What's the idea?
- New high-speed data products will help in the battle for 5G and data processing markets.
- The company's sensors will be needed when implementing energy-efficient infrastructure.
- Forecasted positivity in the target markets will support the company's growth rate.
- The new takeover will broaden the range of applications for IoT technology, but will increase the debt burden.
About Company
Semtech Corporation offers its customers advanced algorithm solutions, analog semiconductor products and mixed-signal semiconductor products. The company's business is divided into three main segments: Signal Integrity (optical data and video products), Wireless and Sensing (specialised RF products as well as specialised sensor and power devices) and Protection (high-performance protection devices that protect electronic systems against power surges).
Why do we like Semtech Corp.?
Reason 1. Industry potential
According to the last reporting period, 42% of Semtech Corp.’s revenue was generated by the Signal Integrity segment, another 32% came from the Wireless and Sensing segment and the remaining 26% of the company's revenue came from the Protection segment. Positive news is seen across all three of the company's business lines. Let's go through them one by one:
Signal Integrity:
Semtech participated in the European Optical Communications Conference (ECOC) on September 19, where it demonstrated its achievements:
- A new technology that enables data transmission at 200 Gbit/s over single-mode optical fibre using its FiberEdge chips. The technology is expected to significantly reduce the cost of high-speed networks and enable the deployment of new optical modules with very high data rates.
- Expanding its platform with two 24-28 Gb/s integrated circuit solutions with single-band transimpedance amplifiers (TIA — current to voltage converter type) capable of industrial temperature range for use in optical modules for 5G wireless base stations. In addition, the platform is also extended with four-channel TIA and linear TIA wireless optical modules.
- Launched a new receiver for next-generation optical links for data centres, offering ultra-low power consumption and low latency. In addition, the company unveiled another receiver designed for 5G backbone deployment.
- A new transmitter designed for data centres and long-haul wireless optical lines. According to the company, the new transmitter provides best-in-class performance for optical lines up to 10 km.
- A new four-channel driver that offers best-in-class performance and low cost for short distance optical lines.
We expect new products to help Semtech increase market share and profitability in the promising markets of 5G, high-performance computing, artificial intelligence and data processing. Research shows that these markets have good prospects ahead:
- According to Allied Market Research, the 5G market is forecast to grow at a compound annual growth rate (CAGR) of 65.8% until 2030.
- The artificial intelligence market, according to Grand View Research, expects to grow at a CAGR of 38.1% over the 2022-2030 horizon.
- MarketsandMarkets expects the high-performance computing market to grow at a CAGR of 6.7% until 2027 and the big data market at a CAGR of 11% until 2026.
The company itself estimates a long-term growth rate of 10+% for the segment, driven by increased product demand due to the accelerating pace of data transfer and video display adoption, and expects the served accessible market (SAM) to grow from $0.7 billion to $1.4 billion by 2026.
Wireless and Sensing:
- On November 10, Semtech Corp. announced a partnership with the solar cell manufacturer Exeger on solar energy technology for IoT sensors (IoT- Internet of Things). The Semtech platform will significantly reduce power consumption and increase battery life of the devices. A successful application of the new technology could increase Semtech's customer base with customers who require such energy-efficient sensors. For example, there may be demand for devices that allow remote monitoring of assets in the oil and gas industry, where there is a need to respond quickly to emergencies at remote sites.
- On September 27, Semtech announced that Kiwi is using its devices for a new network control unit for gas metres, which, thanks to the capabilities of Semtech technology, can be fully autonomous for 10 years.
The events of the last year have increased the world's attention to energy efficiency and the development of green energy. We believe that interest in the company's products will grow along with the digitalisation of energy systems. MarketsandMarkets expects the IoT market to grow at a CAGR of 16.7% over the 2022-2026 horizon.
The company itself estimates a long-term growth rate of 20+% for the segment through the proliferation of LoRa and PerSe platforms, and expects the served accessible market (SAM) to increase from $0.3 billion to $1.5 billion by 2026.
