National Semiconductor Is Poised To Benefit From Texas Instruments' Moat

Dec. 7.11 | About: National Semiconductor (NSM)

Texas Instruments' (NYSE:TXN) recent purchase of National Semiconductor (NSM) surprised many, but the combination shows promise. Now that it's under TI's wing, National's product portfolio should have plenty of opportunities to regain lost market share. National's business will suddenly benefit from a salesforce that is 10 times larger and TI's long-standing customer relationships, both of which bode well for future growth. Also, we have become less fearful about the integration risks surrounding this massive acquisition.

National's analog chip business has grown at a below-average industry rate in recent years, which we think made the firm vulnerable to an acquisition (and made the 78% premium that TI paid so eye-popping). National lost share in the handset market and drove away some of its key customers by raising prices, refusing to budge from these prices, and walking away from these customers when they declined to accept National's terms. The strategy may have made sense if National had capacity constraints or wanted to make new investments elsewhere, but the firm was rejecting these customers while maintaining half-empty production facilities, leading to high fixed costs with no offsetting revenue. National later recognized these flaws, but struggled to regain the trust of these customers.

Customers have many suppliers to choose from in the fragmented analog chip industry, and few saw National as a strategic supplier critical to their future success. Even in cases where customers put National back on the radar, the design time for new product ramp-ups meant that noteworthy revenue streams might not be realized for a couple of years. The TI acquisition wipes away all of this ill will, and TI should see more customer engagements simply by applying a rational sales strategy to National's business, now known as Silicon Valley Analog.

SVA's high-quality product portfolio should greatly benefit from TI's massive salesforce, which we see as a contributor to the firm's narrow economic moat. TI has more than 2,500 sales representatives, versus 100-150 for National; TI's salesforce in China alone is larger than National's entire team was. National shifted to web-based sales tools and cut head count in recent years, whereas TI's strategy has long focused on having more salespeople and field application engineers on the street. The merger gives SVA the best of both worlds: better web-based sales systems plus knowledgeable salespeople for customized support. Although TI hopes to generate SVA growth across all regions and end markets, China appears to be a particularly promising opportunity. TI has a significant presence there, while National never had a sales team in mainland China and was instead located in Hong Kong.

TI's "stress test" for National before making the deal involved four quarters of National's revenue growth continuing at a below-average industry pace, followed by 12 months of industry-average growth and 12 months of above-average growth. Although TI hopes to do better than these bare-minimum estimates, the stress test provides investors with some good insight about near-term expectations for National's business, especially given recent macroeconomic concerns. Considering the currently shaky environment, we wouldn't expect TI to outperform these expectations anytime soon, and TI even admitted that above-average revenue growth in the second year would be an overly aggressive goal at this point.

Once National was acquired, TI took rapid steps to bring it into the fold. On Day 1, TI rebranded National's business as Silicon Valley Analog, and its salesforce was selling SVA products along with TI chips from the outset. TI and SVA also worked on integrated solutions, where an SVA analog chip may work alongside a TI digital signal processor or microcontroller. To assist the salesforce, the combined company established a hotline for salespeople in each region, so a sales rep on the road could call in to a corporate center and be briefed on a specific SVA product. We feared that a TI-National deal would have significant product overlap, but TI believes that only 5% of National's products are redundant with TI's analog portfolio, compared with initial expectations of 10%-20% overlap.

SVA's mobile devices power division, which sells to large handset manufacturers, lost a sizable amount of share to TI and others in recent years because of the aforementioned flawed sales strategy. Now, though, we think the handset market (25% of sales) provides the greatest growth opportunity for SVA in the years ahead as these chips are sold alongside other TI wireless chips. TI's goal is to make its OMAP application processors and connectivity chips available to a broad array of customers, including nonhandset applications and devices that require embedded processors. TI's extremely diverse product portfolio could be a competitive advantage in the years ahead as the firm strives to cross-sell both TI's and SVA's handset-focused chips into new end markets.