Wireless Industry Analyst

I value Texas Instruments at $32 per share. As we have seen in the last few weeks, the strengths are a good management, its analog strategy, the HPA growth and manufacturing efficiency. Its weakness is the wireless business. The growth drivers do not have the ammunition yet to drive the company out of the rut caused by the wireless world. This means that the share price will continue to hover around the $30 mark for quite sometime into the future.

TI has made the conscious decision to pursue analog vigorously. This has certainly paid off, especially with HPA growing phenomenally in the last few years. The company benefits further from the higher margins from HPA which I anticipate will grow at about 15% over the next few years. In keeping with this push, TI has diverted all its manufacturing capabilities towards analog slowly migrating towards the fabless model for digital manufacturing. This move away from the Integrated Device Manufacturer (IDM) model to a more hybrid strategy has allowed TI to become more nimble.

On the other hand, TI also seems to have made a conscious choice to stay away from mainstream wireless development. As I pointed out, it appears to be a miscalculated strategy that has come back to bite it. A healthy 15% CAGR in its OMAP business will help maintain stable revenue from the wireless business as it compensates the loss in digital baseband and chipset business to its competition. The company is trying hard, however, to explain that all is not lost on the 3G side claiming that its most recent Ericsson deal’s “revenue potential is very, very significant over the course of time.” But it really appears that the company has missed the 3G bus and is trying hard to catch up with a soap-box car.

Overall, I estimate that TI will have a modest 4% growth in revenue for the next five years. The $32 valuation would not have been possible without TI’s constant push for a higher margin product portfolio, manufacturing agility and the laudable margin targets. If it can somehow transform its wireless fortunes, either through partnership deals or an accelerated development effort and complement it with regained design wins, then we may see the stock inch towards the $40 mark. In the interim however, I am going to stay away from this stock for I don’t see any promising ROI here.

In the past two segments on TI, I have presented my perspective of TI’s wireless strategy. Let us now look at how this will impact the company’s revenue outlook over the next few years.

With the current indicators, it appears that TI’s wireless business will not grow appreciably over the next five years. I expect the growth to be between 1-2%. The connectivity solutions will also lose their overall market share. This number just does not seem right considering the opportunity that 3G presents. But then, a combination of TI’s flawed (IMHO) baseband strategy and the competition will likely take the teeth off TI’s wireless program.

The savior, however, will be the OMAP business. Though the company’s market share will likely reduce from its current 65% to about 40-50%, the volumes achieved by the growth in 3G will reduce the impact of this loss. I expect OMAP-related revenue to double in the next five years. Note, however, that retaining the high market share will also be contingent on EMP, Nokia and Motorola using OMAP for a majority of their 3G platforms. Further, if TI can work out a partnership agreement with someone like Interdigital, for example, then perhaps it can leverage its complimentary OMAP solution to provide a very competent bundle for smartphones that Nokia may pounce at. More on this thread of thought can be found here.

Thanks to the OMAP business, I estimate that wireless will continue to contribute around a third of TI’s revenues into the next decade. But this will not yield anywhere close to what could have been obtained had TI played its cards right. If TI maintains its current market share, the wireless revenues will have grown at a much higher rate (around 10%).

Wireless, it seems to me, is a missed opportunity for TI today. In the concluding part of this series on TI, I will provide my valuation of the company and briefly discuss its future outlook in the context of all the details that I have laid out so far.

[Long IDCC at the time of writing]

I have, in the past, discussed the synergies that existed between Qualcomm and InterDigital. As I completed penning my Texas Instruments (TXN) series on Sramana Mitra’s site, I noticed that even the Dallas-based semiconductor giant could benefit immensely from an alliance with InterDigital.

TI is the market leader for 3G application processors with its OMAP product-line. But it does not currently have a standard 3G baseband solution. The company’s OMAP roadmap merely has placeholders for future merchant ICs with 3G baseband. Its mammoth market share comes from custom chips it develops for Nokia and Motorola among others. This position is, however, challenged by the multiple sourcing trend that the handset vendors are now adopting. Left behind in the 3G baseband race, not only by Qualcomm but also by Broadcom, Infineon, InterDigital etc, TI is finding itself losing mobile share. The aggressive strategy and the niche product positioning by the competition is not helping its cause either.

On the other side, InterDigital sells its SlimChip 3G solution with a fully equipped software stack both as an IC and as intellectual preperty (IP). Besides, in a recently conducted independent study by Signals Research Group, InterDigital’s SlimChip came out as one of the top performing baseband solutions along with iCera and Infineon. That InterDigital finished high among very competitive solutions establishes the company’s credibility. Also, this complements its positioning as a top choice for the smartphones segment for bandwidth intensive data services.