Protection:
On October 19, Semtech Corporation unveiled a new platform for protection against failure modes in industrial, telecoms and consumer applications. The new platform provides enhanced protection features that extend the life of electronic devices and potentially reduce electronic waste. According to Grand View Research, the global electrical circuit protection market will grow at a compound annual growth rate of 5.6% over the period 2022-2030.
The company itself estimates a long-term growth rate of 20+% for the segment due to an increased need for off-chip protection due to shrinking process geometries, increased adoption of high-speed interfaces and e-waste reduction initiatives, and expects the served accessible market (SAM) to increase from $1 billion to $2 billion by 2026.
Reason 2. New takeover
Semtech is expected to complete a takeover of the world-renowned IoT solutions provider Sierra Wireless in fiscal 2023 at $31 per share, valued at around $1.2 billion. The acquisition will combine IoT and cellular technologies to enable digitalisation through a chip-cloud platform, develop many new IoT applications and create a portfolio of cloud services.
The deal is expected to immediately bring in more than $100 million in recurring revenue from cloud IoT services and have a positive effect on EPS, as well as doubling the company's revenue. In addition, the takeover promises operational synergies of around $40 million.
Separately, we note that the transaction is planned to be financed both with cash on the balance sheet and with new project debt financing. On a rough preliminary basis, this could push the merged company's Net Debt/EBITDA ratio to ~3.6x. This debt load is already high, but as the company has maintained negative net debt since October 2016, we believe that Semtech will actively deleverage and reduce risk to investors through stable cash flows.
Financial indicators
The company's results for the last 12 months:
- TTM revenue: up from $674.1 million to $796.9 million
- TTM operating profit: up from $102.7 million to $191.3 million
in terms of operating margins, an increase from 15.2% to 24.0% due to a decrease in cost of revenue from 38.5% to 35.8% and SG&A expenses from 25.3% to 22.4%.
- TTM net profit: up from $90.6 million to $158.9 million
in terms of net margin, an increase from 13.4% to 19.9%
- Operating cash flow: up from $141.2 million to $244.9 million thanks to improved profitability and positive changes in working capital
- Free cash flow: increase from $110.4 million to $215.8 million
Based on the results of the most recent reporting period ended on July 31, 2022:
- Revenue: up from $185 million to $209.3 million
- Operating profit: up from $36.7 million to $64 million
in terms of operating margins, an increase from 19.8% to 30.6% due to a decrease in the cost of revenue from 37.6% to 35.1% and other non-recurring income of $18.4 million
- Net income: up from $32.9 million to $51.6 million:
in terms of net margin, an increase from 17.8% to 24.7%
- Operating cash flow: up from $53 million to $77.3 million
- Free cash flow: increase from $46 million to $70 million
Semtech has demonstrated good financial performance both in the last 12 months and in the last quarter, building up cash flows that will help it feel more comfortable with higher debt levels in the future.
- Cash and cash equivalents: $362.2 million
- Net debt: -$190 million
The company is in a strong financial position, but be mindful of the increased debt burden in the future, which we mentioned when considering the new takeover application.
Evaluation
In terms of trading multiples, Semtech Corp. is undervalued relative to the industry:
Ratings of other investment houses
The minimum price target set by B. Riley's minimum price target is $34 per share. Benchmark, in turn, has set a target price of $65 per share. According to the consensus, the fair value of the stock is $51 per share, which implies a 74% upside potential.
Key risks
- A negative macroeconomic scenario could lead to lower demand for products.
- Coronavirus-related difficulties in China are reducing the company's growth rate.
- Despite strong demand from smartphone buyers in North America, there is weakening demand in China and Korea, which is slowing growth.
- On 7 October, new restrictions were announced. In theory, Semtech products are not intended for militarisation purposes and should not be subject to restrictions, but if such controls are further strengthened, exports of some products could be hampered.