In today's uncertain markets, investors have fled to "risk-off" assets. However, this may present a buying window for stocks that are perceived to be risky. In particular, Teradyne (TER) is a clear leader within the semiconductor test space that is diversified, profitable, and growth-oriented.
Products and Growth Opportunities
System-on-a-Chip (SOC) Test
Teradyne is currently the leader in the SOC test space, with market share well north of 50% (management estimates it to be closer to 60%). While SOC performed well above expectations in the first half of 2012, the market expects a seasonal correction in the second half of the year, particularly in hard disk drives. Combined with an unfavorable macroeconomic environment, the short-term outlook is negative. However, in the longer-term, Teradyne's strong product offerings will take advantage of a cyclical recovery in the future.
Memory test equipment is an area in which Teradyne can grow. Its competitor Advantest (ATE) currently controls the market with approximately 60-70% share, as opposed to ~20% for Teradyne (Barclays research). Most of the research on the Street appears to expect flat market share for Memory Test, so this segment is neutral for Teradyne.
Teradyne's latest acquisition in wireless test, LitePoint, does not appear to be priced in. LitePoint is extremely strong in connectivity (WiFi) testing with approximately 70-80% market share (Barclays research). This is due to technology that is decisively ahead of their competition in many aspects. While LitePoint has relatively small market share in the cellular test market, the fact that LTE technology requires manufacturers to replace the existing installed base of testers gives Teradyne a chance to grow in this space as companies reevaluate alternatives in testing products. The upcoming WiFi transition from 801.11n to 801.11ac will also provide room for top-line growth in LitePoint.
LitePoint's revenue surged 258% Q/Q to $112 million in the most recent quarter, as an unexpected number of customers accepted their new products. While results for 2H 2012 are expected to be lower due to seasonality, this large upside surprise is an example of both LitePoint's potential and the market's undervaluation of this acquisition.
With this exposure to smartphone and tablet growth, the above-average margin LitePoint business is poised to become a critical component of Teradyne's top-line growth and gross margin expansion over the next few years. In other words, Teradyne is taking advantage of Wireless Test's secular growth story.
Teradyne's strong market position and product line is multiplied by above-average margins and free cash flow. Over the last five fiscal years, Teradyne has averaged significantly higher EBITDA margins and FCF to Sales ratios than its two most comparable competitors, Advantest and LTX-Credence (LTXC):
Source: Company 10-Ks
This large advantage in cash generation gives Teradyne the opportunity to either invest in profitable opportunities (such as LitePoint) or return capital to shareholders through buybacks and dividends. Its competitors do not have the same flexibility. Teradyne's current valuation does not reflect this, as its EV to TTM EBITDA ratio is 5.47 as opposed to 21.60 and 20.22 for Advantest and LTX respectively (data from Bloomberg).
Furthermore, Teradyne is the only one of the three to have generated positive earnings over the last twelve months. This speaks to the diversity of Teradyne's business and customer base, as only one customer accounted for 10% or more of revenue last quarter.
There are a few key risks to keep in mind when considering Teradyne as an investment:
- The mobile semiconductor space tends to be more concentrated. As LitePoint grows its cellular test market share, expect increasing concentration of Teradyne's customer base.
- The semiconductor industry as a whole is highly levered to macroeconomic conditions. Slowing growth or an unexpected recession would have a severe negative impact on Teradyne's revenues and stock price.
- Intense competition may induce margin contraction or even loss of market share. Teradyne's market leadership depends on strong R&D and effective marketing. While the company has historically been successful in these areas, competitors and customers can be unpredictable.
Teradyne is a market-leading company in SOC testing and opportunity for aggressive growth in wireless testing. This strength is compounded by the above-average margins and FCF. Given the market's current discounted valuation of Teradyne, I recommend looking to accumulate the stock on any pullbacks within the next few months.