Avago Technologies Limited is a designer, developer and global supplier of analog semiconductor devices. Avago offers products in three primary target markets: wireless communications, wired infrastructure, and industrial and automotive electronics.
Applications for Avago products include smartphones, connected tablets, consumer appliances, data networking and telecom equipment, and enterprise storage and servers.
All amounts in US$ unless otherwise noted.
Technology — Communications Technology — Semiconductors SOLID Q4/F13 RESULTS AND Q1/F14 GUIDANCE
Investment recommendation: Avago reported Q4/F13 results above our
estimates with strong Wireless and Wired division sales offsetting weaker
than expected Industrial demand. Management provided strong guidance for
the typically seasonally softer Q1/F14 that was also above our estimates. The
strong guidance was driven by continued strong trends in the company’s
Wireless division. We believe Avago’s proprietary technologies, strong IP
portfolio, and diverse customer base in several growth markets position the
company for strong long-term growth trends with industry-leading margins.
We reiterate our BUY rating and increase our price target to $54. Investment highlights
Q4/F13 sales of $738M and pro forma EPS of $0.89 were above our
$731M/$0.82 estimates driven by a strong 20% Q/Q sales growth in
Avago’s Wireless division versus our mid-double-digit growth estimate.
Industrial sales were weaker than anticipated and declined 5%
sequentially versus Avago’s sequentially flat guidance due to weaker
demand in China and Japan due in part to lower distributor inventories.
Avago guided to a 3-6% Q/Q sales decline for the typically seasonally softer
Q1/F14 with overall sales and EPS guidance basically in line with
consensus. Further, Management anticipates roughly sequentially flat
Wireless division sales following strong Q4/F13 Wireless results. We
believe the strong Q1/F14 Wireless guidance is consistent with our
expectations for a TDD-LTE enabled iPhone with strong Avago content
launching at China Mobile prior to Chinese New Year as well as for strong
Avago content in Samsung’s next generation flagship smartphones. Longer
term, we believe the ramping demand for Avago’s FBAR filters in its
Wireless business and stable growth trends in Wired and Industrial
divisions position the company for strong long-term sales and earnings
growth. Please see our Avago note, published Oct 15th, titled ‘Well
positioned for strong near-term results with strong IP and products driving
long-term growth in all divisions’ for further details.
Due to Q4/F14 results above our estimates and given the strong
Q1/F14 guidance, we increase our F2014/F2015 pro forma EPS
estimate from $3.30/$3.93 to $3.36/$3.98. Valuation: Our $54 price target (was $53) is based on shares trading at roughly 13x – 14x our F2015 pro forma EPS estimate.
Global surveys post the recent BlackBerry Z10 launch indicated mixed initial sales with limited initial supply cited as the reason for early post-launch stock-outs at some carrier stores rather than overwhelming demand. Our follow-up checks have indicated steady but modest sales levels.
With new BB10smartphones launching in the U.S. only in mid-March or later at subsidized prices no better than competing high-end Apple/Samsung smartphones, combined with our expectations for the Galaxy S IV to launch at a similar time frame in the US market, we are lowering our BB10 sales estimates for the February quarter and all of F2014.
We reiterate our SELL rating and $9 price target
Given our store surveys indicated modest Z10 sales into the channel in the U.K. and Canada, we have reduced our February quarter BB10 smartphone shipment estimates from 1.75M units to 300K units.
Further, we believe carrier support for BlackBerry 10 in the U.S. is modest, as demonstrated by Sprint only planning to launch the Q10 and T-Mobile only the Z10. Further, we anticipate carriers will not build large inventory levels for BB10, consistent with prior BB7 high-end launches, and will initially stock modest levels given the weaker consumer demand for high-end BlackBerry smartphones.
With our expectations BB10 smartphones will face increasing competition from a host of new Android and Windows smartphones and potentially a new iPhone in 1H/C2013, we anticipate global carrier partners will order cautious initial BB10 inventory levels, leading us to lower our Feb. quarter and F2014 BB10 estimates.
We reduce our F2013/14 EPS estimate from ($1.10)/($0.48) to ($1.18)/($0.62) and introduce our F2015 estimate of ($1.03). Valuation: Our $9 price target is based on sum-of-parts analysis .
For a company that is still expected to grow, albeit at a much reduced rate, that’s an attractive valuation.
Importantly, Apple also has $135 billion of cash and no debt. Much of this cash is available to be returned to shareholders in the form of stock buybacks and, possibly, dividend increases. So it’s worth considering Apple’s market value and multiple excluding this cash.
