Sector of the Day: Analog Devices Isn't a PC Chip Maker
Robert Cyran, Correspondent
This company makes chips used in devices such as cell phones and robotic pets -- a booming market.
When it seems like every chip company in the world announces profit warnings, the common-sense thing to do is avoid anything related to chips. But it may be slightly smarter to ease your way into some of the better chip companies with reasonable stock prices.
Analog Devices (NYSE:ADI - news) fits the bill, since it's a one of the top companies specializing in chips used outside of PCs and its stock has had a good beating.
Where the shares once traded at a rather ridiculous $100, they now sell for $60. This looks reasonable, considering the shares trade at 22 times this year's estimated earnings (its fiscal year ends in October). Granted, expectations may be high but they're not too excessive considering the booming demand for its chips. Even better, the quality of Analog's earnings are high in comparison with companies like Intel (NasdaqNM:INTC - news).
Should the downturn turn nasty, Analog Devices is well-positioned to ride it out without crimping investment or research. Taking out debt, the company has over $1 billion in cash on its balance sheet. Meanwhile, the company is planning to spend about $260 million in capital expenditure next year.
Howling Demand
About three quarters of the company's sales come from analog and mixed-signal integrated circuits (ICs) and the rest come from digital-signal processors (DSPs). Basically, analog ICs convert information from real-world sources such as sound or light and convert them into digital form.
DSPs take the digitized signals from the analog ICs and then work with the information very quickly. Often DSPs and converters are combined on the same chip.
While analog-converter sales are growing quickly, DSPs are growing faster.
According to the Will Strauss, the director of market-research firm Forward Concepts, DSP sales should grow 33% for the next few years after growing 45% this year. And the growth is expected to continue. Many analysts project DSP sales will outstrip microprocessor sales within 10 years.
Technologically Correct
DSPs are growing so quickly because chip growth is moving from PCs to other devices such as cell phones. It's obviously a big market. For instance, Analog is supplying up to 25 million phones to Germany's Siemens AG.
It's not just telecom either; DSPs show up in digital cameras, hearing aids, high-speed modems and anywhere digital information needs to interact with the real world in real time. As prices and performance improve, DSPs find their way into more and more devices.
For instance, lonely people who can't deal with responsibility of cleaning a litter box are coming out in droves to buy robotic pets. These toys need DSPs so that they can react in a quick, life-like fashion.
For example, say an owner speaks to a robotic dog. The DSP chip translates the owner's voice into digital form, figures out an appropriate reaction and then issues a slightly metallic bark.
Despite the growth in the market, competition will be limited.
More Chiba Than Silicon Valley
There's a world of difference between analog and digital engineering. As one analyst told me, ``I was trained as an engineer but, frankly, I have a tough time understanding analog, and I'm not even sure I want to understand it.'' There's little chance digital-chip makers will move into analog.
The analog and DSP world in particular, are a bit like corporate Japan; a few monolithic companies dominate the landscape, yet compete fiercely. Manufacturers are reluctant to switch suppliers; if they switch they must rewrite the chip-driving software; it's easier and faster to stick with the same supplier.
Texas Instruments (NYSE:TXN - news) is the giant, with about 50% of the DSP market. Most of the rest is split between Lucent (NYSE:LU - news), Motorola (NYSE:MOT - news) and Analog Devices.
``Analog Devices has probably taken some hide out of Lucent or Motorola because their DSP sales grew 100% this year while the DSP market grew 45%,'' says Strauss.
While Texas Instruments will do well given its market dominance, Analog Devices should do better. Analog Devices has been growing faster, and its stock is cheaper.
``Analog Devices is definitely seeing some softness in markets such as handsets and broadband where there's an inventory overhang, but other markets are holding up very well,'' says Greg Mischou, an analyst at UBS Warburg. He points out Analog has less exposure to soft markets than many chip makers. Texas Instruments for example, is highly dependent on handsets.
From Glut to Growth
Despite short-run problems, handsets may eventually rank among the areas of strongest growth. Analog Devices and Intel have been working together on a new chip for mobile devices such as new-generation phones.
It seems like a good collaboration; Intel is very good at chips that manipulate data and Analog Devices knows how to process signals.
``Analog was having trouble getting above 300 MHz and Intel didn't have the developmental tools so it's a good match,'' says Strauss. He goes on, ``It's nothing to make Texas Instruments quake in their boots, but it's a good start.''
Unfortunately the chips aren't in production yet. Until they come out, any predictions about sales are not worth much. For now, Texas Instruments dominates the market for mobile-phone chips.
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