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WIKI ANALYSIS
National Semiconductor Corporation (NSM) is an OEM of analog and mixed signal integrated circuits. Although the company continues to manufacture a number of other products as well, corporate restructurings over the last few years has increased its focus in the high-performance analog space. The Gartner Group has released its final estimates for 2006, according to which, semiconductor sales grew 10.2% to $262.7 billion. The latest SIA forecast pegs it at $248.8 billion (up 9.4% over 2005, with the analog component growing 16.8% to $37.3 billion in 2006). The market is expected to grow 10% to 273.8 billion in 2007.
Semiconductor devices are generally divided into three categories analog, digital and radio frequency (RF). Analog semiconductors condition and regulate real world information such as light, temperature, speed, pressure, power and electrical currents. Digital logic semiconductors process information in only two states. Mixed-signal semiconductors combine both analog and digital technology into a single device. Typically, an analog sensor samples real world information, and then converts the input into an electronic analog signal, which is converted into a digital format for further digital processing. The analog and mixed-signal markets tend to be more varied and specialized, with customized products that have longer life cycles than the digital industry segment. There is an ongoing drive to decrease the number of discrete devices, lessen power requirements and shrink the size of the existing devices, which correspondingly increase performance and reliability. Consequently, a greater amount of functionality is being consolidated into increasingly smaller devices.
National has design centers all over the world three in the U.S., three in Europe and two in Asia. The company currently has 2,700 patents to its credit. A significant portion of the manufacturing, including wafer fabrication, wafer sorting, product assembly, final testing and coating is done in-house. Its five manufacturing facilities are located in Arlington (Texas), Greencock (Scotland), Melaka (Malaysia), South Portland (Maine) and Suzhou (China).
The World Semiconductor Trade Statistics define standard linear products as amplifiers, data converters, regulators and references for power management, and interface products. The company has been shifting most of the product mix to these categories, and has also started deriving a small percentage of revenue from application specific products. In fiscal 2007, the total analog segment generated 88.4% of the company's sales. Power management products comprised the largest percentage of the total analog business at 46.0%, amplifiers comprised 25%, interface products 7%, data converters 5% and application specific products 5%. The remaining 12% was derived from other products, including microcontrollers, connectivity processors and embedded Bluetooth TM solutions. Most of the products are targeted at the handset market, although the company also serves the communications infrastructure, consumer, computing, industrial automotive and other markets.
Operations are categorized into two power management and analog signal path. The power management group is made of products such as switching and voltage regulators, controllers, low drop-out voltage regulators, white LED drivers, voltage references and battery management ICs. The company is expanding the power management group to include LCD display, device connectivity, telecom and application specific products. The analog signal path group consists of high-speed precision operational amplifiers, high-fidelity low-power audio amplifiers, high-performance analog-to-digital and digital-to-analog converters, precision timing products, high-speed serial digital interface products and thermal management products.
Products are sold directly to OEMs and ODMs such as Motorola, Nokia, Sony Ericsson Mobile Communications, L.M. Ericsson, LG Electronics, Toshiba, Samsung, Sharp, Seagate, Apple, Matsushita Electric, Robert Bosch, Siemens, Tektronix and Cannon. In 2007, around 55% of total sales were generated from direct sales, the balance coming from distributors. The top ten customers generated 62% of total revenue in fiscal 2007, with distributors Avnet and Arrow accounting for 14% and 13%, respectively. The top competitors are Analog Devices, Linear Technology, Maxim Integrated Products and Texas Instruments. The revenue contribution by geography in fiscal 2007 was the U.S. 22.2%, China 27.9%, Singapore 17.7%, Japan 11.3%, Germany 11.1% and the U.K. 9.9%.