Now, here is a part of a recent press release from InterDigital that forms the basis for my thesis –

“InterDigital's SlimChip products feature a "slim" modem architecture where the modem - which provides core wireless connectivity - is separated from the applications processor and peripheral functions. This approach allows wireless device manufacturers to customize the pre-certified modem, in a rapid and cost-efficient manner, …”

My thesis is that if TI can negotiate a deal with InterDigital to sell a bundle of the SlimChip IC with its own OMAP, or perhaps incorporate InterDigital’s IP in an OMAP-Vox solution, then both companies can benefit. For TI, it will be a chance to retain and even grow 3G market share by marrying its manufacturing excellence to performance, an area in which it has always been behind Qualcomm. For InterDigital, any such alliance will not only imply SlimChip sales levels it can never get to otherwise but also a chance to change industry and Wall Street perceptions.

TI’s executives have mentioned that they are watching the market and are prepared in case they see a trend away from its custom IC products for 3G. They also perceive a good position if the industry does not sway from separate baseband and application processors in the chipset. If not, they suggest a quick ramp up in 3G baseband integration. While not discounting TI’s capabilities, I think that the time to market will disadvantage it considerably given the lengthy product cycles. The alternative is to go with someone like InterDigital. This will have both parties laughing their ways to the coffers.

[Long Qualcomm, InterDigital at the time of writing]

[Originally for Sramana Mitra's site]

I mentioned in the last segment of this series that I was not happy with TI's wireless and mobile market strategy. Let me try to explain why.

My bearish feeling about TI’s wireless business stems from what I think has been a flawed baseband strategy. The company seems to have grossly misjudged both its primary customer and its competitive landscape. Nokia and Ericsson’s multiple vendor strategy is a stark proof that TI can no longer leverage on its strengths such as manufacturing excellence either. The company, realizing this, has recently pursued a hybrid manufacturing strategy (moving towards a fabless model for digital), but it may be late to counter aggressive competition. So, while not being able to compete on baseband with Qualcomm, Interdigital and iCera, TI is also being handed design losses at customers it would consider its childhood buddies by the likes of Broadcom.

Another fact that cannot be ignored is that all the major baseband providers either have their own application processor product or an active development program running. There is also a move towards integrated application processor plus baseband processors. This, until now, was perceived as another TI strength that is fast eroding due to smarter competition. TI’s answer which ought to have been a 3G OMAP-Vox chip is conspicuously absent from its product-line.

Thirdly, the fortunes of its connectivity solutions - WLAN, Bluetooth and GPS – are tied with the mobile chipset design wins compounding the company’s wireless woes. Though independent of the OMAP or custom chips, these are often bundled in the mobile chipsets. TI has spent substantial resources on these technologies with cutting edge R&D work. But it has made a conscious decision to focus on the mobile market though each of these connectivity solutions presents a wider prospect. This dependence on mobile not only drastically reduces their total addressable market, but also implies suboptimal utilization of the related advanced research and development work.

In summary, TI’s competitors are carving shares for themselves with niche products and the company seems all but a muted spectator. In the sequel, I will take a brief look at the financial impact of the wireless reverses for TI and the impact of its focus on the application processor segment.

[Originally for Sramana Mitra's site]

In the last two parts of this series, I looked at TI’s position in the analog and DSP markets. We also concluded that the OMAP was central to TI’s wireless strategy. I am afraid that TI has put all its eggs in this one basket, and has perhaps miscalculated the strengths of its competition, especially the new entrants. And the result? It has all but lost its dominance in the wireless market and also the golden chance to make the best of the mobile revolution.

Before we look at the outlook for TI’s wireless business, let us step back to look at some of its current statistics. About $2bn of TI’s 2007 revenues were from 3G with the 3G OMAP alone accounting for $500mn. Custom chips that TI manufactures for the likes of Nokia accounts for most of the rest. Let me reiterate again now that these custom-chips, that make TI the largest 3G chipset vendor at more than 50%, do not have its IP for the baseband. For more relevant statistics, I will direct the interested reader to the earlier articles of this series here and here.

Also, TI has consciously stayed away from developing 3G digital baseband. I think that this is a mistake. I believe that baseband is the most important part of the 3G chip. This contrasts TI’s position that the application processor is the heart of the phone. I do agree that 3G is about the experience – the music you hear, the TV you watch, the games you play, the high-resolution still images and videos you capture are all integral to tomorrow’s phones and will be enabled by the application processor. But what good is it if your mobile data and internet experience is bad? Unlike voice, data will hog bandwidth and limit the network’s capacity effectively reducing user throughputs. So it serves the mobile user well to get a phone with a good baseband processor with well-implemented advanced receivers.

