EZchip: New Processor Will Be Unique

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Investors went into the long Labor Day weekend after closing a third successive month of rises. The Nasdaq index is the strongest riser so far this year, up 18%, and was the best performer in August too, rising by more than 4%, mainly thanks to Apple (NASDAQ:AAPL). Apple rose by more than 9% in August, in advance of the new iPhone launch in the next quarter, and also because of the victory in the patent case against Samsung (OTC:SSNLF) at the end of the month.

As occurs every year, the return to work after the summer break will be crowded with events. In the coming days we will have launches, announcements, and a large technology company conference in New York. The conference is organized by Citi (NYSE:C), and from it we will learn about developments in the third quarter, as we enter its final third. On Wednesday, in New York, Nokia (NYSE:NOK) will unveil its new smartphones. They will be based on what is considered a very promising operating system, Microsoft's (NASDAQ:MSFT) Windows 8, and will reach the market in late October, in time for the Christmas shopping season.

Many see this as just about the last chance for Nokia and Microsoft to take a substantial chunk of a huge, growing and profitable market of a billion smartphones a year, currently dominated by Apple and Samsung.

Still in New York, at the same time as Nokia, Motorola, for the first time as part of Google (NASDAQ:GOOG), will launch two new smartphones for Verizon's high-speed LTE network. And if that is not enough, on the U.S. West Coast, Amazon (NASDAQ:AMZN) is holding an event on Thursday at which it is believed it will unveil new Kindles.

There will also be an important Israeli announcement this week. On Wednesday, EZchip Semiconductor Ltd. (Nasdaq: EZCH) will hold a special call with analysts and investors to give details of the line of new network processors it began work on two years ago. For the past two years, the company has succeeded in keeping secret what it was developing, and there is not a single analyst, or expert in the field, who knows what the new network processors are meant for-- not even technology guru George Gilder, who discovered EZchip's great potential. Twelve years ago he revealed the company in a big way to Wall Street investors, and since then he has met its managers here and over there several times a year.

What is known is that three years ago, because of the global financial crisis, major U.S. semiconductor company Freescale (NYSE:FSL) was compelled to close its small development center in Omer, near Beersheva. EZchip jumped at the chance, and proposed to some of the best communications semiconductor developers in the area, who wanted to continue to live in the south, that they should become the kernel around which the company would build the development center for its new line of network processors. The center was set up in Kiryat Gat, unconnected to Intel (NASDAQ:INTC) or to Micron Technology (NASDAQ:MU), which have large semiconductor fabs in the southern city.

It is also known that a handful of potential customers were in on the secret during the development process, and perhaps on Wednesday we will know who they are, but presumably at least some of them are buyers of the NPU network processors that EZchip sells today.

The R&D costs for the new line of processors have grown so much in the past two years that by the end of the year they will account for about half of the company's entire R&D budget.

For reasons to do with the competition, the company's management would have preferred not to expose the new processors at such an early stage, but a public company that spends half its R&D budget on a new product cannot avoid explaining to its investors what it's about. In addition, more potential customers joined the circle of those in the know recently, so there was the fear that information about the new processor line would leak out in any case.

The new processors will start to contribute to sales in another three years, and by then the fifth generation NPU processors (NP-5) will be at the start of their sales cycle. The NP-4 processors that are currently only beginning to realize their potential will then be at their sales peak. The Kiryat Gat processors, plus NP-5, should boost the company to very high sales and profit levels, lasting at least until the beginning of the next decade. With $154 million net cash now, which will only grow in time, the company will find new sources of growth in the next decade as well.

I believe that at Kiryat Gat, the company is not developing network processors of the kind that are on the market today; it's not a "me too" product. These are unique processors, with solutions for the needs of the network in the coming years, the like of which does not exist in the semiconductor market today. Therefore, like EZchip's existing products, these will be processors with very high gross profit margins, the fruit of original "outside the box" thought, and which the company's management estimates have the potential to double the target market.

Published by Globes [online], Israel business news - www.globes-online.com - on September 3, 2012
© Copyright of Globes Publisher Itonut (1983) Ltd. 2012 Reprinted on Seeking Alpha with permission

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