Telecom: The Best Chip Stocks for the Broadband Revolution
Senior research analyst: Luciano Siracusano (06/15/00)
(updated 6/15/00, 10:35 am ET)
Semiconductor makers for the high-speed communications markets may well be one of the hottest sectors right now, and a clear sign of this could be seen last week in New York at PaineWebber's Growth and Technology Conference.
Some of the sessions with the biggest crowds included the handful of companies serving this market. The companies include some of the fastest-growing companies in America, many of which sport stock prices that rank among Wall Street's most richly valued, including Broadcom Corp. (NASDAQ: BRCM - news), Vitesse Semiconductor (NASDAQ: VTSS - news), and RF Micro Devices (NASDAQ: RFMD - news).
If you click here, you'll see a table that illustrates comparable financial data on seven companies that we believe will continue to capitalize on the blistering demand for integrated circuits that help transport voice, video and data at lightning speeds. For our purposes, the key metric is in the far-right column, the PEG, or price to earnings growth ratio.
The PEG ratio is obtained by dividing the forward P/Es (current price divided by next 12 months earning estimates) by their three-to-five year growth rates. We're using estimates from First Call/Thomson Financial for the next four calendar quarters, including the current quarter.
The companies in this field are showing dramatic sequential revenue growth and reinvesting a significant portion of profits back into research and development. Although many of these stocks carry high trailing P/E ratios, most are actually pretty reasonably valued based upon their PEG ratios.
For example, if you look at the PEGs for Broadcom and PMC-Sierra (NASDAQ: PMCS - news), they look expensive. But the companies are two of the strongest in the sector and have earned their high multiples.
Broadcom has come to command the largest market cap in the group by virtue of its gorilla-like dominance in TV set-top and cable modem markets, where it controls 90% of the action. Chips for these two markets as well as those for high-speed enterprise networks account for 90% of Broadcom's sales.
In the most recent quarter, earnings came in at $41.8 million on a 19% sequential growth in sales to $191.3 million.
Broadcom has assembled some of the finest engineering talent in Silicon Valley to create integrated circuits that permit the cost-effective delivery of high-speed bandwidth networking using existing communications infrastructures that were not originally designed for the transmission of broadband digital content.
With Broadcom entering emerging markets like home networking, VoDSL (Voice Over Digital Subscriber Lines), satellite and wireless, there's every reason to believe the company can continue to grow both its top and bottom lines at a compounded annual growth rate, or CAGR, of 50% for the next three to five years.
Moreover, Broadcom's ability to integrate hundreds of components into a single chip makes it a formidable force in the race to design ever-more integrated solutions. Although the company knocks heads with rivals like Lucent Technologies (NYSE:LU - news) and Texas Instruments (NYSE:TXN - news) in some markets, Broadcom faces no single competitor across all the product lines in which it competes.
With more than 800 engineers and a very high retention rate-fueled in part by its generous stock-option plan-the company should continue to consolidate its leadership as the communications company most responsible for bringing broadband capabilities directly to consumers.
Although Broadcom is making an initial foray into optical networking, the two semiconductor companies with the early lead in building the communications infrastructure of tomorrow are PMC-Sierra and Vitesse Semiconductor.
Here is our list of seven chip stocks for the broadband revolution.
Vitesse Semiconductor derives roughly 88% of its revenue from communications markets and has established itself as an industry leader in the production of ICs used in long-distance fiber-optic transmission, helping to eliminate bottlenecks in the Internet's backbone.
Semiconductors made with Vitesse's Gallium Arsenide (GaAs) technology have advantages over more common silicon chips in transmitting data at very high speeds. The company also makes products for data storage and optical networks. Vitesse makes integrated circuits that are scaleable up to OC-192, or 10 gigabits per second, the fastest speed for data transmission currently deployed in the core of the Internet's backbone.
Vitesse, which is growing by approximately 50% annually, sees a large market opportunity emerging in the area of ``network processing.'' The company believes it can capitalize on the industry's movement away from Application Specific Integrated Circuits (ASIC) to Application Specific Standard Products (ASSP).
For years, chip makers have designed ASICs for key clients. As the name implies, ASICs are geared to the products of one OEM, or original equipment manufacturer. But some analysts view ASSPs as the semiconductor industry's wave of the future. Vendors want to speed the time to market for their products, and they are looking for standardized integrated solutions that decrease the number of chips needed to perform integral applications.
For chip makers, the transition to ASSPs will increase the number of customers.
Vitesse will seek to fill this key market by creating a scaleable synchronous switch fabric architecture that can become an industry standard. Vitesse expects to battle PMC-Sierra in its quest to become the ``integrator'' on the infrastructure side of the communications IC revolution.
Moving outside the infrastructure arena, another big driver of semiconductor sales is the demand for more powerful wireless phones.
One of the strongest companies in this space is RF Micro Devices, which makes proprietary radio frequency integrated circuits (RFIC) for wireless communications applications. Some 90% of the company's sales come from the sale of such devices to makers of cellular phones and other wireless devices.
