LSI CORP LSI
March 21, 2011 - 11:37am EST by
dle413
2011 2012
Price: 6.60 EPS $0.00 $0.57
Shares Out. (in M): 626 P/E 0.0x 11.7x
Market Cap (in $M): 4,132 P/FCF 0.0x 13.2x
Net Debt (in $M): 677 EBIT 0 335
TEV ($): 3,456 TEV/EBIT 0.0x 10.3x

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Description

LSI is a fabless semiconductor company with heavily entrenched positions in storage and networking.  The Company is coming out of a deep investment cycle where management essentially had to rebuild the major product lines, and in the next 6 to 12 months is poised to see revenue from design wins accumulated in the past couple of years.  Given the high level of investment over the past few years, margins have suffered (Op Margins bottomed at 7% in 2009 and were only 13% in 2010) but should expand as revenues grow and opex stays flat.  With top line revenue growth accelerating, margins expanding, a newly announced buyback of ~20% of the market cap, and an EV/FCF of <8x on forward, LSI should go much higher as the story unfolds through 2011.

Note:  On 3/8/2011 LSI announced the sale of their storage systems business to NetApp for $480m.  This business generated $705m in 2010 revenue at ~33-34% gross margin, and LSI is getting $35-40m/qtr in opex savings from the divestiture.  In conjunction with the deal, LSI announced a $750m share repurchase program (~20% of market cap) that they anticipate implementing "aggressively."  This deal sets up LSI as a pure play semi company, increases their margins, and sets them up for faster comparable revenue growth.  LSI should be much easier for investors (or a potential acquirer) to value, and the significant buyback should support the stock until their design wins start to ramp in 3Q11. 

Business

LSI is a leading fabless semi company in three markets:  server and storage connectivity (37% of sales), HDD/SSD (32%), and Networking (26%). 

Server and Storage Connectivity (37%):  LSI is the leading provider of silicon to server and storage OEMs (IBM, HPQ, EMC, etc) for silicon that connects to storage.  Products include RAID adapters, SAS for servers and external storage, and SAN fabric.  LSI has >50% share in most of these segments, with PMCS as their main competitor.  This is a good business because LSI has developed a hardened software stack that works on multiple generations of platforms and is trusted by the main vendors to work.  There are only a couple of players; it would be essentially impossible for a new one to enter given the time it takes to establish credibility with customers, and LSI has >50% share.  The market is levered to volumes in servers and storage systems, so should be a >10% grower.

HDD/SSD (32%): The HDD SoC market is the business most people think of when you talk about LSI.  The key to this product is the chip that reads the magnetic information coming off of a hard disk drive and converts it into the 1's and 0's a computer needs.  LSI has ~30% share vs MRVL's ~60% share, with the balance held by ST Micro and Renesas.  STM and Renesas are essentially exiting the business, allowing LSI and MRVL to take the remaining share and forming a duopoly market.  The HDD market has been a major concern of investors recently due to a weak PC market, tablets, and solid state drives.  While the HDD/SSD argument is best reserved for another forum (see our STX write-up), for LSI the key issue is that this market isn't going away, their profitability is much more stable vs the HDD makers, and it is becoming a duopoly allowing them to grow their share significantly in the next couple of years.

Networking (26%): LSI has developed networking products that leveraged their HDD read channel IP that is good at turning noisy signals into clean 1's and 0's.  Over the past few years they Company has seen legacy products hurting this segment, but their "go forward" networking revenues grew >50% in 2010 and has a number of new products ramping in 2011.  Key products include network processors, DSPs, and custom products.  Management is very excited about several wins ramping at Cisco, which they think can be a "multi hundred million" account soon, as well as wins at ERIC, NSN, Huawei, ALU, and ZTE.  This business is being driven by a trend for networking companies to move to more merchant silicon vs internally designed chips.

Consensus View

  • This company has been an underperformer for several years
  • Nobody wants HDD exposure
  • Confusing mix of semis and storage systems

Alternative View

  • LSI has rebuilt product line and is about to realize benefits of long investment cycle
  • HDD is only 1/3 of sales, is a stable business, and leads to SSD opportunities
  • Sale of storage systems makes this a cleaner story that will be appreciated by the market or acquired by another semi firm

Risks

  • Failure of new design wins to ramp in Networking
  • Loss of key customers in Server / Storage Connectivity

 

 

Catalyst

  • Accelerating revenues and expanding margins in 2H11 as new products ramp
  • Stabilization of HDD business and launch of new SSD products
  • Significant share count reduction due to buyback
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