Atheros' Growth May Be Its Downfall

After looking through Netgear (NTGR) recently and digging through annual and quarterly reports, I came across one of their suppliers that also looks interesting on the short side. Atheros Communications (ATHR) makes many of the chips that go into wireless devices. The company’s product lines are included in many PCs, networking items such as routers and switches, mobile and WiFi phones, and many emerging wireless consumer electronics such as bluetooth devices and wireless gaming controllers.

The most recent quarters results came out with the company pulling in revenues above $100m for the first time. Revenues were up 38% and non-GAAP EPS was $0.25 up 47% from the same quarter last year. The PC business was a strong performer and the company is optimistic that lower prices in routers using the new 802.11n technology are driving demand and leading an increase in volume. The company mentioned the PAS (Personal Access Systems) which are used primarily in WiFi phones was a weak line, and this specific line had higher margins than many of the company’s other products. However, this line is a small portion of overall revenue and many analysts are willing to concede that this business will largely be out of the picture with other products picking up the slack.

The stock sold off as investors were disappointed with guidance for Q3. Management said revenue would come in around $105-108m for the quarter and EPS will likely be at or near Q2 earnings. This would represent 36% revenue growth and 37% EPS growth if the company hit the high end of its guidance. While this sounds like impressive growth, the numbers would solidify a trend of declining growth levels as the company matures and faces larger hurdles. After seeing sales ramp between 55 and 75% for the last year or so, now there will have been 2 quarters of growth in the mid 30’s which indicates the company is reaching a stage in its growth where the law of large numbers is beginning to catch up.

The company cited networking as being a lighter component in Q2 due to seasonal weakness. This is exactly the argument Netgear made (see previous article) as it released its quarterly results. Expectations are for this business to pick up in Q3 and Q4 but my assessment of the economy is that consumers and small businesses may be hesitant to spend much more as they see concerns with the prospects of the economy. Also, many who currently use an 802.11g type device will see little benefit in upgrading to a .11n device because they will be satisfied with the current level of service they get from existing devices.

My concern with ATHR is that it is trading at a small growth stock multiple and is maturing into a larger more established growth stock. This is part of the natural process of a company maturing and is admirable, but investors will likely begin discounting the slowing growth and placing a lower multiple on the stock. From a macro perspective, I think we are in a changing environment where risk will be a larger concern for investors and that will also cause a multiple contraction on many risky assets across all different sectors. I would use caution investing in this name and believe it is well suited as a potential short position.

Disclosure: Author has a short position in ATHR

ATHR 1-yr chart

Comments

[Thomas Crown]

PAS has nothing to do with wifi phones. perhaps you should read the ATHR filings, too.