Semiconductor Industry 2015 Analysis

By Jordan Cissell, Cole Howie, and Paul Kolotka

FI 414-001

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Table of Contents

Semiconductor Industry Overview ………………………………………………… 3

Historical Performance ………………………………………………… 4 Current Conditions ………………………………………………… 5 Future Predictions ………………………………………………… 5 Texas Instruments, Inc. Overview ………………………………………………… 6 History ………………………………………………… 6 Qualitative Assessment ………………………………………………… 7 Ratio Analysis ………………………………………………… 8 Intrinsic Valuation ………………………………………………… 8 Skyworks Solutions, Inc. Overview ………………………………………………… 10 History ………………………………………………… 11 Qualitative Assessment ………………………………………………… 11 Ratio Analysis ………………………………………………… 12 Intrinsic Valuation ………………………………………………… 13 Avago Technologies Overview ………………………………………………… 14 History ………………………………………………… 14 Qualitative Assessment ………………………………………………… 15 Ratio Analysis ………………………………………………… 16 Intrinsic Valuation ………………………………………………… 16 Works Cited ………………………………………………… 17 Appendix …........................................................................ 18

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Semiconductor Industry Overview The semiconductor industry is at the mature stage of the industry life cycle in 2014 with 832 companies around the world, primarily in the United States and eastern Asian nations, producing a broad range of components including diodes, fuel cells, microcircuits, memory chips, and solar cells for use in end products like microprocessors, memory devices, transistors, microcontrollers, and wireless communication devices. Microprocessors represented 58.0 percent of the industry’s product allocation mix in 2014. 1 While most firms involved in the semiconductor industry manufacture products that serve as inputs for other companies, especially those involved in computing and wireless communication technologies, some firms in the industry are more thoroughly vertically integrated. South Korean corporation Samsung and U.S.-based Texas Instruments manufacture semiconductor components for their own end-user products like cellular telephones and calculators, respectively. The semiconductor industry is driven largely by demand from computer manufacturers and telecommunication manufacturers and providers. As computer and telecommunication companies’ success is predicated largely on the companies’ ability to stay abreast of consumer demand and ever-evolving trends in technological development, these forces also both have a significant effect on the success of companies in the semiconductor industry, at least indirectly. Accordingly, success in the semiconductor industry necessitates significant, ongoing dedication to research and development initiatives. The ongoing expansion and development of the “Internet of Things,” the interconnectivity of computers, smartphones, vehicles, social media accounts, and other electronic devices represents a lucrative opportunity for the industry, as all of these products require semiconductor technology to properly function. For the first time in 2011, China replaced the United States as the world’s leading consumer of semiconductor enabled devices, and emerging markets accounted for nearly 60% of new orders of computers in 2013. 2 Due to the definitively global presence of both companies operating within the semiconductor industry and the various technology companies that make up their primary customer base, the trade-weighted index also represents a significant economic driver on the semiconductor industry. The trade-weighted index, also called the real broad index, is an indexed ratio measuring the strength of the U.S. dollar versus the currencies of all of its trading partners, with each partner’s weight apportioned based upon relative trade volume. Semiconductor manufacturers are situated primarily in the United States and eastern Asian nations, and demand for their products comes from companies around the world. Revenues from the Asia and Pacific region accounted for 60 percent of the industry’s total revenue in 2014.3 As the trade-weighted index increases, the U.S. dollar appreciates relative to other currencies, making U.S.-produced semiconductors more expensive around the world and decreasing export revenues. Several high barriers to entry exist in the semiconductor industry. Many of the industry’s major players have developed and fortified intellectual capital and process knowledge through many

