The Wall Street Transcript recently interviewed Tristan Gerra, the Senior Semiconductor Component Analyst and a Director at Robert W. Baird & Co. Inc. Key excerpts follow:
TWST: What are you telling investors to do at this point?
Mr. Gerra: We are somewhat cautious on the space and we think that while we should witness a continued recovery for the SOX near term, we don't think that Q4 is going to bring very good data points. As end demand remains weak, the semiconductor market will remain more of the stock-picker type, specifically companies with good fundamentals or gaining market share, rather that buying the whole group on an upcoming upcycle with all companies, or most companies, benefiting from that trend.
TWST: What names are you pointing investors toward, if any?
Mr. Gerra: STMicroelectronics (STM) is a name we like. We have an outperform rating on the stock. This is a company that has performed a significant turnaround over the past couple of years by coming back in the wireless market and gaining market share, specifically at the expense of Texas Instruments (TXN) after missing the 2.5G product cycle, which was the previous generation of phones. We expect STM to continue gaining market share in wireless over the next couple of years. The company has done a significant amount of restructuring, which so far has been offset by currency and the appreciating euro. The recent strengthening of the US dollar versus the euro should bring to light all the restructuring efforts that the company has put in place over the past couple of years and benefit both gross margins and operating margins for the rest of this year, in our view. We like the name on a combination of top-line growth exceeding that of the industry average, along with margin leverage.
TWST: Why are they gaining market share? What have they brought to the market that wasn't there?
Mr. Gerra: A couple of years ago, the management team of STMicro decided to refocus their wireless effort exclusively on 3G by redirecting 1,000 engineers. This resulted in renewed consumer focus, along with new products which have gained good traction at tier 1 wireless OEMs over the past one to two years.
TWST: Is there anything that competitors can do to gain share back?
Mr. Gerra: Certainly. Market share shifts always occur. QUALCOMM (QCOM) is well positioned to remain the number one supplier of chips in the wireless space, and we think QUALCOMM will have an opportunity to start shipping to Nokia, given the recent settlement of the licensing litigation. STMicroelectronics, coming from a position where they previously had little market share in 3G baseband, has much more to win than they have to lose at this point.
TWST: Is there a second name?
Mr. Gerra: We like the programmable logic space, which is basically two companies, Xilinx (XLNX) and Altera (ALTR). We like those two companies, but we like Xilinx currently better, a function of low valuation relative to Altera. We expect Xilinx' market share to stabilize next year, post losses against Altera for the past few years, driven by recently introduced 65nm-based products. From an end-market standpoint, Xilinx and Altera are the companies in our group that have the least consumer exposure. Pure consumer exposure for Xilinx is around 7%, the rest is really infrastructure, enterprise related for the most part and even though that's a segment that can slow down as well in a recessionary environment, it's usually less sensitive to a slowdown than pure consumer applications.
We see a secular growth theme in communication acting as growth drivers for those two companies. We also believe the programmable logic market will continue to outpace the entire semiconductor industry over the next few years.
TWST: So it's one of the spots where you can see continued strong growth?
Mr. Gerra: That's correct. At the same time, Xilinx is one of the highest quality semiconductor companies, in our view.
TWST: Are there any other names to mention or are those really the three to focus on?
Mr. Gerra: In the small cap space, we have an outperform rating on Lattice (LSCC). This is a tier 3 supplier of programmable logic, so it's very small relative to Xilinx and Altera, competing in a space that we think has high barriers of entry and continues to outpace the entire semiconductor growth. Even though Lattice is a much smaller company, they've been able to gain a lot of design wins recently on the basis of differentiated products, which should lead them to gain market share late this year and next year and that should play well particularly given the stock's valuation, which is below book value currently.
TWST: Why is it selling below book?
Mr. Gerra: Lattice is a small company without a perfect execution track record and it's had some recent management changes. The combination of attractive valuation, expected revenue reacceleration over the next few quarters, and potential cost cutting near term should help the stock, in our view.