Texas Instruments Incorporated TXN
July 16, 2010 - 6:32pm EST by
citrus870
2010 2011
Price: 24.77 EPS $2.40 $2.49
Shares Out. (in M): 1,222 P/E 10.3x 9.9x
Market Cap (in $M): 30,275 P/FCF 0.0x 0.0x
Net Debt (in $M): -2,791 EBIT 4,396 4,439
TEV ($): 27,484 TEV/EBIT 6.3x 6.2x

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Description

 
Texas Instruments designs and makes semiconductors that it sells to electronics designers and manufacturers all over the world.  The company began operations in 1930 and is based in Dallas, TX.  While all high school and college students know TI for their calculators, that product accounts for only 4% of sales.  96% of sales come from semiconductors. 
TI operates in three reportable segments:
 
Analog - consists of high performance analog, high-volume analog & logic and power management;
 
Embedded Processing - consists of digital signal processors (DSPs) and microcontrollers used in catalog, communications infrastructure and automotive applications; and
 
Wireless - consists of DSPs and analog used in basebands for handsets, applications processors and connectivity products for wireless applications.
 
The growth drivers for TI are analog and embedded.
 
For the last three years, TI has been working to evolve into the world's largest producer of customized "smart" chips.  These analog chips are used to process "real world" signals, such as sound and power, that control digital applications.  Indeed, during this period the company spent cash acquiring businesses, opening new plants, and building out its core of engineers in India and China.  Today, TI has 13% market share in analog, which makes it the dominant player in a $32 billion market.  TI also has leading market share positions in digital signal processors (used in cell phones) as well as applications processors (chips used to run software and applications in mobile devices). 
 
TI has 11% market share in embedded application chips, where the company enjoys scale and technology advantages.  TI is the second-largest player in this $14 billion market.  Embedded chips provide specialized functions for a myriad of devices, such as Bluetooth headsets, medical equipment, digital cameras, and automobile controls.  As Barron's wrote in a June 2010 article on the company, these chips "speed things up, lower noise levels and boost performance."  TI has publicly stated that its goal is to grow its embedded business at twice the rate of competitors over the next three to five years.
 
TI's baseband operations supply chips that connect cell phones to wireless carriers' networks.  TI foresees increased competition and lower prices in the wireless baseband chip business.  Accordingly, the company is in the process of winding down its wireless business.  This segment accounted for 20% of revenues in 2008 but is lower margin than the rest of the company.  Therefore, as the baseband business goes from $2.5 billion in 2008 to zero by 2013, the company should see a natural lift to margins but a headwind to topline growth.
 
The company has the benefit of large size and an extremely strong balance sheet.  Sales are expected to be $13.8 billion in 2010 and will exceed $14 billion in 2011.  The company has no debt and has cash of $2.8 billion.  This firepower gives it the capacity to move forward with acquisitions at times when rivals are cutting back.
 
Over the longer term, we expect the company to demonstrate moderate topline growth.  While sales have declined since 2007 (cyclicality), we expect low single digit to mid single digit growth from 2010 to 2013.  More specifically, we anticipate growth of 12ish % in analog and embedded offset by lower wireless chip sales as the baseband business is shut down.  In terms of margins, we foresee long-term EBIT margins settling into the high 20% range or possibly up to 30% as TI gains share relative to the rest of the semiconductor market.
 
Management is led by Chairman and CEO Rich Templeton.  He is only 51 years old but has been a 30 year veteran of TI.  Templeton has extensive operating experience.  He was president of semiconductor business as well as chief operating officer before taking over the CEO position.  Templeton has been a nimble manager, playing an important role in the company's history of reinvention (moving from oil to defense to semiconductors).
 
Templeton has been CEO since 2004.  During that period, both operating margins and ROI have expanded to all-time highs.  EBIT should come in above 31% in 2010 and 2011.  EBIT was only 20% a couple of years ago.  Templeton has obtained these results while maintaining a cash cushion and avoiding debt in order to handle the inevitable downturns in this highly cyclical industry.  Meanwhile, he has continued buying back stock right along through the downturn, including 3% of shares in 2009.  He also raised the dividend, which is now at a 2% yield.  TI has raising the dividend each year for the past six years and has repurchased roughly 30% of shares in that timeframe.  Templeton understands the power of returning capital to owners.  This discipline has attracted desirable shareholders like Davis, Legg Mason, and Capital Research.
 
Given the cost advantages, product breadth, massive sales force, and attractive margins of this business, you would think TI ought to have a high valuation.  Yet this company falls in the category of tech-oriented business thrown away by the market right now.  In fact, TI sells for a mere 5.4x current year EBITDA, 6.3x EBIT, and 10.3x EPS.  To be sure, growth will be harder to come by and the company will continue to have to adapt to the cyclical chip industry.  But given the track record of management and the visible focus on more profitable business lines, the current valuation is far too low.

Catalyst

Continued share repurchases
Execution of transformation plan and market realization that TI has become the leading supplier of chips for "smart" applications
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