Can Surveillance Save Vimicro?

By Stephen D. Simpson, CFA | April 11, 2012 AAA

By and large, tiny chip companies just don't make it - they lack the resources to keep up in R&D with the major chip companies, and large multinational companies are hesitant to trust key sockets to an unproven player. Factor in the additional risks that go with investing in small Chinese companies, and it is not hard to see why tiny Vimicro (Nasdaq:VIMC) has been all but forgotten by the market. It is worth asking, though, whether the development of the Chinese video surveillance market could yet make this a long shot worth considering.

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Punting Mobile and Under Pressure in PCs
Vimicro's traditional business is in producing multimedia processors/controllers for PCs and mobile phones. More to the point, while companies like OmniVision (Nasdaq:OVTI) make the actual image sensors that go into PC-based webcams, Vimicro's chips handle more of the "back office" work for those webcams.

Unfortunately, Vimicro has had a rough go of it in recent years, as seen in the revenue erosion. Integrated chips produced by the likes of Texas Instruments (Nasdaq:TXN) have shrunken its addressable mobile market to the point where management spun off the business.

The PC business, too, has come under pressure. Though still the largest contributor to revenue, the company no longer boasts of selling to Apple (Nasdaq:AAPL) and faces the real threat that other clients like Lenovo (OTCBB:LNVGY) and Hewlett-Packard (NYSE:HPQ) switch to cheaper solutions from Taiwanese rivals.

SEE: A Primer On Investing In The Tech Industry

Can Surveillance Restore the Growth?
That's a dim backdrop, but it may be too soon to say all is lost of Vimicro. In particular, the company is putting most of its future growth hopes on the burgeoning Chinese video surveillance market. Vimicro's products are not only compliant with relatively new standards (SVAC), but the company had a role in creating them.

With the potential for literally millions of cameras in Chinese cities, the overall market could be worth billions and the market for controller chips could grow to the hundreds of millions. Vimicro will no doubt face competition from local chip companies, as well as well-known names like Texas Instruments and Intersil (Nasdaq:ISIL), but first mover advantage should be worth something.

Several Drawbacks to Consider
The opportunities for Vimicro in the Chinese video surveillance market may indeed be large enough to not only restore the company to profitability, but back to the ranks of a growth company, but there are some substantial risks for investors to consider.

First, the company's financial reporting is much slower than American investors are accustomed to; it took five weeks for the company to report third quarter results and results for the year ended Dec. 31, 2011 still aren't out, as of this writing. Along similar lines, the company does not routinely include the level of detail in its financial reports that investors may expect.

SEE: 12 Things You Need To Know About Financial Statements

Vimicro is also an incredibly small company and an incredibly risky stock. While the balance sheet is healthy, there is minimal sell-side or institutional support and investors really are on their own with this moreso than in most stocks.

There is also simply the risk of competition to consider. Vimicro once had approximately 60% share of the PC webcam chip business, but now holds maybe 20% and was never really able to get anywhere in the mobile phone business. Likewise, there is the risk that the surveillance business goes to larger suppliers and/or that Vimicro cannot hold on to whatever early gains it may achieve.

The Bottom Line
Certainly Vimicro is not an expensive stock today. Trading below 70% of tangible book value, these shares could definitely perform well if the results pick up and the stock/company can get more attention. That said, long shots like Vimicro are only appropriate in well-diversified portfolios in the hands of risk-tolerant investors who can accept the risk that this company simply cannot rebuild itself into a growth story.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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