Given all of the excitement surrounding technology IPOs, many investors are struggling over how to divvy up their portfolios. Semiconductors provide an ideal way to play the sector's positive secular trends given that they are indirectly linked to most tech end markets. In this article, I will run you through my DCF model on Xilinx (XLNX) and then triangulate the result with a review of the fundamentals against Altera (ALTR) and Texas Instruments (TXN). I find that Xilinx is meaningfully undervalued.
First, let's begin with an assumption about the top-line. Xilinx finished FY2011 with $2.2B in revenue, which represented a 5.4% decline from the preceding year. I model 8.6% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold eating 35% of revenue versus 15.5% for SG&A, 18% for R&D, and 2% for capes. Taxes are estimated at 18% of adjusted EBIT (ie. excluding non-cash depreciation charges to this a pure operating model.
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around 0.5% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $41.08, implying around 25% upside.
All of this falls within the context of strong performance despite a challenging environment:
"Fiscal year 2012 was marked by challenging industry conditions. In spite of these, Xilinx introduced a record number of 28-nanometer products, gained market share on the 40-nanometer node and reported record operating cash flow of $827 million. Additionally, cost reduction efforts of the company contributed to gross margin improvement in each consecutive quarter of the year, enabling Xilinx to report a record gross margin of 66.4% in the March quarter.
Turning to the March quarter, Xilinx sales were $559 million, up 9% sequentially and down 5% from the same quarter a year ago. This was better than our guidance heading into the quarter, primarily due to better-than-expected business from wireless communications customers deploying LTE and 3D technology, as well as a strong rebound across-the-board in the Industrial and Other category".
From a multiples perspective, Xilinx also has some momentum. It trades at a respective 16.7x and 14.1x past and forward earnings versus 16.7x and 15.5x for Altera and 19.8x and 12.9x for TI.
Consensus estimates forecast Altera's EPS forecast declining by 27.2% to $1.71 in 2012 and then growing by 26.9% and 15.2% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $2.14, the stock would have very little upside. In light of this weak return, I believe investors will shift over to Xilinx as the economy improves. 24 of the 27 revisions to EPS have gone down for a net change of 3.6%. With that said, the company is still led by an impressive management team.
And then there is heavyweight TI. Consensus estimates forecast TI's EPS declining by 18.6% to $1.80 in 2012 and then growing by 32.8% and 18.8% in the following two years. Assuming a multiple of 17.5x, a deserved premium, and a conservative 2013 EPS of $2.36, the stock would hit $41.30 for 34.4% upside. TI offers a dividend yield of 2.2% on top of this sizable value discount. Accordingly, I recommend opening long positions in this leading semiconductor.
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.