Texas Instruments Suggests A Soft Landing In The Works

Figuring out the semiconductor industry is a little like playing one of those games where you are supposed to guess at what the image is as it is revealed a piece at a time. While Linear Technology (Nasdaq:LLTC) started the reporting cycle with a sour note, Maxim (Nasdaq:MXIM) seemed incremental better, and so too now does Texas Instruments (NYSE:TXN). If Texas Instruments is more indicative of the "real" state of the industry than Linear, perhaps the worst of the mid-cycle correction is over.

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A Mixed End to a Rebound Year
As is so often the case, the strength of Texas Instruments' quarterly results depends very much on the frame of revenue. After all, 17% year-on-year revenue growth sounds good - up to the point when it translates into a 7% decline in sequential performance. Analog is TI's biggest segment, and revenue here was up 20% annually and down 4% sequentially, while embedded processing saw a 31% annual increase and 7% sequential decrease. Wireless was comparatively boring, up 1% from last year and flat relative to the third quarter.

Profitability was not quite as positive for TI. Due at least in part to higher capacity and lower utilization, gross margin fell 150 basis points from last year. Although the company did do a solid job of holding the line on operating expenses, the decline in gross margin led operating margin to contract about 200bp on a sequential basis, while rising 170bp from last year after adjusting for a divestiture gain. (For more, see The Bottom Line On Margins.)

Orders fell 4% from last year and 9% from the third quarter, leading to a 0.89 book-to-bill ratio. While management did say that lead times were back to normal (suggesting that the book-to-bill should have bottomed), it is worth noting that inventory did climb almost $100 million on a sequential basis and stands (on a days sales basis) at a pretty high historical level.

Whither Thou Goest?
The $64 million question is whether this normalization of lead times really does mark the end of a mid-cycle correction. After all, Maxim's recent report would suggest more room for correction (negative), but Maxim's business mix is changing and new product placements may make those comparisons less valid. Likewise, some of the dour guidance from Linear could be company-specific; Linear has long been willing to turn down business to protect its margins so it might not be such a great read-through for other vendors that are more willing to be flexible on price.


In the case of TI, tablets are just starting to emerge as a real revenue opportunity. The company won a socket for its OMAP in Research In Motion's (Nasdaq:RIMM) PlayBook, and the company estimates that there could be as much as $30 in chip content up for grabs in each tablet. With customers like Nokia (NYSE:NOK), Motorola (NYSE:MOT) and Hewlett-Packard (NYSE:HPQ) on board already with OMAP and cross-selling and design wins possible in power management, connectivity and other areas, TI could very well be building a little inventory to take advantage of these launches in 2011. Moreover, commentary from Linear, Maxim and Omnivision (Nasdaq:OVTI) suggests that capacity is pretty tight in the industry as whole.

The Bottom Line
Texas Instruments certainly cannot take its eyes off the ball, or competitors like Intel (Nasdaq:INTC), Broadcom (Nasdaq:BRCM) and Qualcomm (Nasdaq:QCOM). Likewise, inventory concerns and lead times will be a worry for investors until the numbers encourage them to move on to a whole new worry. Still, for companies with exposure to growth consumer devices like tablets, phones and TVs (and that includes TXN, Maxim and Atmel (Nasdaq:ATML), 2011 could be a year that gets better as it goes on.

A liability-adjusted cash flow yield of over 5% suggests some undervaluation in these shares, but a discounted cash flow analysis tells a somewhat different story. Then again, DCF analysis is not easy with cyclical businesses, and management commentary suggests some momentum returning to the business. Consequently, Texas Instruments may yet be attractive for risk-tolerant investors wanting exposure to semiconductors, but value hounds probably have better options in the sector. (For more, see DCF Valuation: The Stock Market Sanity Check.)

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