1 IBISWorld 2 Fidelity 3 Hoover’s

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years of competition, and they often protect this information and these processes through patents and other forms of residual claims. The industry measured average revenue per worker ratio of $430,000 in 2014.4 Growth and progress in the semiconductor industry is largely motivated by increases in capital spending, research, and development. In recent years, this investment has led to significant technological advancement in the field. Perhaps most importantly, chips have been getting smaller and more affordable. According to Moore’s Law, the number of transistors per chip doubles approximately every two years. This increase is made possible largely from smaller chip line widths. In other words, circuits are getting smaller so makers can now fit more power into smaller chips.5 However, industry analysts say Moore’s Law is reaching its limit as of early 2015, as the research and development costs associated with bringing one new chip to market is approximately $132 billion.6 Competition in the industry is fiercely competitive, and market share is not highly concentrated among the industry’s 832 players. Intel Corporation’s 18.0 percent represents the largest market share claimed by a single entity, with Samsung measuring a relatively close second at 13.8 percent. Beyond these two major players, however, market share is widely dispersed, with the 830 other companies comprising together 68.2 percent of the entire market. The third and fourth largest market claims are just 3.5 percent and 2.1 percent, belonging to Broadcom Corporation and Texas Instruments Inc., respectively.7

Historical Performance The semiconductor industry performed poorly following the financial crisis in in late 2007. In the five years leading up to 2014, industry revenues have grown at an average annualized rate of 4.8 percent, though a significant portion of this growth represents the industry “playing catch-up” on losses sustained during the recession period. In 2008, industry revenues decreased by 6.8 percent, and the industry recorded a 17.3 percent revenue drop in 2009. The explosion of consumer demand for smartphones in the years following the recession contributed significantly to the industry’s relatively successful and quick rebound from the downturns in performance in 2008 and 2009. Asian semiconductor manufacturers have continued to claim greater shares of the market at the expense of U.S. manufacturers’ claims. In the five years leading up to 2014 the value of U.S. industry imports have increased by an annualized average rate of 11.2 percent, up to $41.5 billion. In the same period, the value of U.S. exports has decreased at an average annualized rate of 0.9 percent to $26.7 billion.

Current Conditions

Total semiconductor industry revenue value in 2014 measures $79.5 billion, though revenues are expected to contract by 1.7 percent by the end of 2014. The industry is highly competitive, and most firms rely heavily on patents, intellectual capital, and process capabilities to carve out a competitive advantage. The devotion of significant sums of capital to ongoing research and development is imperative to keep up with demand for new capabilities that work in conjunction

4 Hoover’s 5 Fidelity 6 The Wall Street Journal 7 IBISWorld

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with technological developments made by computer and wireless communication manufacturers, who are in turn devoted to ongoing research projects in order to fulfill end consumer demand for continuous and novel innovation.8 Revenue measurements are currently considered highly volatile for the industry, as the trend of increased offshore manufacturing and volatility of prices of raw materials necessary for semiconductor production can have significant effects on industry revenues.

Future Predictions

Revenues are expected to grow at an average annualized rate of 3.0 percent for the next five years, up to $92.0 billion in 2019. The value of U.S. industry exports is expected to continue to decline over the next five-year period, decreasing by an average annualized rate of 3.8 percent, down to $22.1 billion, up to 2019.9 Research and development should continue to be crucial to success in the industry, as projected changes in technology and shifts in consumer preference should create opportunities for firms that are poised to capitalize on the new demand. In the coming years, manufacturers will shift their focus away from silicone-based semiconductors and towards wide bandgap semiconductors, which can operate at twice the maximum temperature of their silicon counterparts. Smartphones, digital cameras, and the increasing integration of automobiles and smart technology represent major growth areas for the semiconductor industry over the next five years.

