To All:
Well, let me answer my own question about Morgan Stanley and Edelstone. This is an extremely bullish report, and lends credence to the whole, "we're only in the third inning" line of thinking:
TFN First Call
January 26, 2000
North America: United States of America
Technology: Semiconductors
January 26, 2000
Change in Price Target
LSI Logic
(NYSE: LSI, Bloomberg: LSI US)
Another Blowout Quarter with Strong Momentum
__________________________________
Mark L. Edelstone
(edelston@ms.com) (415) 576-2381
Louis P. Gerhardy
John Cross
Sonia Kimotsuki
__________________________________
-LARGE POSITIVE EARNINGS SURPRISE
As expected, strong revenue growth and higher capacity utilization drove
another large positive surprise.
-WELL POSITIONED PRODUCT LINE
LSI's ASICs and standard product solutions support the high-growth Internet
infrastructure, wireless, and consumer markets.
-MARGINS SHOULD CONTINUE TO EXPAND RAPIDLY
Gross and operating margins increased sharply for the fourth consecutive
quarter and they should trend sharply higher.
-LSI REMAINS UNDERVALUED AND ATTRACTIVE
With $3 of earning power late this year and $4 by the end of 2001, LSI is
one of our favorite stocks.
__________________________________
STRONG BUY
Price (January 25, 2000): $ 88.00
Price Target: $150
52-Week Range: $ 81.88 - 23.31
WHAT'S CHANGED
Change of Target Price:
$100 to $150
Earnings (2000):
$2.35 to $2.40
Earnings (2001):
$3.35 to $3.40
__________________________________
Price: Abs. and Rel. To Market & Industry
The PDF versions of the complete document including these graphics or tables
are available to Morgan Stanley clients through Research Link at www.ms.com,
contact your sales representative for access information.
Company Description
LSI Logic manufactures advanced ASICs (application-specific integrated
circuits). The company has been a pioneer in the development of ASIC devices.
LSI operates manufacturing facilities in California, Oregon, and Japan.
__________________________________
FY ending Dec 31: 1999A 2000E 2001E 2002E
EPS ($) 1.12 2.40 3.40 --
Prior EPS Ests. ($) -- 2.35 3.35 --
P/E 78.5 36.7 25.9 --
Price/Book 8.0 6.6 5.2 --
Market Cap ($ m) 14,846
L-T EPS Grth. ('00 - '05) (%) 20.0
P/E to Growth 1.3
Shares Outstanding (m) 168.7
Q'trly 1999A 2000E 2001E
EPS actual curr prior curr prior
Q1 0.08 0.50 0.48 0.73 0.72
Q2 0.21 0.57 0.54 0.81 0.77
Q3 0.35 0.63 0.62 0.88 0.88
Q4 0.47 0.70 0.71 0.98 0.98
E = Morgan Stanley Dean Witter Research estimate.
Another Blowout Quarter with Strong Momentum
Investment summary and conclusion:
LSI Logic reported fully diluted earnings before goodwill (EBG) from
continuing operations of $0.47 per share versus $0.05 a year ago and $0.35 in
the prior quarter. LSI's fourth-quarter revenue and earnings results were
right in line with our estimates, but they blew away the consensus estimate
of $0.43. Relative to the consensus, we believe that the positive surprise
was driven by revenues at the high end of quidance, a solid increase in gross
margins, and tight expense controls.
Based on the fourth-quarter results, we have fine-tuned our 2000 and 2001 EBG
estimates higher by $0.05 each, to $2.40 and $3.40, respectively. Prior to
the release of fourth-quarter earnings, consensus estimates for 2000 and 2001
were $2.21 and $2.94, respectively, and we expect our new estimates to remain
comfortably above consensus. Given LSI's fourth-quarter results, current
valuations, and our expectation that the potential for positive earnings
surprises will remain high, we reiterate our Strong Buy rating on LSI.
Revenue Growth And Order Momentum Remained Strong...
LSI's record fourth-quarter revenues of $585 million grew 8% sequentially and
31% over the year-ago quarter. LSI Logic is a value-added and key supplier
of custom and standard ICs that are used by its blue-chip customer base to
drive the explosive growth in Internet infrastructure. Last year, the
communications network computing, and data storage markets accounted for 39%,
35%, and 13% of the companies overall revenues, respectively. These product
categories are primarily comprised of the networking, server, and storage
markets, which are all directly tied to the Internet. In addition, they
include a growing exposure to wireless communications and digital consumer
applications, many of which are becoming more communications centric, such as
settop boxes and interactive games.