Excluding its cash, Apple’s business is now valued at about $300 billion, or 2X revenue. Apple’s business currently earns about $40 billion a year. So Apple’s business is valued at about 7-times earnings.
That’s an even more attractive valuation. Even when you consider that Apple’s earnings are now declining.
Think about it this way.
If you spent $425 billion to buy Apple today–the whole company, not some shares of stock–you would be able to immediately pocket the $135 billion of Apple’s cash. You would then own a business that spits out about $40 billion of cash per year. Assuming the business maintains close to this level of earnings, you would get the remaining ~$300 billion of your purchase price back in about 7-10 years. You would then own all of Apple and its future earnings “for free.”
Even if Apple’s earnings shrink over the next few years–which I actually think is likely (Apple’s net income in the next quarter is expected to be down a startling 20% from last year)–it would only take 10-15 years for you to get your money back.
If Apple’s earnings grew instead of stayed flat, meanwhile–which isn’t inconceivable–you would get your money back even faster than 7 years.
In other words, unless Apple’s earnings really tank, and stay down, you will have bought a good company at a reasonable price.
Now, you are not going to be buying all of Apple anytime soon, so you can only think about the description above theoretically. But here is a more likely scenario.
A more likely scenario is that Apple’s earnings will stay flat or drop over the next several years, and Apple will start to get even more serious about returning some of its massive cash pile to investors.
To reiterate: Apple has ~$135 billion of cash.
And it is currently generating more cash at a rate of about ~$40 billion per year.
Apple has no idea what to do with this money.
No company needs $135 billion of cash.
In the past, Apple has demonstrated that it is not stupid enough to make huge, bad acquisitions (at least so far). So one can hope that Apple will not be stupid enough to make such acquisitions going forward.
So that leaves two other ways to use the cash mountain that Apple continues to pile up and doesn’t know what to do with:
Right now, Apple pays a ~$10 annual dividend. With the stock at $450, that’s about a 2.5% yield.
Paying this dividend costs Apple about $10 billion of cash per year.
Apple could easily afford to double this dividend to ~$20 per year.
That would create a 5% yield, which is an excellent yield. It’s also a much higher yield than almost every other stock in the market pays. And even this would only consume $20 billion a year.
And Apple could also easily afford to spend another $20 billion a year buying back its own stock. At $450 a share, this would shrink the share base by about 5% per year. So Apple’s earnings would be split up over fewer shares.
If Apple keeps earning $40 billion a year, and it returns $40 billion a year to shareholders, its cash balance will stay at ~$135 billion, which, again, is vastly more cash than it needs.
Apple could use $50-$100 billion of that cash to buy back stock, and that would shrink the share base even further.
All of which is to say, Apple has multiple levers at its disposal to return cash to shareholders and boost earnings per share irrespective of the business. And the business itself looks cheap relative to its current earnings stream.
Now, I am not suggesting that Apple’s stock is suddenly going to rocket back to $700. For that to happen, Apple would have to release another product that is a quantum leap over the competition, and it would have to sell hundreds of millions of units of this product before its competitors caught up. (As has happened with the iPhone).
I am also not suggesting that Apple’s stock won’t go lower from here. It may very well go lower from here. In fact, it may go lower and stay lower–forever.
As I described a few days before Apple missed Q4 expectations and the stock crashed below $500, Apple could be in the beginning stages of the same sort of implosion that it experienced in the 1990s–the same sort of implosion that has claimed Research In Motion, Palm, Nokia, Yahoo, AOL, Cisco, and dozens of other tech giants over the years. The stocks of these companies are trading at mere fractions of the highs they hit back when they were “must-own” stocks, barring miracles, they will never trade at those highs again. Apple is certainly not immune from this fate. And anyone who still thinks it is is not facing up to the reality of the situation.
But, Apple is also still a good company. And it has good products in fast-growing markets–smartphones and tablets. So if it can merely remain a good company, and keep pace with the competition (again, no guarantees), and if it begins to return even more of its vast cash mountain to shareholders, it should be able to maintain strong earnings per share, at least for a while.
And if Apple can do that, the stock doesn’t just look cheap. It is cheap.
As a reminder, no one knows what is going to happen to Apple over the next few years, including the folks at Apple. So don’t hallucinate that there’s some guru somewhere who can tell you. All of these scenarios are possible, including the “train-wreck” one. Stock prices represent collective guesses about what will happen in the future, and no one knows for sure what the future holds.
