Stock of the Day
Oct 15, 1998
Rambus: Modest Profit Now, Huge Ones Predicted
After the bell on Wednesday, Rambus (Nasdaq:RMBS - news) reported earnings of 7 cents per share, right in line with estimates. If industry experts are to be believed, though, profits measured in pennies may soon be a thing of the past for this company. One well-known analyst foresees Rambus earning $5 per share by 2003. Its technology, called Direct Rambus, speeds the flow of data between memory and microprocessor chips. Nearly every key player in the PC business has taken steps to incorporate the technology into PC designs for next year, suggesting Direct Rambus is about to become an industry standard.
Perhaps more important than the latest Rambus results is the strong trend in PC sales implied by third quarter results from Intel (Nasdaq:INTC - news) and AMD (NYSE:AMD - news) . Just last Friday, AMD also announced that it will license Rambus technology. These are all reassuring signs that Rambus is on track to reap a windfall when the PC industry ramps Direct RDRAM beginning in 1999. A few months ago, Dell (Nasdaq:DELL - news) and Compaq (NYSE:CPQ - news) announced plans to ship RDRAM-equipped PCs next year. Intel, which dominates the microprocessor market, said it began testing devices using Direct Rambus technology in June. Around the same time, two major memory chip makers--Toshiba and LG Semicon--said they've completed testing using the technology for use in future memory chips.
Rambus has developed a unique architecture for chip-to-chip interface. This technology, which it licenses to chip makers, doubles the speed of data transfer between memory chips and microprocessors. Such an increase is sorely needed because the current industry-standard architecture for DRAM (memory) chips has severely constrained improvements to the data transfer rate. As microprocessor speed has leapt ahead, a serious "performance gap" (more like a chasm) developed between memory and microprocessor chips, such that in two years Intel says a faster processor will no longer result in improved PC performance unless memory bandwidth widens.
The Rambus technology is currently being used in applications such as Nintendo video game systems and some workstations, but the big payoff for the company will be if and when Rambus-based memory chips (RDRAMs) become the industry standard for PC systems. They should start collecting on that home run next year. The company is also working on markets like multifunction computer peripherals, Ethernet networking and digital TV, but the PC market is seen as the most desperate for this technology right now. Rambus has already licensed its memory chip technology to all of the major DRAM manufacturers. More importantly, these DRAM makers will likely be forced to use those licenses (and pay Rambus royalties) because Intel is planning to roll out Rambus-based chips by early 1999. Intel can effectively dictate an industry standard because it dominates the high-end market for PC microprocessors, so memory chip makers will need to have compatible Rambus-based products if they want to be inside the same PC as Intel. Last week's licensing deal from AMD adds the sub-$1000 PC market, where it dominates.
The biggest risk for companies like Rambus which license intellectual property is that someone else could develop a competing technology that is better and/or cheaper. The DRAM manufacturers have been trying to develop their own methods for expanding bandwidth, but they've not yet found a better solution than the fast, small and cheap one offered by Rambus. Even if they did, they would probably have a tough time getting their competitors to license it. There is an industry consortium which is working on an open-standard solution called SyncLink, but most industry watchers doubt it will beat Rambus. Intel is in a better position than the DRAM manufacturers to establish industry standards, and for now at least, they are endorsing the Rambus technology rather than trying to outdo it.
Indeed, it is the relationship with Intel that has attracted so much investor interest and confidence that Rambus technology will become the industry standard in the next few years. Last November, Rambus and Intel entered a licensing and development agreement which facilitates the joint development of specs for RDRAM and the main memory controllers to work with the RDRAM. Once Intel puts the technology into chipsets, it's about as close as it comes to a lay-up in this business.
Whenever a hot new company hits the market, it can be tough for investors to get a sense of what a reasonable price is for the stock. A good way to look past the hype is to compare valuation ratios with its peers. Unfortunately, it will be at least a few years before Rambus hits the stage of its business where licensing revenues will give a true sense of its potential. Valuation of Rambus's unique business model is even more difficult than usual because few public companies, if any, have ever had an industry-standard technology to license on such a large scale. There are plenty of other "fabless" semiconductor technology companies which license their designs for specific products, but most are not industry standards or on a scale comparable to this.
Some analysts are using young, high-growth software companies as a benchmark for valuation because of Rambus has no inventory, limited capital expenses, 100% gross margins and gets most of its revenue from licensing. Such stocks have traded at 40 or 50 times projected earnings. Morgan Stanley Dean Witter analyst Mark Edelstone foresees earnings of more than $5 per share within five years. The consensus is for EPS of $0.42 next year vs. $0.28 in fiscal year 1998 (which just ended in September). So far only a few analysts have published estimates for the following year, when RDRAM use should be in full swing, but their early outlook is for well over $1 per share.
Rambus was one of the hottest IPOs of 1997, trading as high as $86.75 from its $12 offering price in May of 1997. While this year's performance has been less spectacular, Rambus has held up better than many of its tech sector peers. It closed Wednesday at $61.12. As a company, Rambus seems certain to score big beginning next year, the only question is how big and that largely depends on the pace of growth in PC sales. With that in mind, the toughest question is how much to pay for the stock of a company whose technology is locked in as a future PC industry standard.
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