8 IBISWorld 9 Ibid.

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Overview Texas Instruments, Inc., is based in Dallas, Texas, and employed over 31,000 people worldwide in 2014. The company manufactures over 100,000 distinct semiconductor products, and it sells its products both as finished goods to end consumers, and intermediate materials to industrial clients operating in more advanced stages of a specific item’s supply chain. Analog semiconductors, which convert real-world inputs such as pictures and sounds into digital data streams, account for approximately 60 percent of Texas Instruments’ sales. Another 20 percent of the company’s total revenues come from the embedded processing segment, which is primarily comprised of microcontrollers used in remote controls, implanted medical devices, power tools, and home appliances. The final 20 percent of the company’s total revenue come from a collection of smaller product lines, most notably consumer goods like calculators.10 Competition is fiercely competitive among the 832 companies in the mature semiconductor industry, and Texas Instruments claims the industry’s fourth-largest market share with ownership of only 2.1 percent of the market.11 However, Texas Instruments holds the leading market share in the specific market for analog chips.12 Texas Instruments recorded $2.82 billion in net income in 2014.13 The Chief Executive Officer, President, and Chairman of the company is Richard Templeton. He has served as CEO since 2004, and Chairman of the Board since 2008.

History

Texas Instruments was founded in 1951, following the reorganization of Geophysical Services, Inc., a small oil and gas company that was founded in 1930. Throughout World War II, Geophysical Services developed and manufactured signal processing and radar equipment. After becoming Texas Instruments, Inc. in 1951, the company essentially created the semiconductor industry, as company employees invented the silicon transistor and integrated circuit in 1954 and 1958, respectively.14 The financial crisis of 2007-2008 had a relatively significant impact on Texas Instruments, as well as the entire semiconductor industry. Texas Instruments’ net income decreased by 27.74 percent between 2007 and 2008, and by 23.44 percent from 2008 to 2009. However, the company boosted

10 Hoover’s 11 IBISWorld 12 Morningstar 13 Ibid. 14 Texas Instruments

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net income by 119 percent between 2009 and 2010, and the company’s revenues have not measured any outrageous increases or declines in revenues in the years between 2010 and 2015.15 In 2011, Texas Instruments purchased rival firm National Semiconductor for a reported $6.5 billion in cash.16 Texas Instruments abandoned its participation in the wireless chip market in 2013, but in the three years leading up to 2014 the company strengthened its dedication to the market for analog semiconductors, of which it claims the highest market share. 17 National Semiconductor also claimed a significant share of the analog market, so Texas Instruments’ acquisition of the company further strengthens the company’s share of the analog market. The company announced in early 2014 that it was implementing a shift to production of 300mm chips rather than the previous 200mm chips, a move that the company and analysts predict will increase gross margins from 60 percent to 68 percent.18

Qualitative Assessment

The company also disclosed in late 2014 that it had the capacity to fulfill $8 billion worth of open 300mm chip orders with existing manufacturing plant infrastructure, suggesting that margin increases from the transition could be even greater if the company does not need to devote significant cash flows to capital improvements in order to complete the switch.19 The company invested approximately $350 million less in research and development in 2013, which precipitated a 20 percent jump in net income over the prior year. However, as burgeoning opportunities in smartphone and smart automobile technology, as well as advancements in digital camera technology, continue to develop in oncoming years, Texas Instruments must demonstrate a significant monetary to dedication to innovation in order to capitalize on novel consumer demand for these developing technologies. The company estimates that its market-leading share in analog semiconductors could account for 90 percent of revenues within the next two years, and analog semiconductors play an integral role in both smart technologies and digital camera operation. The semiconductor industry is a mature one, and Texas Instruments is a mature company, as the entity has existed in its present form for over 60 years. In the coming years, Texas Instruments will likely continue to exhibit relatively slow growth in revenues, as the nature of the industry and the company’s well-established physical and process infrastructure leaves little room for monumental marginal increases. However, the company has demonstrated a long-term ability to consistently generate significant profits, and its healthy financial position suggests that it is poised to continue to do so. The company’s steady position is also protected by high barriers to entry in the semiconductor industry, as Texas Instruments has already established a historically respected brand name and systemic and effective manufacturing and research infrastructure. Foreign manufacturers claim a significant and growing portion of industry revenues, presenting a potential threat to American manufacturers. However, the globally-positioned Texas Instruments

15 Morningstar 16 Hoover’s 17 Ibid. 18 Morningstar 19 Ibid.

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may be better poised to ward off foreign competition than its more locally-confined counterparts, as revenues in Asia account for approximately 70 percent of Texas Instruments’ total revenues.20

Ratio Analysis

The chart below displays key financial ratios for Texas Instruments in 2014 in comparison to the median values of the same ratios for the semiconductor industry. All P/E, P/B, P/CF measurements were provided by Hoover’s, while the PEG ratio data was projected to 2016 by and provided by NASDAQ.