Strategic restructurings have increased focus on high-performance analog and reduced the cost structure
It is the intention of management to continue only those non-analog products that are able to generate good margins for the company. Management intends to discontinue all non-analog business that does not generate high ASPs and margins. Over the last two years, National has been engaged in strategic restructurings that have restructured operations and lowered the cost of operation. As part of its restructuring activities, the cellular baseband IC business was shut down at the end of the May 2003 quarter, and the Geode business was sold to AMD at the end of the August 2003 quarter. Both units were suffering from increased competition and low profitability. Recently the company sold its Advanced PC unit to Winbond and entered into an agreement to sell its cordless telephony chipset business. It also plans to sell its assembly and test plant in Singapore.
Gross margin expansion has been consistent over the last three years
Many of the lower-margin businesses have been disposed off and the company is now focused on higher-ASP analog business. Management stated that the fab utilization rate was 65% in the last quarter, slightly higher than the fiscal first quarter. The Texas fab upgrade to 8-inch wafers is under progress. This should have a positive impact on future gross margins. The company is also introducing many new products that have higher ASPs and margins than existing ones. This is an ongoing boost to gross margins.
The handset opportunity is large and growing
National has a roster of top-shelf customers, including Nokia, Motorola, Samsung and other emerging Asian ODMs/OEMs. In the last quarter, the company increased share at all of the top five handset manufacturers. Nokia already employs National's power management, audio amplifier lighting and display management products and the company's flash lighting chips have enabled it to secure design wins at all of the top five handset manufacturers. According to a recent Nokia press conference, 80 million multimedia handsets were sold last year, and the number is expected to grow to 120 million units this year. Gartner projects that the Christmas selling season will see a 10-15% YOY growth, with total handset units jumping to 1.1 billion units by 2007-end. The company has been increasing its components in 2.5G and 3G handsets. As a result, the dollar content has been rising gradually from $1 per unit to $2-3 per unit in some high-end phones.
The handset business in Asia, particularly China, is expected to grow strongly
China has 400 million new consumers of cell phones and other handheld devices these are being replaced more frequently than in prior cycles. The company had some recent successes in this market with handsets supporting the new 450mg CDMA and TD-SCDMA standards. It has also been designed into handsets marketed by the largest local brand. Significant opportunities are also expected in other developing markets such as India, Russia and Africa. Management expects the Chinese handset demand to be sustained through the fiscal third quarter, as demand remains strong.
The accelerated share repurchase program is bringing down the share count and boosting the EPS
National announced that the Board of Directors had authorized a new program to repurchase $2 billion of its common stock. This along with $380 million in pre-existing repurchase approvals brings the total repurchase program to $2.4 billion. The company will execute $1.5 billion of this buyback through a leveraged accelerated share repurchase program, funded through a senior unsecured bridge facility of $1 billion. The company repurchased a chunk of shares under this program in the first quarter, which brought the weighted average share count to 284 million (down from 327 million in Q4).
The balance sheet is highly leveraged
National has a net debt of $608.8 million and a debt-to-total capital ratio of 83.9%. The debt was incurred with the objective of enabling the accelerated share repurchase. Interest payments were 16.2% of profits or -$0.09 per diluted share in the last quarter. The company should not have problems servicing the debt.
In summary
National's strong IP has enabled the company to build a position for itself in the wireless handset space and generate very strong gross margins. Other end markets are also expected to do well, according to management. Revenue growth was strong in the last quarter, as both internal and disti inventories were reduced. However, management continues to avoid giving specific information about backlog and turns orders. Unlike peer companies, management also does not regularly update the company's actual performance in the various end markets, which makes future results hard to project. Gross margin expansion over the last few years has come mainly from the elimination of lower-margin business, and the other factors that we normally look for, such as utilization rates, are not showing much improvement. Even after the decommissioning and sale of a couple of its manufacturing facilities, manufacturing is shifting to 8-inch wafers. However, the industry is in the process of moving to 12-inch wafers. This makes the company's manufacturing capabilities relatively less efficient. The other side of the story is that National should enjoy better operating leverage as utilization picks up and manufacturing shifts to larger wafer sizes and smaller geometries.
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