08:53am EDT 18-Sep-98 Needham & Co. (David Wong (212) 705 0314) VTSS PMCS LEVL
Good Visibility, High Growth, Opportunity At Reduced P/E
Needham & Company David Wong, Ph.D./dwong@needhamco.com (212) 705 0314
17 Sep 1998 Ryl Ashley/rashley@needhamco.com (212) 705 0406
Vitesse Semiconductor Corporation
Price(9/17/98-VTSS/OTC): $23.56
Price Range(52 Weeks): $37.18-$15.81
Shares Outstanding (MM): 72.6
Average Daily Volume (MM): 1.25
FY Revs ($MM) Op. Mgn. E.P.S. P/E Ratio
9/99E $290.0 33.8% $0.87 27.0
9/98E 175.0 32.1 0.67 35.4
9/97A 104.9 27.3 0.43 -
Investment Recommendation (6-12 months): Strong Buy
Price Target (6-12 months): $48
Quarterly Earnings
Q1 Q2 Q3 Q4
9/99E $0.19 $0.21 $0.23 $0.25
9/98E 0.13A 0.15A 0.18A 0.20E
9/97A 0.08 0.10 0.12 0.13
Vitesse Semiconductor Corporation is a leader in the design and manufacturing of
gallium arsenide integrated circuits. The company combines the high-speed
properties of gallium arsenide with MESFET (metal semiconductor field effect
transistor) based circuit design to create highly integrated chips that work in
speed ranges beyond the capabilities of current silicon technology. Products
include chips for optical fiber transmission at rates of between 1 Gb/s and 10
Gb/s. These are used in telecommunications and data communications (Fibre
Channel, Gigabit Ethernet, ATM). Makers of chip testing equipment use Vitesse's
design libraries to create ASICs (application specific integrated circuits).
Investment Opinion
At a P/E (price to next 12 month earnings estimate) of about 28, Vitesse is
trading at a valuation that is lower than the 30 to 45 P/E range that the stock
has moved in over the last two years. We believe that the company continues to
have top line and bottom line growth potential of about 50% per year. We are
reiterating our Strong Buy rating on the stock.
* We think that there is excellent near term visibility of revenues and earnings
for Vitesse because the company was fully booked going into the quarter. We
believe that the ramp of the new Colorado fab has been progressing smoothly. We
are projecting $54 million in revenues in 4Q98, up from $46
million in 3Q98.
* We are anticipating strong bookings for Vitesse in the September quarter, with
a book to bill of 1.17 and sequential bookings growth of about 10%. We expect
backlog to grow to more than $100 million (about 5 months of revenues) by the
end of September.
* Lucent is Vitesse's largest customer at about 20% of total revenues and about
40% of telecom revenues. We believe, from Lucent's comments at its analyst day
presentation on 17 Sep 98, that Lucent is on track to meet expectations in the
September quarter, and that December quarter revenues for Lucent will be strong.
Reassuring News Out of Lucent
The telecom business accounts for about 50% of Vitesse's revenues. We believe
that the weakness in Vitesse's stock price in the last few days was in part due
to investors' concerns over whether telecom equipment end markets are softening.
We do not believe that Vitesse's telecom business is in any jeopardy.
Lucent is Vitesse's largest customer at about 20% of total revenues
and about 40% of telecom revenues. At its analyst day meeting on 17 September
98, Lucent made comments which we believe indicate that Lucent's business
continues to be strong:
* Lucent said that it was comfortable with analysts' estimates for the current
quarter. According to First Call, consensus estimates for the September quarter
were $0.38, up $0.06 sequentially, or about 19%.
* Lucent indicated that there its business continues to be seasonal (although it
is working to reduce seasonal fluctuations). From past results, the December
quarter is traditionally Lucent's strongest, suggesting to us that Lucent's
demand for Vitesse's products will continue to be high in the December quarter.