Ratio Texas Instruments Industry Median Price/Earnings 20.48 23.62

Price/Book 5.39 2.08 Price/Cash Flow 14.64 14.54

PEG 2.06 0.81

In examining Texas Instruments’ performance via these ratios relative to the industry median, no clear pattern emerges in indication of whether the company’s stock is over- or underpriced. Texas Instruments measures a slightly lower P/E ratio than the industry media, indicating that the average TI investor pays less for every dollar of earnings than one who invests at the industry median. However, the company’s P/B ratio and PEG ratio are both significantly larger than the industry median, suggesting that TI stock may be overpriced, while the price/cash flow ratios for the company and the industry do not differ significantly.

Intrinsic Valuation The intrinsic valuation of Texas Instruments’ stock presented in the appendix was calculated using the dividend discount model with a multi-stage growth periods. The beta used is the adjusted beta provided by Bloomberg, as calculated using daily returns over the trailing three-year horizon. Capping the horizon for beta calculation at three years accurately controls for Texas Instruments’ acquisition of National Semiconductor in 2011. Limiting the horizon to three years maintains that the return data is consistent with Texas Instruments’ daily returns after the acquisition only. The market premium is the S&P 500’s market premium as provided by Morningstar, and the 1-year and 10-year treasury yields are provided by the United States Department of the Treasury yields curve. Because Texas Instruments is a mature firm with well-established infrastructure for research and development and manufacturing, it is reasonable to assume that the Bloomberg-provided 0.5238 plowback ratio for 2014 will remain relatively constant. The ROE used for the model is an average of Texas Instruments’ reported ROE for each of the previous five years. The semiconductor market is a highly volatile market. New growth sectors

20 Hoover’s

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have emerged in the past five years, including increases in the prevalence of smart technology and smart cars, as well as an accompanying growth in demand for analog semiconductors. Simultaneously, American semiconductor firms, Texas Instruments included, have faced increased threats from foreign firms, and the highly globalized nature of both production facilities and demand in the industry causes semiconductors companies’ earnings totals to fluctuate with exchange rates. Therefore, the ROE was averaged to help control for this volatility. Given that the term growth rate for this model was larger than the CAPM cost of equity, it was crucial to extend the model’s time horizon beyond ten years to 22 years, with Texas Instruments reaching a terminal growth rate of 11.89 percent in 2037. Using the 1-year treasury rate of 0.23%, the intrinsic value for Texas Instruments, Inc., is $61.29. Using the 10 year treasury rate of 1.9%, the intrinsic value for Skyworks Solutions is $64.03. At close as of April 22, 2015, the market price of Texas Instruments was $58.73. Therefore, assuming either the 1-year or the 10-year treasury rate, it is reasonable to conclude that Texas Instruments is undervalued relative to its market price.