Based on LSI's ability to design and rapidly ramp highly integrated ICs that
support their customer's efforts to introduce and rapidly ramp differentiated
products into volume production, we believe that the company is well
positioned to take advantage of the key macro trends impacting the technology
landscape. While LSI has historically not been a large supplier to the
cellular handset market, the company has used a renewed focus and its
strength in wireless infrastructure to win handset designs that are currently
enjoying explosive growth from a small base. When combined with the
company's traditional strength in the LAN, WAN, server, storage, and digital
consumer markets, we believe that LSI should enjoy 25%-30% or better revenue
growth in 2000 and 2001.
In support of our constructive view on LSI, the company enjoyed record orders
that strengthened throughout the fourth quarter and grew 54% in 1999. More
important, they have been abnormally strong in the first quarter thus far,
and we believe that LSI's backlog offers excellent near-term visibility.
Given the strength of its product line and our expectations that the
semiconductor expansion phase will remain strong during the next couple of
years, we believe that LSI's current fundamentals are reminiscent of the last
major cyclical expansion phase that enabled the company to string 15
consecutive quarters of sequential revenue growth together and more than
double its revenues between 1992 and 1995.
...And Margins Should Continue To Expand Sharply
Our above consensus earnings view on LSI has largely been predicated on the
view that strong revenue growth and the ability to increase the capacity
utilization at its fab in Gresham, Oregon would support a faster than
expected increase in margins. Based on solid overhead absorption, the
Gresham fab turned profitable during the fourth quarter, and LSI's gross
margin of 41.1% increased 140 basis points sequentially and 570 basis points
over the year-ago quarter.
During the fourth quarter, LSI enjoyed an incremental gross margin of nearly
60%, which is consistent with the average incremental gross margin that was
recorded during the last up cycle. LSI expects a richer product mix and
higher capacity utilization levels to support a 48% gross margin in the
fourth quarter of 1999 and a 52% gross margin in the fourth quarter of 2001.
Management had previously expected its gross margin to reach 45% by the end
of this year, so it is clear that manufacturing operations are exceeding
expectations.
As an offset to the strong gross margin guidance, management intends to
significantly increase R&D to support the development of future generation
process technologies and intellectual property building blocks. As a result,
R&D is expected to increase from 12.7% of revenues in the fourth quarter of
1999 to 16% by the end of this year and 18% in the fourth quarter of 2001.
Regardless, LSI's operating margin should continue to increase rapidly from
the fourth-quarter level of 17%. LSI's fourth-quarter operating margin
increased 300 basis points sequentially and it represented the fourth
consecutive increase since a cyclical low of 2.7% was recorded in the year-
ago quarter. LSI's operating margin increased in 14 consecutive quarters in
the last cycle to reach an all-time high of 26.5%, and we expect that level
to be reached once again within the next two to three years.
Reiterating Strong Buy Rating And Increasing Stock-Price Target To $150 From
$100
With every passing quarter, we grow more confident in LSI's ability to
significantly increase its earning power, and the improved results in 1999
continue to remind us about the fundamental trends that LSI enjoyed between
1992 and 1995. During that period, LSI reported 15 consecutive quarters of
sequential revenue growth, 14 consecutive quarters of sequential improvement
in gross and operating margins, and 14 consecutive quarters of sequential
increases in EPS results. In addition, LSI reported positive earnings
surprises in the majority of those quarters, no negative surprises, and the
stock enjoyed a 25-fold advance.
Based on our current earnings estimates and our expectation that positive
surprises are likely to continue, we believe that LSI is attractive and
significantly undervalued. Consequently, we reiterate our Strong Buy rating
on the stock, and based on the increased confidence in our above consensus
earnings outlook, we have increased our fair-value target for the stock. Our
new target of $150 has increased from $100, and it assumes that the stock
should be fairly valued at a premium to the S&P Industrials and two times our
five-year growth estimate of 20% applied to our run-rate earnings estimate
for LSI in the second half of 2001. |
