Posted 2/15/99
Sectors & Trends
Bargains still exist in chip sector
Analysts expect "astounding" growth in the communications-chip field and smaller players such as Vitesse, Level One and PMC-Sierra are poised to profit.
By Michael Parrish
Microsoft Investor
Think outside the PC box. Think of cellular phones, fax lines, data-transfer systems, business communications systems -- and all the chips needed to make those connections. Think about the fact that 80% of all phone calls today pass along data, not cheery hellos. Think about how many phone and data lines serve you personally.
Communications chips were once a sideline of the big semiconductor manufacturers. But as demand for bandwidth grows relentlessly, smaller companies that have otherwise been making chips for the military and for such inconspicuous uses as automated test equipment have seen their fastest revenue jumps in communications -- and most are repositioning themselves as pure plays. Communications chips has become the fastest-growing of all semiconductor sectors.
What's the bottom line for investors in Vitesse Semiconductor (VTSS), Level One Communications (LEVL), Applied Micro Circuits (AMCC), PMC-Sierra (PMCS) and others? Depending on your choice of industry prophet, the semiconductor business as a whole should grow a solid 9% to 12% this year. Predictions for the communications-chip chunk of this, however, run to 30%, or much more.
"It's astounding the growth that these guys have," says Clark R. Westmont, communications component analyst at NationsBanc Montgomery Securities. "The numbers currently in Street expectations for 1999 are still conservative given the growth rates of the last two years."
David Wong, communications-chip industry analyst at Needham & Co., agrees. "The end markets in telecom and datacom are extremely strong," says Wong, who dismisses last fall's fears of a weakening telecom market as a "purely psychological quirk." And Elias Moosa, technology analyst at BancBoston Robertson Stephens, predicts that similar growth could last for the next five to 10 years.
These aren't necessarily cheap stocks. Fans pushed share prices up strongly last year, ahead of the broader semiconductor revival. But in a high-tech world that has not always been kind to investors, the plain probability of more robust growth for these lesser-known chip makers is enticing. Despite the technology downdraft that blew in early February, "most of these stocks have been pretty strong, and they're currently holding their own," says Doug Fairclough, investment strategist at ClearStation, the online investment site. And, even now, there are bargains to be had.
Vitesse has no debt
Vitesse is a big favorite and it's not hard to see why. The $3.7 billion supplier to the likes of Cisco Systems (CSCO), IBM (IBM) and Lucent Technologies (LU) specializes in high-speed gallium arsenide chips, originally in high demand for supercomputers and now in demand for high-frequency wireless and fiber-optic communications systems. Gallium arsenide is trickier to deal with than silicon, but electrons pass through it up to five times faster.
The company's business picture is equally attractive. Unlike many puffed-up Internet stocks, Vitesse has no debt. Vitesse is also renowned for hitting its numbers quarter after quarter, and the company celebrated the new year by announcing a 73% bump in revenues over the same quarter the year before.
Success has not gone unnoticed, however, and a 69 P/E multiple will give some pause. But Wong and others maintain a "strong buy" rating. "Vitesse is positioned in some of the very fastest-growing markets in telecom and datacom," says Wong. "I think they're one of the best companies in the group."
Level One leverages its growth
Wong also sees a continued gleaming future for Level One Communications, a Sacramento, Calif.-based creator of high-speed silicon communications chips, particularly to send signals down copper wire. Another Level One admirer is Ken Pearlman, senior semiconductor analyst at CIBC Oppenheimer & Co.
The company proves that while gallium arsenide chips are terrific for some communications uses, there's still a big need for sophisticated silicon semiconductors. The company has been growing at a very pretty rate, year after year.
"Basically, we've got a 40% to 60% grower here," says Pearlman, "and if the stock gets a 40 to 45 (price-to-earnings) multiple, that's probably not outrageous." (The forward P/E ratio for 1999 is about 29.) "You've got a company that's been doing this for quite a while," says Pearlman, "and they're very mature. They've been able to understand how to leverage their growth."
PMC-Sierra stock has soared
Also take a look at PMC-Sierra, the $2.4 billion Vancouver, British Columbia-based chip designer (it outsources manufacturing). Considering that since October it's boomed from a $26 stock to more than $80, its forward P/E of about 54 seems almost reasonable. "They're probably the best-positioned company in this space," says Moosa. "They probably have the strongest product portfolio, the deepest relationships with the OEMs (original equipment manufacturers), and the strongest market-share position in most of the markets they compete in."
