Investors looking into the semiconductor space can find an example of almost any sort of business model they may want to buy. Some analog companies, Linear Technology (Nasdaq:LLTC) or Analog (NYSE:ADI) for instance, focus on a wide variety of proprietary high-performance analog chips. Other companies focus more on high-volume chips for consumer applications. Then there's Maxim Integrated (Nasdaq:MXIM) - a chip company that's looking to do a little bit of both.
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Mixing Old with New
Maxim has a solid history in the high-performance analog space, where it garners broadly the same sort of profitable margins and long product lives as the likes of Linear and Analog Devices. More recently, though, the company has been pursuing high-volume apps like chips for handsets. Although these chips frequently have shorter cycles and lower margins, there is definitely money to be made in volume.
Maxim is adding another twist on this model, though. Increasingly the company has been focusing on more integrated solutions and looking to garner a bigger chunk of the chip content from its rivals by offering better price and performance trade-offs. While Samsung is presently the company's largest customer, the company is hoping to win more and more business from the likes of Apple (Nasdaq:AAPL) and Nokia (NYSE:NOK).
Change Comes with a Cost
The trouble with Maxim's new model is that past performance may not presage future results. By and large, Maxim's focus on high-volume chips and its greater presence in consumer ((at least relative to ON Semiconductor (Nasdaq:ONNN) or Texas Instruments (NYSE:TXN)) products suggests that past peak gross and operating margins may be very hard to regain. By the same token, perhaps the company's focus on more fully integrated systems-on-a-chip can counteract that trend.
Historically, Maxim compares reasonably well with most chip companies. There's little that any chip company can really do to counteract the basic cyclicality of the market, but the company's returns on capital and economic earnings have been pretty respectable compared to sector norms.
Will Growth Sustain Valuation?
Maxim isn't strikingly cheap today compared to highly profitable HPA companies, nor the more growth-oriented plays like Broadcom (Nasdaq:BRCM) or Mellanox (Nasdaq:MLNX). What Broadcom does offer, though, is the prospect of above-average growth combined with solid profitability. This move into higher-volume consumer products and more integrated products could make it a share-gainer in the chip sector, giving it a chance at above-average revenue growth.
That's often a major step forward in garnering a robust valuation from growth-obsessed tech investors. The bigger question, though, may be whether Maxim can couple that with the expected levels of productivity, as sell-side numbers do assume a fair bit of improvement.
The Bottom Line
I can understand the appeal of the Maxim Integrated story; above-average growth and share gains, bulwarked by a very profitable legacy HPA business. That said, I wouldn't pay just any price to get that combination.
Today's valuation just doesn't look all that appealing to me. Forward-looking free cash yield (projected free cash flow divided by enterprise value) looks to be sub-5% right now; not enough to really entice me given the highly competitive nature of this market. What's more, a multi-year discounted free cash flow model suggests a fair value of around $29 for these shares - quite close indeed to the current price. For related reading, see Valuing Firms Using Present Value Of Free Cash Flows.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.