Recommendation: BUY

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Overview Skyworks Solutions Incorporated is an integrated semiconductor company with headquarters in Woburn, MA. Skyworks specializes in the production of integrated circuits for wireless devices. In 2014, they employed over 5,550 workers and manufactured hundreds of different semiconductor products. Skyworks company goal is to create simple solutions to complex problems. This means they aim to connect everyone and everything, all of the time.21 Skyworks specializes in the production of handset products like power amplifiers and front-end modules which are primarily used in mobile phones and communications equipment. They also produce other analog devices like diodes, radio frequency chips, phase shifters, receivers, and switches which can be used in a broad array of industries. Skyworks sets itself apart from its competitors by using gallium arsenide, a material that provides more speed and higher efficiency levels than traditional chip materials.22 It has also bucked a current trend in the semiconductor industry by continuing to operate its own production facilities across the United States. Skyworks’ chips are used across industries in many high end devices. Its chips are used in devices produced by notable brands like Apple, Nest, LG, Roku, Xbox, Audi, Volkswagon, General Motors, Hyundai, Amazon, Honeywell, Samsung, and Timex.23 Looking quickly at this list, it is easy to see that Skyworks’ offers a diversified portfolio which capitalizes on trends with increased connectivity and the Internet of Things. It is well positions in areas like mobile devices, smart homes and security, entertainment systems, smart cars, and connected wearables. As well as being a leader in its chief product categories, Skyworks is also a leader among its chief competitors TriQuint, Anadigics, and RF Micro Devices. Itx revenue is at least double each of these competitors and its net profit margin of 21.54% is at least three times higher than its closest peer, RF Micro Devices.24 Although not a stalwart producer like Intel, TI, or Qualcomm, Skyworks has quietly carved out a leadership role with high quality products in its niche market.

History Skyworks traces its history to the founding of Alpha Industries Inc. in 1962. Alpha Industries specialized in producing radio frequency chips which improved speed and performance in early wireless and video communications. In 2002, Alpha Industries agreed to a deal with Conexant Systems Inc., in effect merging Alpha Industries with Conexant’s wireless communications 21 Hoovers 22 Ibid. 23 Skyworks 24 Hoovers

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business.25 The combined company would be known as Skyworks Solutions and began trading on the NASDAQ exchange with the stock ticker SWKS in June of 2002. For its CEO, Skyworks would retain Alpha’s CEO Mr. David Aldrich who would also serve as president. Although no longer president, Mr. Aldrich continues to serve at CEO and is now also chairman of the board. In 2014 he was named CEO of the Year by the Massachusetts Technology Council as he continue to see the company grow in value.26 To that point, Skyworks was recently added to the S&P 500. The semiconductor industry is highly volatile while placing a premium on constant research and development of new technologies. Accordingly, Skyworks Solutions was hit hard during the recession like many of its competitors. In 2008, Skyworks reported a net income of $111 million, its highest ever. However in 2009, Skyworks was hit hard with earnings falling to $93.3 million, a 16% decline. After the recession, Skyworks rebounded quickly with the rest of the industry, posting net income growth of 47% and 65% the following two years.27 Although net income growth retracted in 2012, this was largely due to high merger and restructuring costs after deals to acquire SiGE Semiconductor for $275 million and Advanced Analogic Technologies for $257 million. 28 These acquisitions improved Skyworks’ wireless communication and power management chips divisions, while also getting Skyworks’ semiconductors into devices produced by technology giants like Cisco, Dell, HP, Microsoft, and Sony.29 These activities have set Skyworks up for the period of radical growth that it is currently experiencing. In 2013, earnings increased by 37.6% followed by 64% growth in 2014. Meanwhile, stock price grew from the $20 range in early 2013 to its current price hovering around $95, representing two year annualized growth of 117% during this time period.30

Qualitative Assessment With the development of highly sophisticated and specialized semiconductors, Skyworks has done well to position itself for success in an increasingly connected world. In 2011, 60% of Skyworks’ revenue came from its line of power amplifiers, an area expected to see 5% long term growth. Today, only 38% of revenues come from this more traditional line. Instead, Skyworks has successfully expanded into integrated mobile systems and broad markets which include connected homes, entertainment, auto, wearables, and medical devices. These categories by comparison to the power amplifiers are expected to see upwards of 15% long term growth and over 20% in some cases.31 Given that the semiconductor industry is so dependent on innovation and having the latest technologies, research and develop costs play a substantial role in forecasting future performance. Although Moore’s Law may be showing its age, it is the still the dominant expectation for semiconductor growth. Over each of the last five years, Skyworks has increased its investment in research and development as it has grown. In 2014, Skyworks spent over $252 million dollars on