As Wong notes, PMC-Sierra also has received an unexpected break recently from the quicker-than-expected erosion of its less-profitable legacy business, which will now do less to crimp the company's top line. The big bucks are in the communications side. Westmont agrees that the communications business is where PMC-Sierra scores particularly well, with more than 80% gross profit margins. "That's just unheard of," says Westmont. "It's amazing."
Applied Micro Circuits is pricey for now
A big claim to fame for another company, Applied Micro Circuits, is its leadership, says Westmont: "AMCC's management team is one of the best." Westmont also expects the company's 30% current growth rate to increase as its focus shifts from military and testing to communications; Applied Micro Circuits, he believes, is about where Vitesse was a couple of years ago in this transition.
On the other hand, Wong expects that a recent military contract from Raytheon in the near term actually will help Applied Micro Circuits' efforts to keep revenues on track. This end-of-line order -- the last time Applied Micro Circuits will be producing these military goods -- has a flexible delivery schedule. So Applied Micro Circuits can increase or slow production to make sure it meets its financial targets from quarter to quarter. Applied Micro Circuits' drawback? Only its popularity. The stock price has tripled since October, which makes it a bit pricey for the moment.
Galileo is 'on a roll'
Bargain hunters may be more easily drawn to Galileo Technology (GALTF), a $444 million Israel-based company whose stock has yet to return fully to former glory. Last summer, investors were dismayed when it looked like Galileo had muffed a transition to marketing a faster chip. The stock tanked. Rallying this fall and winter, it took a lesser hit in January when momentum investors panicked about a new-product introduction. But Wong believes it's "actually on a roll," though investors don't yet realize it. He has a "strong buy" rating on the stock, and a target of $35 on shares currently selling at about $20. Galileo's P/E ratio is just 29, cheap for the sector.
Do you happen to be attracted to the 6100 series Nokia cell phone? RF Micro Devices (RFMD) supplies the power amps. The company is especially strong in gallium arsenide integrated circuits, which means it is atop the wave in cell-phone development, according to Dale R. Pfau, wireless technology analyst at CIBC Oppenheimer & Co. The higher the frequency, the more attractive gallium arsenide becomes to manufacturers.
"Anytime you see the frequency going up and the bandwidth requirements going up, there's an opportunity for gallium arsenide," says Pfau. He predicts that RF Micro Devices and Alpha Industries (AHAA), another hard-charging gallium arsenide shop, will continue to benefit from demand growth in wireless. Pfau has "strong buy" ratings on both. Fairclough cites RF Micro Devices and PMC-Sierra as the strongest relative performers in the sector during the tech retrenchment.
TranSwitch (TXCC), a $570 million chip designer in Connecticut (another in the sector that outsources production), is focused on wide-area network manufacturers. "The stock's been a champ," says Westmont, who along with other sector-watchers still expects price growth -- though TranSwitch has tripled since last fall. Other companies worth watching as communications connections bloom include Micro Linear (MLIN), TriQuint Semiconductor (TQNT) and MMC Networks (MMCN).
Turnaround predicted for Anadigics
Expect more investment opportunity as time goes on. Tiny $240 million Anadigics (ANAD), for instance, is not currently admired by many observers. But according to Wong, Anadigics has "some very good things happening which are not going to percolate to the surface for a bit." Anadigics has had its problems, including shareholder lawsuits and painful staff cutbacks. But a change of command has brought a needed change in fabrication plants, according to Wong, which will bring streamlining and profit not far down the road. Wong, who rates Anadigics as a "buy," sees the turnaround in the last half of this year.
Finally, investigate the freshest face among these companies, $8 billion Broadcom (BRCM), which has received enormous attention particularly since it went public with a bang last April. Broadcom is admired by techies for its success with systems-on-a-chip, and it dominates the hot markets for set-top boxes and cable modems. Investors couldn't help note a 450% growth in revenue in 1998, a rate that will undoubtedly slow.
Broadcom's stock price has been volatile of late, however. Some analysts have backed off to hold positions at the moment, because of its current high valuation -- a multiple of more than 160, high even for its peers. "I have no idea where Broadcom's stock price is going," admits Wong. Get out your crystal ball, but do it fast. |
