From uncertainty over end-market demand to high betas, semiconductors carry significant risks. These risks have horrified investors to irrationally steer away from the entire industry. But there is significant upside to be found in smaller firms like BE Semiconductor Industries (OTC:BESIY) and Alpha and Omega Semiconductor (AOSL). As an IR consultant, I believe these companies will receive greater press coverage that could possibly put them into play as takeover targets.
In this article, I will run you through my DCF analysis on Texas Instruments (TXN) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared with Advanced Micro Devices (AMD) and Analog Devices (ADI).
First, let's start with an assumption about revenue. TI finished FY2011 with $13.7B in revenue, which represented 1.7% off the preceding year. Analysts model 7.5% per annum growth over the next five years, and I view this as overly conservative given that 10.6% is expected for the S&P 500. As a tech firm, these metrics are frequently higher. But, for the sake of being safe, I accept this figure.
Moving onto the cost-side of the equation, there are several items to address: operating expenses, capital expenditures, and taxes. I expect cost of goods sold to eat half of revenue versus 11.5%, 12.5%, and 7% for SG&A, R&D, and capex, respectively. Taxes are also estimated at around 28%. All of these figures are roughly around historical three-year average levels.
We then need to subtract out net increase in working capital. I model accounts receivable as 11% of revenue; inventories as 23.5% of COGS; prepaid expenses as 20% of SG&A; accounts payable as 5.5% of OPEX; and accrued expenses as 80% of SG&A.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 8% yields a fair value figure $35.42, implying 11% upside. This factors in the $2.7B net debt and 0.81 unlevered beta.
All of this falls under the context of downward guidance revision:
We have narrowed and lowered our expected ranges for TI's revenue and earnings from our previous ranges. We now expect TI revenue between $2.99 billion and $3.11 billion. We expect earnings per share between $0.15 and $0.19 on a GAAP basis. The revenue and EPS reductions are due to lower demand for wireless products. Our estimates for acquisition-related charges and restructuring charges are unchanged and are expected to total to about $0.10 per share.
From a multiples perspective, TI is fairly attractive. It trades at 17.1x past earnings but only 13.3x forward earnings. This compares with 11.5x and 9.3x for Advanced Micro and 22.9x and 11.7x for Broadcom. Assuming a multiple of 15x and a conservative 2013 EPS of $2.31, the rough intrinsic value of the stock is $34.65.
Consensus estimated for Advanced Micro's EPS forecast that it will grow by 30% to $0.65 in 2012 and then by 26.2% and 29.3% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $0.79, the rough intrinsic value of the stock is $10.27, implying 36.9% upside. The company recently purchased SeaMicro for $334M, which I believe is attractive in the sense that it penetrates the cloud market. Supply chain issues in Llano have hindered value creation, but the fundamentals are otherwise strong. Broadcom is less risky but still positioned for double-digit gains. The company delivered solid recent quarterly results and has strong operational flexibility. It is able to boost margins through outsourcing ships from foundries and its potential for accretive M&A enables efficient increases in scale.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.