Semiconductor Stock Pick: Sigma Designs

On December 17, The Wall Street Transcript interviewed Tristan Gerra, the Senior Semiconductor Component Analyst and a Director at Robert W. Baird & Co. Inc. Key excerpts, including his sector pick, follow:

TWST: Where are you pointing investors? What names do you like at this point?

Mr. Gerra: Sigma Designs (SIGM) is a name we continue to like. This is a company that is a pioneer and leader in IPTV. The ramp of IPTV has been very strong, driven by Europe initially but now in the US as well with AT&T (T). This is pretty much the only semiconductor pure play in the IPTV space and that's a space that has been growing by double digits every year and that we expect to see growing by double digits for the next three to four years. If we talk about a killer app, that's one new segment that didn't exist five years ago. In that space, Sigma Designs is basically getting all the design wins with about 75% market share, virtually no competition, and the company is basically locked in for about two years with those set-top box designs. In addition to IPTV, Sigma Designs also has a leading market share position in the emerging Blu-ray DVD player category on the basis of the same IC architecture. The company is also starting to ramp in HDTVs, advanced TVs that have an Ethernet connection. So this is basically a company exposed to several fast-growing markets while facing a very muted competitive landscape right now.

TWST: What's keeping competition at bay?

Mr. Gerra: The barriers of entry have been higher than most expected. The main reason is the software. This is a very software-intensive process where the decoder, which is what Sigma Designs is selling along with some other functionality on the same chip, really relies on very complex software to work with the digital rights management of IPTV operating platform, specifically the Microsoft IPTV software Edition, which is the leading IPTV platform at the non-Asia largest telcos worldwide. Sigma Designs is the only company that has a chip compliant with Microsoft. So Microsoft has really acted as marketing muscle for Sigma Designs. In addition, H.264 video decoding is pretty complex to do, particularly when you're decoding several frames simultaneously in HD so that you can have picture-in-picture type of functionality. Video quality is very important here. The telcos that are ramping IPTV such as AT&T don't want to trade quality for pricing because quality is what they rely on to take customers away from the cable providers and Sigma Designs has a strong edge in that regard, in our view.

TWST: What kind of growth are you looking for at Sigma for the next couple of years?

Mr. Gerra: We expect the company to continue to grow at a double-digit rate. In calendar 2006, the company almost tripled the top line; in calendar 2007, we expect the company to double the top line again; and then, we expect double-digit growth for the next two years. The company has been growing the top line at double digits sequentially for the past eight quarters, every single quarter.

TWST: Do they have the management in place to support that kind of growth?

Mr. Gerra: So far they have been successful. Sigma Designs remains a company that is still small in terms of headcount, but they basically have the platform that is applicable to a variety of end applications, and they don't need to grow either sales and marketing or G&A too much at this point because they have the technology platform and the customer relationships. This creates a lot of EPS leverage because you're seeing a double-digit increase at the top line but a low-single-digit increase in terms of operating expenses.

TWST: With that kind of pattern, are they likely to become a target?

Mr. Gerra: They have been a target for the past few years, but they haven't been willing to sell because they knew the opportunities that they had ahead of them. Going forward, this is always a possibility, but I think the company clearly has enough momentum to remain on its own for a while.