Texas Instruments Is Worth $45 And Here’s Why

Competing with companies such as Qualcomm (NASDAQ:QCOM), Broadcomm (NASDAQ:BRCM), Nvidia (NASDAQ:NVDA) and Intel (NASDAQ:INTC); Texas Instruments (NYSE:TXN) was amongst the top five semiconductor vendors (in terms of revenue) in 2011 ^[1]

However, the stock has registered a decline of almost 15% in the past year, reaching as low as $25 in August 2011. We believe, that the market dynamics fail to account for the strong fundamentals of Texas Instruments and assign a price estimate of $45 to the company, marking our valuation at a premium of almost 60% to the current market price. Our analysis is mainly centered around the following factors –

See our complete analysis of Texas Instruments here

Growing Strength in the Analog Business with Acquisition of National Semiconductors

Historically, TI has been the market leader in analog semiconductors and we believe that it will retain its dominant position till the end of our forecast period, even witnessing a slight increase in its market share.

The company also remains the market leader in voltage regulators, which contribute around 29% to its analog division revenue. According to iSuppli, voltage regulators are set to grow at an annual rate of 16%, compared to the overall analog segment’s rate of 6.3%. ^[2]

Last year, the company launched its dual analog-to-digital converter (ADC) drivers that provide the industry’s highest performance-to-power ratio. It also announced its new line of ARM® Cortex™-A8 microprocessors multiple integrated industrial communication protocols. Aimed at the industrial automation market, these new microprocessors are expected to further bolster its industrial electronics market share.

TI’s acquisition of National Semiconductor, which was the 7th largest analog company with a 4% market share, reinforces our belief of it’s market share rising, as it benefits from the positive synergies of the two companies. National’s strength is power management, amplifiers, and interface chips nicely fit in to complement TI’s existing portfolio of high-performance analog products. Since the analog division account for more than 55% of our price estimate, it remains by far the most important division in TI’s portfolio.

Incremental Revenue Generating Capacity

In the past couple of years, with the acquisition of National Semiconductor and some other companies’ fabrications and equipment and factories, Texas Instrument has added around $7 billion worth of incremental revenue generating capacity.

The company’s gross margin has witnessed a y-o-y decrease from 2007 to 2011, barring an increase in 2010. The additional manufacturing capacity coupled with a slowdown in industry demand led to lower factory utilization, which was responsible for the decline in its profit margins. However, we expect that as the industry revives and demand picks up, TI could leverage on this additional capacity, consequently increasing the factory utilization rates which in turn will pull up the gross margins. Based on this assumption, we estimate the gross margins to reach around 53% by the end of our forecast period.

According to research firm IDC, the global semiconductor revenue is expected to rise 6-7% this year. ^[3] If chips go into another strong bull cycle as predicted, TI’s additional capacity and margin advantages could make the company shine and retain its position as one of the top five semiconductor vendors.

Innovative Offerings in Wireless Connectivity and Application Processors can Become New Revenue Drivers

With TI’s announcement to cease all R&D effort for cellular baseband in 2008, the revenue from this division has drastically gone down and is expected to cease by the end of 2012. We expect TI’s market share in wireless to decline till end of the year, as baseband revenue was almost 60% of wireless. However, we are of the view that going forward the enhanced product offering in the wireless segmentwill help it retain the 7% market share till the end of our forecast period.

Last year, TI came out with its new line of OMAP4 mobile application processor and also introduced the WiLink 8 which integrates five wireless technologies onto a single chip. Recently announced programs that are based on TI’s OMAP 4 platform include Samsung’s Nexus & Galaxy SII Smartphones, Motorola’s Droid Bionic and Droid RAZR Smartphones, LG’s Thrill Smartphone and Amazon’s Kindle Fire tablet. We feel that exiting the baseband business would lead to a greater focus on stand-alone application processors and connectivity solutions, which are aimed at the more rapidly growing smartphone market.

We expect the wireless product market to almost double from the current level of $33 billion, by the end of our forecast period.

Potential Risks: Idle Capacity, Failure of OMAP, Stagnant Share in Analog Division

If the growth in the chip market does not pick up as expected, the increased costs associated with the incremental capacity could come back to bite TI, as it will negatively affect margins in the long run. If the margins stay at a level of 51% till the end of our forecast period, we could see a little over 4% decline in our price estimate.

Additionally, if the company’s OMAP application fails to stay its ground in the stiff competition, there could be a major impact on our valuations. The application processor and connectivity division contributes close to 20% to our price estimate. Our estimate is based on TI retaining around 9% of the market share in this segment, mainly on account of innovative product offering. Thus, any change in the company’s stand on the OMAP chip business could significantly effect our valuation.

Lastly, if the market share in the analog division does not increase by as much as estimated, we could see a downside in our price estimate. A 1% decline (than what we forecast) in market share will bring down the price estimate by almost 3%.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Worldwide Semiconductor Revenue Reached $307 Billion in 2011, Gartner Press Release, April 17, 2012 [↩]
2. Voltage Regulators Set to Grow to $16.3 Billion by 2015, iSuppli, July 4, 2011 [↩]
3. Worldwide Chip Sales May Grow at Faster Pace, IDC Says, Bloomberg, April 30, 2012 [↩]