This segment is intended to add context to the next two parts where I discuss TI’s wireless strategy. It is important that you digest these points before proceeding so you can get a holistic perspective of TI’s position in wireless.

In the prequel, we discussed TI’s growing analog semiconductor business. Digital Signal Processors (DSPs) is an equally big business for the company contributing 40% of its semiconductor revenues. TI dominates the DSP market with 65% share and its products are preferred in a variety of applications ranging from communication infrastructure, automotive navigation, imaging systems to HD video products.

The main drivers for TI’s DSP business are wireless handsets and infrastructure. The company’s DSP play in the cell phone market primarily comes from its OMAP business. The company enjoys between 65 and 70% of the application processor market share. OMAP processors are used for streaming video, 2D/3D gaming, video conferencing, high resolution still image, video capturing in 2.5 and 3G handsets and in PDAs.

The OMAP platform is a mix of its OMAP processors, software and support that deliver real-time applications with low power consumption – the two key components of tomorrow’s cell phones. TI offers stand-alone OMAP processors for use in smart phones. The customer can pick from a range of OMAP products for high performance and basic multimedia functions.

The company also offers integrated communications and application processors through its OMAP 730, 850 and OMAP-Vox modem technology. The OMAP-Vox platform integrated the baseband modem, the OMAP processor and the Digital RF Processor (DRP) together with analog and power management functions to provide a complete solution targeting the feature phone and the smartphone markets. The solution is currently available for GSM/GPRS/EDGE technologies only.

TI’s OMAP also pictures in the custom 2G and 3G products that it manufactures for the likes of Nokia and Ericsson. In these cases, TI integrates the customer’s baseband IP with its OMAP processor, DRP and power management functions to design customized chips. It does not however have its own 3G baseband chip or IP. While the company does not view this as a deficiency in its product-line, this strategy may well turn out to be its Achilles heel (I will discuss its mobile strategy in a sequel). Interested readers can see TI’s OMAP product roadmap here.

To summarize, TI is looking at DSP to open new growth markets in diverse areas like public safety, medical and automotive. Its OMAP processors are in most smartphones in the market today. The company is also buoyant about its prospects here. Though no other competitor has so far got wide traction in the application processors market, this position may be challenged due to newer entrants and TI’s own strategy to shun 3G baseband development. In turn, this will determine the fortunes of the DSP business and the extent of influence that the mobile market will have on its future.

[Originally for Sramana Mitra's site]

In the last part of this series, I presented a brief analysis of TI’s 2007 Financials. As I mentioned before, the company’s semiconductor business has two pillars – namely DSP and analog. While DSP has been TI’s traditional strength, analog, which is one of the largest semiconductor markets, is fast becoming its future mainstay.

TI is the world’s largest supplier of analog semiconductor solutions. The statistic to note here is that its $5.29bn revenue represents just under 15% of the total addressable market of $36bn, presenting a huge opportunity for the company to grow.

TI has an increasingly strong presence in the high-performance analog (HPA) semiconductor market. The company has successfully grown its market share in HPA every year since 2001. HPA is driven by power management chips and precision high speed data converters and amplifiers. It contributes to 45% of TI’s analog revenues helped by stable pricing and the company’s technological acumen. Besides, as the product mix gets skewed to HPA, TI will be able to achieve its margin targets.

TI is taking steps to consolidate its position in the analog market and to have sustained growth in excess of the fragmented analog market growth. It has been investing heavily in analog since the past decade. A substantial portion of the company’s R&D expense has been spent in activities such as increasing analog field applications engineers to bolster its world-wide support network. Also, its CFO Kevin March said recently that acquiring smaller companies to grow market share was always in the cards. TI believes that this strategy will allow it to rapidly leverage its sales force and customer contacts to complement the acquisition’s product offerings. In keeping with this mindset, the company acquired integrated circuit designs and POWERPRECISE solutions last year.

TI’s increased attention to this market has resulted in impressive financial results. Analog revenues have grown by 11% over the past two years. The corresponding HPA growth has been about 28%. The company has continued to broaden its analog portfolio to bring differentiated custom, standard and commodity analog products to the market. It is well-positioned to exploit the continued thrust towards efficient power management, especially in mobile communications. If it can continue to skew its product mix towards HPA products, TI can further the already market share in the analog space with impressive margins despite falling prices. This will also drive its future growth.

[Originally for Sramana Mitra's site.]