25 Press Release 26 Skyworks 27 Morningstar 28 Hoovers 29 Ibid. 30 Morningstar 31 Skyworks

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research and development costs, up nearly 12% year over year.32 It is reasonable to expect these costs to continue to increase over time, however in the short term it is reasonable to expect firm growth to outpace the costs. Should these costs begin to increase faster than firm growth, it is reasonable to believe that Skyworks could potentially mitigate these costs by going fabless by sending more of its production to Mexico or to Asia, closer to its target market as other firms have done in the not so recent past. Skyworks has also positioned itself well to deal with the semiconductor industry’s shift in geographic focus. Skyworks is headquartered in Massachusetts and has manufacturing facilities in California, North Carolina, Iowa, and along the Mexican border.33 That being said, only 5% of its sales take place in the United States. Instead, 52% take place in China and an additional 40% occurs throughout the rest of the Asia-Pacific. 34 As this is the highest growth area where technology saturation has not already taken place, Skyworks should continue to grow with these markets. Although this does open Skyworks up to considerable currency exposure, it is reasonable to expect that the strong dollar will not do enough to offset the strong regional sales growth.

Ratio Analysis The chart below displays key financial ratios for Skyworks Solutions in 2014 in comparison to the median values for other companies in the semiconductor industry. All P/E, P/B, and P/CF measurements were provided by Hoover’s while the PEG ratio data was projected and provided by NASDAQ.

Ratio Skyworks Industry Median Price/Earnings 24.77 23.62

Price/Book 5.16 2.08

Price/Cash Flow 13.88 14.54 PEG 1.00 0.81

Based on the table above, Skyworks Solutions appears to be overpriced based on its PEG ratio, P/E ratio, and P/B ratio all above the industry average. That being said, Skyworks might not be far from correct pricing given that the ratios with the exception of P/B are pretty close to the industry average. Based solely on P/CF though, it would be reasonable to suppose that the stock might be slightly underpriced relative to its peers. Overall, this can be read as a mixed pricing signal. To quickly gauge the implications of the P/E ratio, multiply the industry P/E by Skyworks’ 2014 EPS to get a price estimate of $57.63, which implies Skyworks may be seriously overpriced despite the positive factors from the qualitative analysis.

Intrinsic Valuation Several assumptions are needed in order to use a Dividend Discount Model (DDM) to find Skyworks’ intrinsic value. First, it is important to understand that Skyworks is a growing company that just paid its first annual dividend in 2014. To account for this, assume the industry growth rate

32 Morningstar 33 Skyworks 34 Hoovers

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from Bloomberg of 26% and adjust it upward to reflect the qualitative growth drivers. In this model, the initial period’s growth rate is estimated at 35%. Looking quickly at Bloomberg’s projected dividends for the next three years, this seems reasonable, if not a little conservative. To calculate adjusted beta, it is important to use daily data to maximize observations and to only use 2.5 years of data given the Skyworks’ acquisitions in 2012. The market premium comes from Morningstar, and the 1 year and 10 year treasury yields come from the Department of the Treasury’s yield curve. It is important to look at both given the current rates uncertainty and the over twenty year interval used for this valuation. Because Skyworks is a growth firm, it is reasonable to assume its plowback will remain close to 88% even if that is somewhat high for the industry. Given that Skyworks’ ROE of 14.8% is close to the industry average, it is safe to assume it to be constant as well. To account for cost growth and slowed sales growth in the long term, a multistage growth model has been used herein with a terminal growth rate of 13%, down significantly from the initial 35%. Given the growth rate for this model is higher than the CAPM cost of equity, it was also very important to us a time horizon beyond ten years. Using the 1 year treasury rate of 0.23%, the intrinsic value for Skyworks Solutions is $90.00. Using the 10 year treasury rate of 1.9%, the intrinsic value for Skyworks Solutions is $102.38. Depending on the interest rate used, this model too offers mixed signals. Despite this, at $96.83 as of the close on April 22, 2015, it is reasonable to conclude that stock of Skyworks Solutions seems fairly priced despite its valuation ratios.