One final caveat…
Most of the folks who bought Apple stock over the past 5 years bought it because they considered it a “growth” stock, not a “value” stock. The scenario I described above is very much a “value” stock scenario. If Apple’s earnings do decline over the next couple of years, the “growth” investors who bought Apple’s stock will jettison it, and the “value” investors will have to buy it. This process will take time. So even if Apple does end up delivering a compelling return over the next few years, this “turnaround” will likely take a while.
Shares of Research in Motion finished the week strong after Jeffries upgraded the stock to a bullish rating saying RIM’s new BlackBerry 10 devices performed as well or better than rivals in recent tests. The analyst said that recent trials of BB10 test devices showed vast improvements over existing smartphones. “Recent tests and demos have shown a solid browser, smooth touch interface, and intuitive navigation. We now believe the operating system performance could be better than or equal to Android Jelly Bean and likely on par with iOS 6.”
Additionally, the analyst said that “checks indicate that large app developers are going to put resources into developing BB10 apps. Previously we had thought they would take more of a wait-and-see approach.” On top of the positive outlook for BB10, the report said that the BlackBerry maker will allow BlackBerry email and messaging (BBM) on iPhones and Android devices, possibly leading to increased licensing revenue for RIM.
RIM reported soft but better than expected Q3/F2013 results, with sales of $2.7B and pro forma LPS of ($0.22) versus our estimates of $2.6B and ($0.49) and consensus estimates of $2.7B and ($0.35). While results beat our expectations and we were impressed by cost savings execution and working capital management, our bearish thesis on BB10 remains unchanged and we expect ongoing quarterly losses. We reiterate our SELL rating and lower our price target from $10 to $9 due to our estimates for declining services ARPU leading to a lower sum-of-parts valuation. Investment highlights
While resilient sales of BB7 smartphone in markets such as Indonesia, South Africa, and Venezuela demonstrate the strength of the BlackBerry brand in international markets, we believe strong global sales of new BB10 devices are critical for RIM to return to profitability. With our analysis indicating increasing competition from iPhone 5, Android and Windows 8 smartphones in Western markets and from ramping lower-tier smartphones based on Qualcomm and MediaTek turnkey solutions globally, we expect softer sales of BB7 smartphones in future quarters with persistent pricing and margin pressure.
While RIM management remains bullish for its BB10 smartphone launch January 30, we do not believe BB10 devices will turn around its struggling business. With a very low probability the market will support RIM’s new mobile computing ecosystem, we believe RIM will eventually need to sell the company.
Given our cautious BB sales outlook and our belief RIM’s subscriber base and services ARPU will decline over the next several quarters and years, we maintain our SELL rating and lower our price target to $9.
Valuation: Our $9 price target is based on our sum-of-parts analysis
When it come to mobile, 2013 will bring us these three things:
Mini tablets with screens less than 8 inches in size will be the rage, accounting for 60% of tablets sold.
The market for smartphones and tablets combined will grow by 20%.
2013 will be a make-or-break year for mobile platforms. Those that don’t attract interest from at least 50% of app developers won’t survive. Google and Apple are past that threshold. Microsoft now sits at 33%. RIM is at 9%.
Big IT companies will feast on smaller cloud players
The software-as-a-service phenomenon really grew up in the past 12 months, with big vendors like Oracle and SAP spending billions to buy their way into the market.
“There will be over $25 billion in SaaS acquisitions over the next 20 months, up from $17 billion in the past 20 months,” it says.
Some companies are too highly valued to make for easy acquisitions, like the publicly traded Salesforce.com, worth $22 billion, or the fast-growing, still-private Box at $1.2 billion. But a bunch of others could be ripe for deals: Okta, Zenoss, and ServiceMax come to mind
A lot of smaller, specialized clouds will sprout up
In 2012, a lot of new cloud tech came out that made it easier and more affordable for anyone to build a cloud.
That means that in 2013, a whole bunch of new clouds will crop up. These will serve specific industries, for instance hospitals, construction companies, banks.
New data-center technologies that took root in 2012 will become the big thing in 2013.
These include “converged systems,” where companies buy machines that have computation, storage, networking, and software bundled together.
Another is software-defined networks, which is a new way to build networks.
These represent a tremendous opportunity for the established players like Cisco, Dell, HP, and Oracle. But they are also a big risk if they get it wrong. A whole class of startups are rising up to disrupt these guys.
Your work computer will be an ID you keep in your head
The bring-your-own-device trend, also known as BYOD, will morph into BYID—bring-your-own-ID.
That is, your work computer will be available to you anywhere, on any device. All you have to do is properly log in.
This is the ultimate result of investments in new cloud, mobile, and data-center technologies