Apple (NASDAQ:AAPL) supplier RF Micro Devices (RFMD) has surged remarkably this year, with shares up 35%. Moreover, RF Micro's announcement that it is looking to merge with fellow chip maker TriQuint Semiconductor (TQNT) has given bulls more reasons to cheer. The cost synergies and market share gains that could arise from the merger could lead to even better share price performance going forward, since RF Micro was already looking to enhance its operating model.
RF Micro sees additional margin expansion in the future as it is focusing on cost reduction and making its processes more efficient. Also, the company is supposed to see strong demand in the future, since it supplies content to smartphone giant Apple (AAPL).
As such, it is not surprising to see that RF Micro is seeing strong customer order activity. It is seeing strong design with activity in flagship smartphones and tablets, which is why management is optimistic regarding the company's performance in the second half of the year.
Apple to propel growth
RF Micro Devices is tapping multiple opportunities to increase its dollar content in the world's leading smartphones and tablets. For example, the company has won more content inside Apple's latest iPhone 5S, according to Canaccord Genuity. Looking ahead, the launch of Apple's new iPhone could be yet another growth driver for the company. Apple is rumored to produce bigger screen smartphones to win market share from Android rivals such as Samsung.
According to The New York Times, bigger screen smartphones are finding more takers. For example, in China, 20% of all smartphones that were shipped last year were five inches or larger in screen size. Moreover, such big-screened phones, known as phablets, are just 4% of smartphone sales in the U.S. So, if Apple introduces a bigger iPhone, it will be able to tap a big market. As a result, even RF Micro Devices will benefit, as it is a component supplier to the smartphone giant.
Other end market opportunities
Global macro trends should also lead to growth in RF Micro's addressable market. The Internet of Things is one such opportunity that's gaining steam as a result of growth in embedded connectivity, connected homes, automotive Wi-Fi, and wearable technologies, and thereby increasing RF Micro's addressable market.
In addition, telecom carriers are adopting new technologies such as envelope tracking, carrier aggregation, and transmit MIMO to address the increasing requirements for always on broadband data, which increase RF Micro's dollar content opportunities. The deployment TD LTE and LTE advanced are leading to more LTE content in mid-tier smartphones, while in developing economies, consumers are switching from 2G phones to high-dollar content 3G smartphones.
RF Micro is also targeting incremental content in new and growing categories such as antenna control solutions, power management circuits, diversity switches, and a variety of new products that integrate filters and duplexes.
The continued adoption of RF Micro's ultra-low cost CMOS power amplifiers in next-generation handset platforms for emerging markets is also a growth driver. The migration of many smaller customers to this platform has lifted RF Micro's profits marginally. Further margin expansion is anticipated with the migration of the largest customer for CMOS PAs to ultra-low cost products. Further, the commencement of shipments to an additional tier one customer is also expected to provide a boost.
Making the business more efficient
RF Micro is implementing a flexible sourcing strategy of raw materials to reduce gas and silicon costs. It has also added assembly capabilities to reduce packaging costs. In addition, it is lowering the content of precious metals in its manufacturing process, while pushing forth higher volumes across its supply chain to bring costs down further.
Its flexible sourcing strategy is providing several benefits. RF Micro has reduced its manufacturing footprint and its fixed asset base significantly over the past few years. It sold its MBE facility and its gallium arsenide fab in the U.K. and has expanded its external sources of supply. RF Micro has a good balance of internal and external resources with fluctuations in demand, and this will support a better margin performance. The combined capabilities of its gas fab and its external foundries are well-equipped to satisfy the full breadth of customers' performance, size, and cost requirements.
RF Micro has also installed and qualified additional assembly capacity at its Beijing facility. A margin boost can be expected, as this move will reduce its reliance on external suppliers, while its internal production capacity will run at better utilization rates.
RF Micro is also planning to invest in assembly and equipment to reduce precious metals usage. It has made a multi-million dollar investment to secure BAW filter capacity and now has access to SAW, temp comp SAW, and BAW filter capacity from multiple sources.
RF Micro's earnings are expected to grow at a brisk pace of 18% over the next five years. But there could be more upside to this estimate as the merger with TriQuint will bring in more synergies. Finally, at a forward P/E of just 13, investors wouldn't be paying much for this growth, making RF Micro Devices a solid investment even after strong gains this year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.