Buy Into Atmel's Doubts

By Stephen D. Simpson, CFA | November 01, 2011 AAA

As 2011 winds down, it looks as if few, if any, chip stocks will escape the malaise. Cavium (Nasdaq: CAVM) reported a slowdown in its business just a little while ago, and now Atmel (Nasdaq: ATML) has missed its revenue target and issued sharply lower guidance for the next quarter. Although there are plenty of doubts around this company, and more now with the revised guidance, it's hard to make money in slam-dunk stories; risk-tolerant investors ought to consider stepping up and buying this name on weakness.

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Hitting a Wall in the Third Quarter
Atmel announced that revenue rose 15% from last year (adjusting for a spinoff), and was basically flat on a sequential basis, a result that was about 1% shy of the average Wall Street guess. Microcontrollers were fairly strong, up 18% from last year and flat sequentially, with 8-bit showing more sequential strength. Non-volatile memory and RF/auto were both down sequentially, while ASIC showed solid growth, but comprises a small amount of total revenue.

Although Atmel's revenue was not that bad, profitability was not very strong. Gross margin jumped nicely from last year, but slid 70 basis points, sequentially. Adjusted operating income jumped nicely from last year, but slid about 4%, on a sequential basis. The company continues to spend a sizable amount on R&D, accounting for about 13% of sales, while inventory days were flat, on a sequential basis. (To know more about R&D spending, check out: R&D Spending And Profitability: What's The Link? )

Guidance Will Hit the Stock
Management surprised the Street with very weak guidance, that calls for a sequential revenue decline of 12 to 16%. Not only have non-Apple (Nasdaq: AAPL) tablet sales really not taken off at customers like Dell (Nasdaq: DELL) or Lenovo (OTCBB: LNVGY), but a major customer, Samsung, goes through a regular fourth quarter inventory adjustment process, that leads to lower orders. On top of this, it sounds as though chip demand from industrial customers has really slowed. This is a problem not only for Atmel, which gets around 40% of its sales from industrial and auto customers, but also other chip companies, like Linear Technology (Nasdaq: LLTC), ON Semiconductor (Nasdaq: ONNN) and Maxim Integrated (Nasdaq: MXIM).

The Spectre of Competition
Maybe a little late for Halloween, but the spectre of future competition in touch is starting to spook some investors. Although management raised its maXTouch sales guidance, and there is reason to believe that future adoption in applications like cameras and gaming systems is on the way, there are worries about a shift towards single chip solutions and new entrants.

In addition to known entities like
Cypress Semiconductor (Nasdaq: CY), Synaptics (Nasdaq: SYNA) and Microchip (Nasdaq: MCHP), Silicon Labs (Nasdaq: SLAB) is moving further into the space; it ships for the Samsung Galaxy Y phone already. Likewise, Maxim, Texas Instruments (NYSE: TXN) and Broadcom (Nasdaq: BRCM) are looking to get into touch controllers, often by integrating them with other chips. Last, and by no means least, Samsung itself is thought to be working on these chips and that could be a serious blow to Atmel, as this is a sizable customer.

It should not be ignored that, even with the announcement that Hewlett-Packard (NYSE: HPQ) is killing the Touchpad, which uses Cypress controllers, Cypress's TrueTouch business seems to have grown about twice as fast, on a sequential basis this quarter (though admittedly from a roughly 15% smaller base), compared to Atmel. Still, Cypress gave generally similar guidance as Atmel for the next quarter and Atmel's guidance on its touch products was arguably more positive, so it isn't clear that Cypress is taking away business from Atmel.

The Bottom Line
Investors don't often get second chances at good growth stories, unless there is a company-specific screw up or a broad market decline; with Atmel, it looks like both. Still, this company has very good microcontroller technology and should have good growth prospects in new markets and with new products, like a recently-announced stylus. It also happens to now be trading below a double-digit enterprise multiple and an EV/revenue of three. (To know more about enterprise multiple, read: Value Investing Using The Enterprise Multiple. )

No good idea comes without competition, and there is certainly now a risk that Atmel goes onto the same roller-coaster tracks as OmniVision (Nasdaq: OVTI) and experiences some of the same volatility that comes from investors worrying about whether OmniVision chips are being replaced by rivals. If you want a cheap stock with growth potential, you have to take on risks, and that is certainly true for Atmel today. Investors looking for less risk should probably look to other cheap stocks like Altera (Nasdaq: ALTR), Broadcom, or Intel (Nasdaq: INTC), but those who have been waiting for a second shot at Atmel, may want to start following this very closely.

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At the time of writing Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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