth and shipment increase will be more visible (currently, royalty fees from the IP licensing business are difficult to calculate) and boost the firm’s profit.

    　　How do we differ from the market? The market worries the growth of its turnkey business will weigh on the firm’s overall gross margin (GM). In our opinion, although the business has relatively low GM, its gross profit can be transformed into net profit and the revenue growth of the business should improve the firm’s profitability. We suggest investors pay attention to future changes in the firm’s net profit margin and its growth ceiling in the long term.

    　　Potential catalysts: Orders from internet firms and computer system manufacturers and/or customer acquisition for the processor business beat our expectation.

    　　Financials and valuation

    　　We estimate VeriSilicon’s EPS at Rmb0.25 in 2022 and Rmb0.40 in 2023, implying a CAGR of 293%. We are upbeat on the firm’s stable revenue growth, given its developing IP licensing business, the increasing reusability of one-stop customized chip design technologies, and customer conversion between businesses. We expect sales volume of its high-end chiplets to increase after 2023, and calculate the firm’s net profit will likely reach Rmb964mn in 2025. We think VeriSilicon should be valued at 35x 2025e P/E, implying a target market cap of Rmb33.6bn. If the discount rate is 8.3%, the target price of the firm in 2023 should stand at Rmb58.00, implying 33% upside. We initiate coverage of VeriSilicon with an OUTPERFORM rating.

    　　Risks

    　　Demand for semiconductor IPs from downstream chip designers disappoints; trade friction; litigation risk; competition intensifies; overly concentrated customer structure; failure to accurately forecast demand.