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Good write-up in today's Financial Post.
PMC-Sierra finds sweet spot of the market
Strong technology
John Schreiner
Financial Post
VANCOUVER - In 1996, Burnaby, B.C.-based chip maker PMC-Sierra Inc. made a wrenching strategic decision to refocus its business at the cost of taking a $69-million (US) restructuring charge and terminating 245 employees.
The decision was to stop producing chipsets for modems because margins were evaporating and instead to devote the company's resources to chipsets for high-speed network applications -- for what Bob Bailey, the chief executive officer, calls "the sweet spot" of the Internet.
It was the right decision and the stock market has rewarded Mr. Bailey for making it. The shares (adjusted for last year's split) of PMC-Sierra (PMCS/NASDAQ) have climbed from $4 in July, 1996, to a recent high of $102.25, giving the technology company a market capitalization of $7-billion (all in U.S. dollars). The shares closed yesterday up $4 5/8 at $97.
"We are probably in the top 10 for market capitalization among the pure-play semiconductor companies," Mr. Bailey says.
"I think we've benefited from the lustre coming off the dot-com stocks," he suggests. "The safe play on the Internet is real companies with real profits and real growth -- that happens to be companies building the infrastructure."
And the company is rated "buy" to "strong buy" by a long list of analysts. Sandy Harrison of Pacific Growth Equities Inc., San Francisco, has a "buy" recommendation and a target price "in the low to mid-hundreds in the next six to 12 months."
"We think they are leader [in their market]," he says. "They have established themselves early on and because of their early entrance and early establishment, they can continue to carry that forward."
David Wong, a technology analyst with Needham & Co., New York, retains a "buy" on the stock even though it has passed his target. "It is one of the leaders in a space [in the chip market] that is extremely strong at the moment," he says.
"It's a very, very fine company," agrees David Hodgson, the technology analyst at Odlum Brown Ltd. in Vancouver. He has no recommendation on the company only because its lofty valuation does not fit his value investing model.
"There is no question that the company is deserving of a premium multiple," he says, "but how much do you pay and how many years out do you discount good news?"
The company was founded in 1984 in California as Sierra Semiconductor Corp. by James Diller, who was the chairman until retiring earlier this year. In 1992, Sierra invested in a technology offshoot of B.C. Telephone Co. that was spun off to become PMC-Sierra. Making modem chipsets was the Sierra side of the business while the Burnaby arm was working on semiconductors for networking.
Mr. Bailey, an American-born electrical engineer with a master's degree in business administration, was recruited in November, 1993, to be the Burnaby firm's president and chief executive when PMC-Sierra had only 29 employees.
Now 42 years old, Mr. Bailey was then already a veteran of the semiconductor business, having spent 10 years with Texas Instruments and then four years turning around a money-losing division of AT&T Corp. "I moved to B.C. where there never had been a semiconductor company before and we had decided we would start one," he recalls.
Now with 600 employees, most of them in British Columbia, PMC-Sierra is one of the largest technology companies in the province.
It pays its employees the equivalent of Silicon Valley salaries to keep them from being lured south -- although Mr. Bailey concedes he cannot do much to combat the significantly higher tax rates in Canada.
"If we had the same tax rates [as Silicon Valley], I think we could have a thriving high-tech industry here."
PMC-Sierra thrives because it has a technological lead in the field of networking semiconductors just as Internet-driven demand for high-speed data transmission is exploding.
"I think they've done a very good job at establishing themselves in key markets," Mr. Wong says. "I think it's a combination of good strategy and execution of good strategy."
Mr. Hodgson, the Vancouver analyst, agrees. "They haven't put a foot wrong for a couple of years."
"Voice traffic is growing in single digits annually," Mr. Bailey says. "Data traffic is exploding. The Internet is doubling every 100 days. The pipelines for that information are not set up to handle that kind of load."
In the company's annual report, he explained it this way to his shareholders: "Armed with ultra-fast microprocessors, [personal computer] users are producing and transmitting a glut of data that has shifted the bottleneck from the desktop to the bandwidth-challenged network.... And there is no let-up in sight as the demand for network bandwidth grows unabated even as the cost of bandwidth drops.... The networking semiconductor company best-positioned to benefit from this kind of trend is PMC-Sierra."
The integrated chipsets his company is making (using fabricators in Asia) are being purchased by major companies in the communications business. Lucent Technologies and Cisco Systems each accounted for more than 10% of PMC-Sierra's 1998 revenue, which totalled $161.8-million.
The company continues on a hot sales pace this year, with first-half revenue of $109.4-million, compared with $74.3-million a year earlier. Mr. Bailey calculates that PMC-Sierra now has about 25% of the worldwide market for merchant broadband semiconductors (those sold on the open market). The business, he said, is growing at a rate of 50% to 70% a year.
Mr. Harrison, the San Francisco analyst, believes that PMC-Sierra's technology is strong. "They either have developed it and can refine it or, in instances where they think they are lacking, they will do an acquisition to get it in-house."
Just such an acquisition was announced by PMC-Sierra late in August. The company is paying $400-million in shares to take over Abrizio Inc., a private company in Mountain View, Calif., that specializes in chip technology directly complementary to PMC-Sierra's chips.
"They have a unique technology that is used at the core of the most complex high-performance systems that are at the core of the Internet," Mr. Bailey says. "This is what opens up the bottlenecks."
Abrizio, whose patented technology emerges from research done at Stanford University, is a small company with no revenue. However, its chipsets are designed into broadband systems developed and about to be marketed by several large customers. That is one reason that the Burnaby company has paid handsomely for Abrizio and its group of engineers.
"They're way ahead of us," Mr. Bailey says. "This acquisition is designed to further enhance PMC-Sierra's position in the sweet spot of the semiconductor market -- broadband infrastructure."
For accounting purposes, the acquisition is being done on a pooling of interests basis, if only because it will spare Mr. Bailey having to explain to his shareholders how accounting manoeuvres turn profits into losses.
In 1998, PMC-Sierra took over a Maryland company called Integrated Telecom Technology Inc. for $55-million and then reported a 1998 loss of $2.9-million after taking a total of $43.5-million in charges to write off acquired research and goodwill.
"The fact is that we were very profitable last year," Mr. Bailey says.
Mr. Hodgson warns that the chip business is notoriously cyclical. "But I don't think the party is over for them [PMC-Sierra]," he adds. "There still are lots of legs left in the Internet market."
PMC-Sierra Inc.
CEO: Robert Bailey
Ticker: PMCS
Listed: Nasdaq stock market
Head office: 105-8555 Baxter Place, Burnaby, B.C. V5A 4V7
Telephone: (604) 415-6000
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