* The Lucent news comes after a number of negative announcements from
telecommunications equipment makers:
* Alcatel released 1H98 (June) earnings results. Alcatel said it anticipated
that its whole year 1998 operating performance would fall short of analysts'
expectations. While this is of concern with respect to the implications for the
communications chip suppliers such as Vitesse (Alcatel is a Vitesse customer),
the performance of many of the chip suppliers seems to be relatively independent
of Alcatel's fortunes. .Alcatel said that its second quarter (June) income was
impacted by a slowdown in telecom sales. In general, June was a good quarter
for the wireline chip companies that we follow, with companies such as Vitesse,
PMC-Sierra (PMCS, $28.56, Strong Buy), Level 1 (LEVL, $20.375, Buy) and AMCC
(AMCC, $15.25, Buy) showing strong sequential revenue growth. Alcatel's year
over year growth in telecom revenues in 1H98 was only about 4%. This is in
sharp contrast to the 30% to 50% per year growth in communications chip revenues
of the Vitesse, PMC-Sierra, Level 1 and AMCC, although all these companies are
vendors to Alcatel.
* Ciena reported 3Q98 (August) results and indicated that it expected 4Q98
(November) revenues to be below those of 3Q98. In 1998 we estimate that Ciena
will account for about 4% of Vitesse's revenues. We do not believe that
weakness in Ciena's business in the September to November time frame will have a
big impact on Vitesse's results, especially given the strength in Lucent demand
that we expect in the same period.
* Tellabs announced in a conference call that September quarter revenues might
be flat sequentially. However, the company also said that it thought December
quarter revenues would be strong (seasonal). We believe that Tellabs accounts
for only about 2% to 4% of Vitesse's total revenues. We believe that strength
in Tellabs December quarter would be positive for Vitesse, though the effect is
unlikely to be large.
Stock Valuation Is Below Range Of Last Two Years
Figure 1 shows historical P/E for Vitesse. The stock is currently trading at a
P/E of about 28, which is below the 30 to 45 range that the market has supported
for the stock over the last two years. FY95 to FY98 revenue CAGR for Vitesse
was 60% per year. We are projecting both top line and bottom line CAGR of above
50% for the company going forward (FY98 to FY00). Using a P/E of 42 on our
July 99 to Jun 00 EPS estimate of $1.13 (or a P/E of 50 on our calendar 1999
estimate of $0.96) gives us a six to 12 month price target of $48 for the stock.
Figure 1: Price/(next 12 mth earnings estimates) For Vitesse
Month P/(Est. E.) Month P/(Est. E.) Month P/(Est. E.)
Jan-96 20.4 Jan-97 41.9 Jan-98 32.5
Feb-96 28.8 Feb-97 31.7 Feb-98 38.9
Mar-96 29.3 Mar-97 30.7 Mar-98 34.9
Apr-96 35.5 Apr-97 32.2 Apr-98 40.2
May-96 32.2 May-97 34.9 May-98 35.3
Jun-96 26.8 Jun-97 32.1 Jun-98 40.5
Jul-96 27.6 Jul-97 44.6 Jul-98 42.9
Aug-96 31.3 Aug-97 42.8 Aug-98 33.7
Sep-96 38.2 Sep-97 46.0 17-Sep-98 28.4
Oct-96 29.1 Oct-97 37.5
Nov-96 41.8 Nov-97 36.7
Dec-96 38.3 Dec-97 30.9
Next 12 month earnings estimates calculated as the wieighted average of current
FY and next FY consensus estimates
Source ; First Call for Earnings Estimates, Bloomberg for Prices
Projected Revenue and EPS Growth of More Than 50% per year
Figure 2 contains historical revenue and EPS data together with our projections
and estimated growth rates. We are expecting revenue growth and (fully taxed)
EPS growth in excess of 50% per year over the next two years.
Figure 2: Revenue and EPS Growth Rates
September FY revs. EPS EPS
($000s) (fully taxed)
FY95 42,882 $0.03 $0.02
FY97 104,850 $0.43 $0.31
FY98E 175,021 $0.67 $0.54
FY00E 403,000 $1.22 $1.22
FY95-97 CAGR 56% nm nm
FY95-98E CAGR 60% nm nm
FY98-00E CAGR 51.7% 35.4% 50.2%
Source ; Company reports, Needham & Co. Estimates
We believe that Vitesse's future growth will come from:
* Strength in the telecom (OC-48) fiber optic market (now)
* Strength in the Fibre Channel market for storage devices (now)
* Emergence of the Gigabit Ethernet market (1999)
* A Rebound in the ATE market (second half 1999)
* Penetration of the ATM market (second half 1999) |