In the prequel, I pointed out that Texas Instrument (TXN) supplied semiconductor solutions to many markets making it one of the largest semiconductor companies in the world. Before I move on to dissect its businesses in detail, I wish to review the company’s 2007 financial results to put the rest of the series in perspective.

TI’s total revenue for 2007 was $13.83bn at a gross margin of 53% and an operating margin of 25.3%. This was a 3% decrease from the 2006 figure of $13.73bn. The company attributes this decrease to lower demand for its RISC processor, lower demand for mobile chips and DLP products. The margins, on the other hand, are certainly impressive when compared to the rest of the industry. The semiconductor industry’s gross margin average is at 50.5% while the operating margin average is at 18.6%. TI’s superior margins are due to its continued shift to higher margin products such as high-performance analog (HPA) and changes in its manufacturing strategy. The corresponding EPS was a healthy $1.83 giving it a P/E ratio of 15.41 as on March 15, 2008.

The education technology business has been a steady source of about $500mn for the past four years. This year’s $526mn amounted to 3.8% of the company’s revenues. With a fairly mature product-line the business continues to become more efficient recording its 11^th straight year of improved margins and profitability. The gross margin for this business unit was 64.6% and the corresponding operating margin was 39.4%.

The semiconductor business generated $13.31bn in 2007 at a gross margin of 53.2% and an operating margin of 29.2%. The operating profit increased by $52mn from $3.83bn to $3.88bn. The two key components of the business unit, namely analog and DSP, both yielded over $5bn in revenue. The two together accounted for 80% of the semiconductor revenues.

Analog revenues were up 1% from last year to $5.29bn driven by a 9% growth in HPA. This was offset by reduced sales in custom analog parts for mobile phones, an offshoot of its customers adapting a multiple vendor strategy. DSP revenue was at $5.07bn and also saw declines across many markets. On the other hand, TI has about 65% of the DSP market share. This business continues to remain one of TI’s fortresses. The company’s OMAP processors have substantial traction in the mobile world and will be a steady source of income moving forward.

Nokia, as TI’s single-largest customer, accounted for 19% of its 2007 revenue. With the Finnish company opting to source chips from ST Microelectronics, Infineon and Broadcom as well, this figure may go down in the years to come. However, more than 80% of TI’s revenue comes from outside the US. The fairly diverse and global nature of its customer base, coupled with the markets and applications it caters to, provides TI substantial resilience to an economic slowdown.

TI is also buttressed by sound economics. The higher profitability from its product mix and its move towards better capital efficiency has generated a cash flow of over $4bn this year. The company also managed to increase its return on invested capital for the sixth year in a row.

The continued thrust for efficiency and higher margin products are in line with TI’s goals – to grow faster than its markets, grow earning per share faster than revenue, 55% gross margins and 30% operating margins. Whether it can grow faster than the competition in all its markets is debatable, but its track record gives me the confidence that its margin goals are very attainable.

Last fall, I presented a deep-dive analysis of the world’s leading mobile semiconductor company, Qualcomm (QCOM). More recently, I looked at the fortunes of Broadcom (BRCM), the company involved in several legal battles with the San-Diego based Qualcomm. Over the next few weeks, I will look at Texas Instruments (TXN) as I continue to dissect mobile chipset vendors to understand the convergence devices eco-system.

Texas Instruments (TI in short), was the revenue leader in the mobile handset semiconductor space until Qualcomm took the lead in 2007. TI had about 16.5% of the mobile semiconductor revenue share to Qualcomm’s 18%, according to an iSuppli report. On a related note, Forward Concepts Analyst, William Strauss estimates that TI was the leader of the mobile baseband chipset business with about 40% of the market share.

Wireless is only one part of TI’s semiconductor story. The company’s total semiconductor revenue for 2007 was $13.3bn. The corresponding wireless revenues were at $4.91bn, about 37% of the total. TI’s semiconductor revenue comes from other markets such as broadband communications, computing, consumer electronics, industrial and automotives as well. In fact, iSuppli reports that TI is ranked 4^th in the world among all semiconductor companies. Only Intel, Samsung and Toshiba were ahead of TI. (Incidentally, Qualcomm also appears in the list advancing to the 12^th position.) The company is also the market leader in both analog and DSP semiconductor solutions, which together account for 80% of its semiconductor revenue. The semiconductor giant’s position is further bolstered by another $526mn in revenue (about 4%) from the education technology business, the source of the ubiquitous TI calculators.

So, when you talk of breadth and resilience, what applies to Broadcom (BRCM), applies all the more to TI. So, while I will throw extra light on TI’s wireless business in the sequels, I will also take a look at the key components of its semiconductor business. This will give a more holistic perspective of the company’s economics and help in its valuation.