Cavium: An Antidote To Semi Malaise

By Stephen D. Simpson, CFA | February 03, 2011 AAA

Tired of wondering whether or not the semiconductor sector is in a lull? Tired of reading about analysts tearing apart new iPhones or Galaxy tablets in order to figure out whose power chip are in the socket? Cavium (Nasdaq:CAVM) may be an antidote for tech investors suffering from tired eyes and ears when it comes to semiconductors. While Cavium is a small and risky name, the company is posting impressive growth and appears to have big aspirations for its future.

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A Solid End to the Year
Cavium reported that its sales for the December, 2010 quarter rose 8% from the September quarter, and 86% from December, 2009. That figure was slightly better than analysts had forecast and came about even those the company's largest segment saw a 2% sequential decline in sales. Keep in mind, too, that large customers like Cisco (Nasdaq:CSCO) and F5 (Nasdaq:FFIV) have not been impressing anyone lately with their growth lately, so the company has had to surmount that challenge as well.

On the profitability side, Cavium continued to show solid improvement. Gross margin improved about 40 basis points on a sequential GAAP basis, while operating margin improved more than a full point. While the non-GAAP figures for Cavium were different, the directionality was the same. (For more, see 2010: The Year In Chips.)

The Road Ahead
Cavium's base is in specialized networking chips that can handle complex routing needs and enable more intelligent and effective networks. That has given it a solid business with customers like Cisco, F5, and Juniper (Nasdaq:JNPR), while the sophistication of its chips has given it a lead on rivals like NetLogic (Nasdaq:NETL) and Broadcom (Nasdaq: BRCM). In some cases, customers have to choose between using Cavium's chips or cobbling together multiple chips from competitors to achieve the same capabilities; a Hobson's choice when space, power efficiency and other operating characteristics are considered.

But that is not all that Cavium is about, and Cavium seems to be focused on building itself into a more diversified chip company. With its earnings, Cavium also announced the acquisitions of Celestial Networks of China for $55 million and Canada's Wavesat for about $10 million. Celestial will enhance the company's technology in HD video and HDMI interfaces, with product opportunities in areas like TV, set-top boxes and media players. Wavesat, on the other hand, is more of a 4G wireless play. (For more, see Can Maxim Outgrow Its Cycle?)

While some investors may fret about the company stretching itself too thin, the reality is that it is difficult to consistently grow shareholder value as a niche chip company. While a range of companies including Broadcom and Qualcomm (Nasdaq:QCOM) arguably had their start as much more focused and specialized companies, a lot of their current success is a product of competing in multiple markets.

The Bottom Line
Cavium is not cheap, but growing tech companies seldom are, and that is particularly the case when they sit in the supply chain of popular growth stocks like F5 and Citrix. As far as growth stocks go, though, Cavium is executing well on the metrics that matter - the company is posting above-market growth, is diversifying its product and customer base and is posting improving margins. Value investors probably won't get another crack at this name without a serious market pullback (or a significant company-specific disappointment), but there is no obvious reason for growth investors to let go of this one just yet. (For more, see F5 - Suddenly Valuation Matters Again.)

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