A Brutal Miss-And-Lower-Guide Has Silicon Labs' Growth Premium In Question
Summary
- Silicon Labs missed for the fourth quarter and guided down significantly for the first quarter on ongoing challenges in IoT and growing weakness in China's industrial markets.
- IoT, isolation, and timing can all be growth drivers, but Silicon Labs faces some large, well-positioned players across the board and SLAB's reliance on Chinese customers may become a liability.
- SLAB shares aren't cheap enough to be compelling relative to the discounts available with many other chip stocks.
It’s generally accepted by most investors that you have to pay up for growth, but with the recent weak performance at Silicon Labs (NASDAQ:SLAB), including an ugly guide-down for the first quarter, I’m concerned that these shares could be liable to investors asking “wait … why are paying up for this?” I had previously expressed my view that Silicon Labs was entering a rocky operational stretch, but this is a little worse than I’d expected, and the company definitely needs markets like IoT, isolation, and timing to start coming through in the second half of 2019.
An Ugly Quarter
There’s not a lot of positive things to say about the fourth quarter at Silicon Labs, as there were disappointments across the board, driven in no small part by ongoing weakness in China and what I believe is a weaker-than-appreciated position in MCUs.
Revenue did rise 7% from the year-ago quarter, but the market typically fixates on quarter-over-quarter performance, where revenue contracted 6%, and revenue missed expectations by about 4% anyway. The IoT business did comparatively better, up 9% yoy and down 5% qoq, despite an ongoing transition at a smart metering customer, while Infrastructure rose 18% yoy and fell 13% on weaker sales of digital isolation chips in China. Access fell 8% yoy and 7% qoq, while Broadcast fell for both periods.
Gross margin was a comparative bright spot, holding steady versus last year and declining just 20bp qoq while coming in a little better than expected. Operating income dropped 5% yoy and 20% qoq, though, missing expectations by 10%.
Guidance was even worse.
Although Silicon Labs’ guide for a 10% to 15% qoq decline in revenue doesn’t look as bad as STMicroelectronics’ (STM) 20% qoq decline guidance, and Texas Instruments (TXN) guided for a 10% qoq decline at the low end, the STM guidance was 8% below prior expectation and the TI guidance was about 4% below the prior expectation versus the 14% revision (at the midpoint) implied in Silicon Labs’ guidance. Moreover, SLAB’s higher reliance on Chinese customers arguably puts this guidance at greater risk if conditions there deteriorate even further as the trade war drags on.
Growth Drivers Versus Risks
IoT is the main sizzle to the Silicon Labs story, as SLAB offers both microcontrollers (or MCUs) and wireless connectivity, as well as some sensor offerings. Thus far, the real strength in Silicon Labs’ IoT platform has been on the wireless side, where the company boasts an impressive range of offerings including WiFi, Bluetooth, Zigbee, and Z-Wave. While MCU revenue was down, wireless was stable (and grew outside Bluetooth) and wireless is now about 60% of the IoT business.
That’s a mixed blessing in my view. While Silicon Labs does have MCU offerings, they’ve never stacked up all that well to MCUs offered by companies like NXP Semiconductors (NXPI), STM, Texas Instruments and others. In several cases, device teardowns have shown Silicon Labs winning connectivity/wireless slots, but not the MCUs. In my mind, that’s a weakness that rivals like Cypress (CY), TI, and others can exploit. There will be cases where designers are willing to cobble together components, but my concern is that integrated offerings will become more common and push SLAB out of some desirable business.
I also see digital isolators as a meaningful growth opportunity. Isolators help protect systems from high voltage surges and they’re increasingly common in a range of electrical equipment as they are taking share from older optocouplers (a business where Broadcom (AVGO) has a strong legacy position). With digital isolators offering improved efficiency, speed, and overall performance, I see ongoing share shift toward digital isolators, with Silicon Labs having meaningful opportunities in a range of industrial equipment, aerospace, telecom, and electric vehicles. The “but” here is that there are plenty of sizable competitors, including Analog Devices (ADI) and TI, and Silicon Labs skews more heavily to China – arguably not a bad thing longer term, but a more challenging exposure in the near term.
Timing is another meaningful long-term growth driver for Silicon Labs, with opportunities in the data center and 5G markets. Here again there is significant sizable competition (including ADI and TI, as well as post-IDTI Renesas), and I’m concerned about Silicon Labs’ leverage to Huawei relative to other vendors like Nokia (NOK). Huawei is squarely in the crosshairs of the U.S. government today and it remains to be seen what this will mean for Huawei’s 5G volumes.
The Outlook
It’s easy to skew negative on a company when it is going through troubles, and I don’t want to leave the impression that Silicon Labs doesn’t have legitimate growth drivers. Although I think Cypress has a better all-around position in IoT given its stronger MCU portfolio, there will still be significant business opportunities for SLAB as IoT grows. Likewise, the company has a strong IP position in isolation and timing that will help it compete against those larger names.
Although 2019 is looking like a tough year (management didn’t push back on a sell-side analyst’s suggestion that revenue could be down for the year), I believe the company can it make up as IoT, 5G, and new isolation opportunities accelerate. I’m still comfortable with a long-term revenue growth rate around 8%, with an adjusted FCF growth rate in the mid-teens.
Unfortunately, the shares still don’t look that cheap on DCF, and the near-term weakness in margin and revenue really hammers the margin-driven EV/revenue model I like to use as a secondary valuation approach.
The Bottom Line
I had previously written that I’d be more interested in Silicon Labs in the low $70’s or below, and that still holds. With so many semiconductor stock valuations coming under pressure, I think investors can afford to be choosy and I’m not inclined to pay up for Silicon Labs when the actual growth hasn’t been as far above peers like TI as the valuation would otherwise lead you to think and expect.
This article was written by
Analyst’s Disclosure: I am/we are long AVGO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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