ON Semiconductor – Performance Driven or a Performer in an Opera About to End?

ON Semiconductor ON stock has been VERY profitable in recent months to:

- investors, institutions, and hedge funds trading its stock;

- banks scooping interest and fees on the company's

assorted revolving credit facilities;

and

- insiders raking in huge profits from selling their stock at

seven-year highs.

What dramatic changes in the company have occurred to cause the stock to spiral to seven-year highs? Is the meteoric rise of the company's stock an accurate reflection of the company's improved performance? Or, is On Semiconductor simply another performer in the Fed's Zero-Rate Interest opera? In Puccini's tragic opera, Tosca, the music crescendos until the final act when a planned deception goes bad; and the heroine plummets to her death. When the Fed drops the curtain on zero rates, will the deceptions perpetuated by various stock market players surface, and the bull market plummet to its death? Dramatic analogy, but nonetheless, I decided to take a close look at On Semiconductor, a company I have traded for years. What had really changed about this once obscure semiconductor company to push its stock price to highs not seen in seven years?

Act I, I read the analysts' reports. Analysts who, only a short time ago, rated it a HOLD, with a price target of $8-9, changed their rating to a screaming BUY, with price targets in the mid-teens! I compared the reports they issued to support their HOLD ratings and the reports they used to support their BUY ratings. Interestingly, the reports are almost the same. What differs in them is what is emphasized. By de-emphasizing certain tangible details, like the debt/equity ratio, and emphasizing intangible details, like CEO promises of stock buybacks and intentions to return equity to shareholders, the reports were transformed! The company emerges as the stock to own; and the media, including company press releases on new innovations, kept the positive spin going.

Act II, I explored the company's innovations. ON Semiconductor's recent announcements regarding GaN and high-speed Flash technology, make the company appear a leader in both endeavors. Further research reveals that the company may finally be catching up to competitors. In 2009 Cree licensed its GaN technology to Mitsubishi, awarding Mitsubishi the power to sublicense. More than 50 companies and academics are involved in GaN-on-Si IP, and most of the major GaN players are present in the list of the top patent applicants. As for flash focus speed, the cell phone camera technology is advancing so quickly that focus time is becoming irrelevant. For example, Samsung uses burst technology in their cell phone camera so that multiple photos can be captured in an instant leaving selection of the best for a later time.
I discovered that On Semiconductor's most dramatic innovation, in recent history, was in its accounting practices. The company elects to report Non-GAAP, unaudited financial results. And by adopting a new accounting model in 2013, the company was empowered with the ability to modify their financial past and polish their financial present. Like the analyst reports that were modified to emphasize intangible positives and de-emphasize tangible negatives, ON's new accounting practices framed the company's financial strength in a whole new light!

On Semiconductor explains somewhat on pages 43-44 of the 10-K for 4Q2014, "The statement of operations and balance sheet data set forth below for the years ended and as of December 31, 2014, 2013, 2012, 2011 and 2010 are derived from our audited (when initially publicized they had not been audited) consolidated financial statements." I say somewhat because the company likes to send you on a quest when you read their financials to the land known as "elsewhere" if you want to get a clear understanding:"You should read this information in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our audited consolidated financial statements, including the notes thereto, included elsewhere in this Form 10-K." Such statements are sprinkled throughout their report.
"The Company expanded certain prior year amounts in our consolidated financial statements to conform to the current year presentation." "The prior periods also include revised amounts from a change in application of an accounting convention, related to manufacturing variances, and other adjustments relating to hedging and inventory amounts.

By reporting NON-GAAP, unaudited results, such as those presented in the most recent 10-K, which emphasized the Non-GAAP earnings per share of 19 cents versus the GAAP EPS of 13 cents, the company was able to beat the street estimates. The result? The stock soared higher. One insider, Board Director Emmanuel Hernandez, was quick to dump 10,000 shares at $13 and enjoy a tidy profit. The new accounting procedures, the ValueReporting model of PriceWaterhouseCoopers, implemented when Hernandez was voted in as a Class II member of the Board of Directors in 2013, have certainly worked out in his favor. Other On Semiconductor insiders are piling up profits as well. More insider selling has occurred in the last 6 months, since the stock's meteoric rise, than has occurred in the past four years!
Act III, I ponder the value-creation model. Should we be concerned that employing a value-creation accounting model has, suddenly, made the company appear more valuable? Reputable firms such as PriceWaterhouseCoopers (PWC) and KPMG utilize value-creation models. PwC, ON Semiconductor's new accounting firm as of 2013, utilizes ValueReporting which attempts to provide linkages between and among various performance measures and measures of intangibles. It links the market overview to the company's competitive position and value creation strategy. It then links that strategy to the financial targets and mechanisms to deliver on them and to the underlying intangibles and value drivers. The KPMG Value Explorer model is another strategic planning model that explicitly builds upon intangibles. Of course, there are disreputable accounting firms employing the intangible-oriented, value-creation model. The now defunct accounting firm of Arthur Andersen had its own value creation version, called Value Dynamics, a value accounting approach aimed at maximizing profits. Their clients included Enron and WorldCom, rated the biggest bankruptcy in the world prior to the fall of Lehman Brothers and WaMu.

So, yes, there should be concern regarding metrics, models, and how intangibles are valued in a company's financials, especially, when a company that has an already weak debt/equity ratio, seeks to gain access to MORE credit. On May 4, 2015, ON Semiconductor amended its existing five-year senior revolving credit facility to $1 billion. The 8-K identifies the transaction as "an Off-Balance Sheet Arrangement of a Registrant."

As the curtain closes, I wonder about the zero-rate environment as it relates to value-creation models of accounting. The Chinese curse goes, "May you live in interesting times." Investors, in On Semiconductor and in other companies employing similar accounting practices that factor in market overview when quantifying valuation, should feel cursed by living in zero-rate-interest times. The current market overview is one of "free" money. The floodgates are open. Low-rate leverage, even in the billions, can be valued as an asset not a liability! Companies that use the leverage to fuel organic growth, may, eventually, become worthy of their lofty stock prices. Companies that use the leverage to buy back their own stock at inflated prices, to buttress their balance sheets to become worthy of amassing even more debt, or to compensate insiders may not fare so well. What happens to companies that need the music of the Fed's Zero-Rate Interest opera in order to present a financial performance worthy of applause? Where will the stock prices of companies like ON Semiconductor be AFTER the fat lady sings?