- Skyworks Solutions is the third debt-free company that I have chosen to cover in the debt-free series.
- Skyworks Solutions is outside of my normal businesses I cover because the semiconductor industry changes too rapidly for me to keep up with.
- Skyworks is diversified with a number of clients but investors need to be aware that a few clients make up a large part of the company's revenue.
- Outstanding share count has been reduced by more than 10% over the last five years.
- DGI investors should take note that the dividend has more than tripled since 2014.
The semiconductor industry is something I tend to avoid covering largely because the pace with which technology is changing often times exceeds what my brain can keep up with. This doesn't mean that I won't invest in the industry, but it does mean that I will let smarter individuals who have engineering backgrounds do most of the coverage for me.
With that said, writing this article on Skyworks Solutions (NASDAQ:SWKS) is something that falls outside of my comfort zone and I believe it will be an opportunity to learn something new about an interesting company/industry even though I will be focusing on the financials more than the underlying technologies developed by SWKS.
I wanted to start by finding a competitor or two that I can make some comparisons with because I think it can be helpful to see where SWKS fits within its industry. There are a lot of competitors in this fast-changing industry but I don't see any specific company that stands out as a pure-play direct competitor. In the 2019 10-K Report, I was led to Qorvo (QRVO) which is a large supplier for Apple (AAPL) and whose business model is largely dependent on the growing sales of AAPL's devices.
The history of both companies goes back a few decades but both companies have only existed in their current form since the turn-of-the-century. SWKS was the result of a merger between Alpha Industries and the wireless communications segment of Conexant on June 26, 2002. The merger that created QRVO took place on January 1, 2015, and involved TriQuint Semiconductor and RF Micro Devices.
Because QRVO has only existed in its current form for a little more than five years, is more difficult to show the long-term price performance relative to one another. The graphs below provide total returns since the inception date of each company's merger.
For anyone who was lucky (or smart enough) to invest in SWKS at any point before 2010 is undoubtedly appreciative of their investment as the stock has provided a return of over 1800% during that time frame. Qorvo, on the other hand, hasn't seen the same kind of returns since their merger/inception but it would be misleading to suggest that its performance has been poor because both companies (when measured from the January 1, 2015 inception date) show that stock prices have lagged the S&P 500.
Interestingly enough, SWKS and QRVO represent a situation that is somewhat similar to the comparison that was made with Jack Henry & Associates (JKHY) and Fiserv (FISV) with the exception that this isn't a David vs Goliath scenario. I believe it is more appropriate to describe this comparison as a Goliath vs. slightly smaller Goliath scenario.
Corporate Debt Reaches New Highs
The full corporate debt section can be read in the original article shown in the link below.
For those new to the series, the main thing to understand can be seen in the image below that shows US Corporate Debt has reached record highs.
Source: Wolf Street
As mentioned already, SWKS was founded after the merger of Alpha Industries and the wireless communications segment of Conexant on June 26, 2002.
This resulted in a company that has built its business model on "Connecting Everyone and Everything, All the Time." This phrase comes from the About page for SWKS which states:
We are empowering the wireless networking revolution, connecting people, places and things around the world. As the demand for ubiquitous, "always-on" connectivity increasingly expands, our innovative, high performance analog semiconductors are enabling breakthrough communication platforms from global industry leaders - changing the way we live, work, play and learn. Through our broad technology expertise and one of the most extensive product portfolios in the industry, we are Connecting Everyone and Everything, All the Time.
In simpler terms, SWKS is finding a way to integrate its technology with almost anything you can imagine. The list below talks about some of the products that have SWKS technology integrated into them:
- Cellular Infrastructure
- Connected Home
- Wearable Products
Shares Repurchased - The Debt Comparison
I have found myself driven lately to identify companies that are reducing share count without incurring massive debt in the process. I found Boeing's (BA) use of debt and share buybacks over the last five years to be particularly appalling as they used cheap debt to buy back shares that were trading for more than double what current shares are currently trading for. These share buybacks, when combined with the flaws of the 737 MAX, created a recipe for disaster that has led Boeing to its current predicament.
I can't emphasize enough that I am not against companies that use debt but that it doesn't become an unsustainable game that puts total returns at risk. In short, this is why I got so interested in debt-free companies because each one of these companies that I have covered so far has found major success without the need to utilize any long-term debt.
In this section, I decided to add QUALCOMM (QCOM) because this is a company that is a true Goliath with a current market cap of more than $90 billion (making it more than three times the combined market cap of SWKS and QRVO). QCOM is considered a major competitor to both SWKS and QRVO.
Although the numbers above are far from a Boeing-like situation, it is interesting to see that all of the companies above have reduced their outstanding shares by a considerable amount. With that said, there are a few details that investors need to be aware of when looking at the numbers in the image above.
- QCOM's major reduction in shares outstanding was largely due to an Accelerated Share Repurchase (ASR) program that was completed at the end of Q3-2019.
- QRVO's recent reduction as noted in its Q3-2020 earnings call transcript stated that the company repurchased "$125 million of stock in the quarter and completed a $200 million add-on to our 2029 unsecured notes issued earlier in the quarter."
SWKS had a solid quarter with $287 million of free cash flow and subsequently returned half of it to shareholders in the form of repurchasing common stock and paying a dividend. This was summarized in the SWKS Q1-2020 earnings call transcript.