Recommendation: HOLD

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Overview Avago Technologies, headquartered in San Jose, CA, and Singapore, is a fast growing player in the semiconductor industry, mostly manufacturing intermediate technologies. Making over 6,500 products, Avago designs and supplies semiconductors, power amplifiers, radio frequency and microwave components, optoelectronics, and application-specific integrated circuits. 35 The company’s “asset-lite” model of manufacturing cuts its production, assembly, and testing costs and its supply chain supports its customers by allowing goods to be manufactured close to their locations.36 Avago is broken up into four components: wireless (i.e. LTE developments), wired infrastructure (i.e. Internet of Things), enterprise storage (cloud streaming and big data), and industrials (energy efficiency and conservation). Of the four, wireless makes up 41% of Avago’s sales, enterprise storage makes up 30%, wired infrastructure makes up 21% and industrials and others are left with the remaining 8% of Avago’s 2014 sales of $4.31 billion.37 Because this industry is so competitive and global, 85% of Avago’s sales take place outside of the US, with China holding 40% of Avago’s sales and the US only accounting for 15%. Avago mostly outsources its manufacturing like most other semiconductor companies, but keeps its internal productions in its headquarter countries of the US and Singapore.38

History Avago Technologies started out as a components division of Hewlett-Packard in 1961. In 1999, HP spun off this division as its own company known as Agilent Technologies. It was in 2005 when two buyout specialists, KKR and Silver Lake, bought out Agilent’s semiconductor business for $2.7 billion, renamed it Avago Technologies, and had its IPO in 2009.39 The 2007-2009 financial crisis period really took a toll on Avago, especially since Avago was only two years old by 2007. In 2007 Avago had its lowest net income of -$159 million with it going positive in 2008, and negative in 2009 going back up positive for constant growth. Avago showed a 1043% increase in its net income from 2009 to 2010, going from -$44 million to $415 million. The company recently had a net sales of $263 million in the 2014 fiscal year. Revenues were also lowest in the financial crisis but never going below $1 billion; the 2014 fiscal year saw revenues of $4.26 billion.40 A year before going public, Avago acquired Nemicon to expand its motion control line and in 2010 acquired Wuxi to expand in Chinese markets. Avago acquired Javelin Semiconductor in 2013

35 Avago 36 Hoovers 37 Avago 38 Ibid. 39 Ibid. 40 Morningstar

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to boost its next-gerenation smartphone components development as well as CyOptics, a player in data and telecommunications. In 2014, Avago acquired San Jose based LSI Corporatoin, a designer of semiconductors and software that accelerates storage as well as networking in different data centers, client computing, and moblie networks. LSI had acquired Agere Systems in 2007, which was a company that was a spin off of AT&T. The acquisition of LSI was paid $6.6 billion in cash by Avago and is expected to generate $200 million in operating synergies annually.41

Qualitative Assessment With a $32.30 billion market cap, Avago is showing positive growth in nearly all of its areas of operation and its indicators are performing better than the industry. Avago is, although a relatively new company to the industry, a company with great growth and like other semiconductor companies shows great stock momentum. However, Avago is underpriced and undervalued compared to its industry peers given its recent positive performance.42 Avago shows a strong amount of sales growth in its wired infrastructures division due to a greater demand for data center storage and servers that drive the demand for Avago’s wired component inputs to these servers. Other than “organic growth”, Avago’s numbers will grow from the increased demand for wireless connectivity, enterprise storage solutions, and from acquisitions. However, it is probably best that Avago invests $5.5 billion in debt to finance future earnings as it has only $2.6 billion in cash currently. Therefore the only way it would be able to participate in a merger would be through financing it with debt or with share offerings which would dilute Avago’s EPS.43 Avago has many big purchasers including HTC, LG, Samsung, IBM, Western Digital, Toshiba, and others. However, Foxconn accounted for 27% of Avago’s net revenue in Q1 2015. As Foxconn’s business is great because of Foxconn’s smartphone product demand is up, this sort of leverage poses risks. If Foxconn were to switch to another company or lose its demand, Avago could be hit in a big way, especially if it decides to take on a larger amount of debt. Nonetheless, Foxconn and Avago’s relationship is expected to remain positive.44

Ratio Analysis The chart below presents different financial ratios from Avago compared to the semiconductor industry average. The P/E, P/B, P/CF were gathered from Hoover’s while the PEG was given by NASDAQ.