The firm also sells power amplifiers, the components that increase the signal strength of wireless transmissions through the radio spectrum.
Nokia (NYSE: NOK - news) is its largest customer, but in recent quarters the company has added capacity so that it can accommodate more customers. It started construction of a second fabrication facility in September of 1999 that will increase capacity three to four times by the end of this year.
Management believes the fab expansion will not only give RF Micro the capacity to generate $2 billion a year in revenue, but it will help to improve gross margins, shorten design times, improve inventory management and help the company better serve customers like Motorola (NYSE: MOT - news) and Ericsson (NASDAQ: ERICY - news).
RF Micro Devices has been able to hold a dominant share in its markets, in part, because of its GaAs HBT (heterojunction bipolar transistor) technology. The company is convinced the industry is migrating toward this low-cost, high-performance technology.
Investors should look for RF Micro Devices to be one of the biggest beneficiaries of the proliferation of wireless devices around the world. Its products are used in both the Code Division Multiple Access, or CDMA, technology and Bluetooth, an emerging technology for high-capacity, short-wave networks that are used for remote connections for cell phones and laptop computers.
Bluetooth has already been endorsed by several major technology firms, including Motorola, IBM (NYSE: IBM - news) and Toshiba.
One company that intends to compete with RF Micro Devices in selling content into the handset market is Alpha Industries (NASDAQ: AHAA - news). With its February acquisition of Network Device, Alpha believes it can meet industry demand for both GaAs HBT products and PHEMT amplifiers and switches.
Here is our list of seven chip stocks for the broadband revolution.
The company, which is growing twice as fast as the markets in which it competes, counts Motorola and Ericsson among its largest customers. It is also targeting the other third of the wireless phone market, seeking to establish preferred or strategic supplier relationships with emerging wireless players like France's Sagem, Korea's Samsung and Sony and Panasonic from Japan.
Today, Alpha has components in more than 40 different handset platforms. Its analog devices help handset manufacturers enhance battery life, reduce size and increase the capacity of such devices to handle ever more data.
The company's goal is to derive $6 worth of content from every phone that it helps to create, up from $4 in 1998.
As a group, the makers of semiconductors for the wireless market hold out the prospects for some great growth over the next few years, but the potential comes with some significant risks.
For example, if telecom giants like AT&T (NYSE: T - news) back off from their capital expansion plans, the pace of broadband adoption in the home may not accelerate as quickly as has been projected.
Another risk is posed by the potential for supply constraints. Many of these companies depend on raw materials, and in some cases, fabrication plants that they do not control.
Moreover, an unforeseen calamity-a hard landing of the U.S. economy or political instability in Asia, for example-could also disrupt future projections for the sector.
A wild card is the prospect of political or legal pressure that would force American companies to change the way they account for employee stock-option compensation. This is not a small issue.
Earlier this week, the New York Times ran a front-page article that only scratched the surface of the issue-one that is not openly discussed on Wall Street but is of growing concern, particularly to institutional shareholders who understand the huge drag it could cause on future stock performance.
Still, many companies are caught between a rock and a hard place: They are locked in a highly competitive market to hire and retain highly skilled workers and executives, and stock options have become the preferred method for doing so since they are a tax-free method for raising compensation without adding to current labor costs.
But the more they rely upon them, the greater the risk that the ultimate day of reckoning will dilute shareholder value. Still, any curtailing of their ability to compensate employees through this method could cause some near-term damage to their businesses and stock prices.
For example, if Broadcom were forced to account for its stock-option compensation as an expense under the Financial Accounting Standards Board Statement No. 123, the company would not have earned $83.3 million in 1999. Instead, it would have lost more than $105 million.
Bottom Line:
As long as the world operates under the present rules of the game, we expect all the stocks in this group to do well over the next year. Broadcom and PMC-Sierra will continue to attract the highest multiples, by virtue of their leadership positions. Lattice Semiconductor (NASDAQ: LSCC - news), Anadigics (NASDAQ: ANAD - news) and Alpha Industries provide the most relative value - as a multiple of their forward growth rates, they are all trading at a discount to the S&P.
Here is our list of seven chip stocks for the broadband revolution.
Alpha Industries Inc (NasdaqNM:AHAA - news)
Anadigics Inc (NasdaqNM:ANAD - news)
AT&T Corp (NYSE:T - news)
Broadcom Corp (NasdaqNM:BRCM - news)
Ericsson, Telefonab. L M AB (NasdaqNM:ERICY - news)
International Business Machines (NYSE:IBM - news)
Lattice Semiconductor Corp (NasdaqNM:LSCC - news)
Lucent Technologies Inc (NYSE:LU - news)
Motorola Inc (NYSE:MOT - news)
Nokia AB Oyj (NYSE:NOK - news)
PMC-Sierra Inc (NasdaqNM:PMCS - news)
RF Micro Devices Inc (NasdaqNM:RFMD - news)
Texas Instruments Inc (NYSE:TXN - news)
Vitesse Semiconductor Corp (NasdaqNM:VTSS - news) |