We paid $75 million in dividends and repurchased 742,000 shares of our common stock for a total of $74 million. During the last 12 months, we have returned 87% of free cash flow back to the shareholders through a combination of our dividends and share buyback program. We ended the first fiscal quarter with cash and investments of $1.2 billion and we have no debt.
Revenue Concentration And PS Ratio
When it comes to the companies that do business with SWKS it shouldn't come as a surprise that the list is quite long but the concentration of revenues is primarily focused on Apple. For the last three years, SWKS has built a particularly strong relationship with AAPL which has resulted in a significant increase in the concentration of revenues devoted to AAPL products. As noted in the 2019 10-K report, AAPL was responsible for 51%, 47%, and 39% of revenues for 2019, 2018, in 2017, respectively.
On a Price/Sales ratio (PS Ratio) SWKS is currently trading higher than its competitors and comes with a current PS Ratio of 6.36x. This compares with QCOM's PS ratio of 4.2x and QRVO's PS ratio of 4.42x. The current premium that SWKS enjoys over its competition doesn't appear to be justified especially when we consider the following risks.
- Continued disruption in APPL's supply chain that could result in additional delays or prevent APPL devices from being built.
- The risk of APPL choosing a different supplier or even creating their own in-house product (similar to what is happening to QCOM and is discussed in further detail below).
A heavy concentration of QRVO's revenues also comes from AAPL as noted in the company's 2019 10-K report. QRVO's concentration of revenues derived from APPL products was 32%, 36%, and 34% of total revenue for fiscal years 2019, 2018, and 2017, respectively. It should also be noted that QRVO has increased its exposure to Huawei with 13%, 8%, and 11% of revenues coming from them in fiscal years 2019, 2018, and 2017, respectively. At first glance, it would appear that QRVO is more attractively priced (based on sales) and they have historically shown that they have less exposure to their top customers.
I also decided to throw QCOM into this mix because of its history with APPL and its recent settlement that awarded QCOM a six-year contract to supply their modems in APPL phones. On top of that, APPL will need to pay at least $4.5 billion as a "make-up fee" before it can begin to use QCOM's 5G modems. Although this is positive news for QCOM in the short term, it is likely to have negative long-term consequences now that APPL has purchased Intel's (INTC) modem business for $1 billion. I would need to hear a very convincing argument in order for me to believe that QCOM will have any APPL market share when its six-year contract is up because it seems pretty obvious that APPL's purchase of this technology serves as the launchpad it needs to end its reliance on QCOM. Although QCOM generates a massive amount of revenue, it's revenues have been largely stagnant for the last decade which is likely part of the reason why it commands a low PS Ratio of 4.2x.
When it comes to PS Ratio it would appear that QRVO is the most attractively priced at current levels while SWKS is overpriced and QCOM is fairly priced to account for future uncertainty.
SWKS Share Repurchases
One theme that has remained consistent among the three debt-free companies I have reviewed is that they appear to do a good job of repurchasing outstanding shares at a discount. In SWKS's 2019 10-K Report, it is noted that the company repurchased nearly 2 million shares over the course of three months and was able to do so at an average price that is roughly 25% less than its current price of $98.83/share.
Share repurchases for a company like SWKS are extremely important especially when we consider that they have zero long-term debt. This means that the company is really left with four options:
- Return money to shareholders in the form of dividends and share repurchases.
- Reinvest those funds in the company and develop additional products and services that will generate more revenue.
- Utilize those funds to acquire other businesses.
- Let the cash sit.
Of the options presented, option number four is the only option that describes what no company wants to do with its money. The only exception to this (that I can think of) is that a company may choose to sit on cash for a longer period than normal when it is building the reserves it needs to acquire another company.
In the case of SWKS, the amount of Cash and Cash Equivalents over the last three years has fluctuated significantly as a result of acquisitions and other expenditures.
SWKS is building up a nice cash war chest but they have also implemented a generous dividend policy that started back in April 2014. When the company first initiated this policy the quarterly dividend payment was set at $.11/share or a total of $.44/share annually. The quarterly dividend payment has quadrupled since the dividend policy was first initiated with SWKS paying shareholders $.44/share quarterly for a total dividend of $1.76/share annually. Traditional DGI's might scoff at SWKS due to its paltry yield of 1.78%, however, the growth of the dividend has been exceptional and the payout ratio is just over 30%.
As I mentioned at the beginning of the article, I am no expert when it comes to the semiconductor industry but I do know that there are tremendous growth opportunities available for companies that are able to innovate and create cutting-edge products year-after-yea. SWKS has done an excellent job of positioning itself over the last five years and it has managed to get to this point without utilizing long-term debt. Management appears to be doing an excellent job of executing its business plan and has chosen to reward shareholders through share repurchases and dividend increases. In its investor presentation, SWKS noted that it intends to return 60-75% of FCF to shareholders annually (in the form of dividends and share buybacks).
Although I love to see a company with all of these positives, it would appear that QRVO may have more long-term potential because it is available at a lower PE and PS Ratio. SWKS is priced for perfect execution in my opinion which means that investors would be wise to wait out the current situation with COVID-19 before choosing to invest or at least waiting until shares are less than $80/share as this would be more in line with the average 10-year P/E ratio 13.88x.
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My Clients' John and Jane are long AAPL, BA.
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