Ratio Avago Technologies Industry Median Price/Earnings 54.15 23.62

Price/Book 7.27 2.08 Price/Cash Flow 18.38 14.54

PEG 0.92 0.81

41 Hoover’s 42 Seeking Alpha 43 Ibid. 44 Ibid.

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Clearly Avago’s ratios are quite large relative to its industry rivals except for the PEG. Avago has a 69.78% growth rate for 2015 while it is in a mature industry. Because of such high growth and momentum as a young company, it is normal for companies like this to experience higher ratios, hence the importance of the PEG to normalize growth factors.

Intrinsic Value Avago’s intrinsic value was calculated using a dividend discount model. The cost of capital comes from the CAPM. Avago’s adjusted beta (with daily data over a three year period) came from Bloomberg, the market premiums from Morningstar, and the one and ten year treasury bill yields from the Department of Treasury to account for both short and long term potentials in the cost of equity. Since Avago is a young firm, its plowback rate of 0.6413 is reasonable as it should continue to reinvest. Avago’s growth rates was calculated by multiplying the plowback rate by the company’s return on equity (both found on Bloomberg) to calculate a growth rate of 0.1335. This growth rate was then used to find the incremental decrease in growth after 2016 by taking the difference of 2017’s actual growth rate and the calculated 0.1335 rate that Avago would move towards and dividing it by 20 as the incremental decreases would span from 2017 until 2037. This increment was used until all the dividends were projected out until 2037. With the 0.23% one-year rate, Avago was valued at $153.81. With the 1.9% ten-year rate, Avago was valued at $165.76. While Avago is currently priced at $123.78 as of the close on April 22, 2015, Avago appears to be underpriced relative to its market price.

Recommendation: BUY

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“About Avago.” Avago Technologies. N.p., n.d. 16 Apr. 2015.

"About Skyworks." Skyworks Solutions Inc. N.p., n.d. Web. 22 Apr. 2015.

Avago Technologies Ltd. Morningstar Investment Research Center. Morningstar,

n.d. Web. 16 Apr. 2015.

Clark, Don. Moore’s Law shows its age. The Wall Street Journal. 17 Apr. 2015.

Web. 23 Apr. 2015.

Colello, Brian. TI’s transformation into a highly profitable analog and embedded

chipmaker is well underway. Morningstar, Feb. . Web. Apr. .

Cother, Jason. Texas Instruments Incorporated. Hoover’s, . Web. Apr. .

Epperson, Lesley. Avago Technologies Limited. Hoover’s, . Web. Apr.

Gallo, Rachel. "Skyworks Solutions Inc." Hoovers. N.p., n.d. Web. 22 Apr. 2015. History of Innovation. Texas Instruments, n.d. Web. Apr. .

Skyworks Solutions Inc. Alpha and Conexant Announce Plan to Close Skyworks Merger

Today. Business Wire. N.p., 25 June 2002. Web. 22 Apr. 2015. "Skyworks Solutions Inc." Morningstar Investment Research Center. Morningstar, n.d.

Web. 22 Apr. 2015.

Texas Instruments Inc. Morningstar, 2015. Web. 14 Apr. 2015.

Ulama, Darryle. Semiconductor and Circuit Manufacturing in the U.S. IBISWorld,

2014. Web. 10 Apr. 2015.

Zanoni, David. "Avago: Likely to be a multi-year strong momentum stock."

25 March 2015. Seeking Alpha. 16 April 2015.

Zeno, Angela, CFA. "Semiconductor Industry Analysis." S&P Capital IQ. Fidelity

Investment Resources, Nov. 2014. Web. 15 Apr. 2015.

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