TOP CONTRIBUTORS

Mark Chou

Michael Luddy

TXN AT A GLANCE

P/E ► 31.9 AVG EV/EBITDA ► 15.9 AVG ROA ► 7.6% HIGH ROE ► 9.4% AVG Debt to Equity ► 0.261 AVG Current Ratio ► 3.69 AVG Interest Coverage Ratio ► 3K VERY HIGH

 

 

 

 

 

 

Texas Instruments (NYSE: TXN) is an American company known best for its semiconductors and graphing calculators. TI is the leader in DSP (digital signal processing) and DLP technologies (digital light processing. DSPs play an integral role in many modern cell phones, wireless routers and computers. These powerful processors receive, refine and display digital signals (e.g. voice and data that has been converted to digital). DLPs, on the other hand, are capable of projecting very high quality images. Furthermore, Texas Instruments is the strongest player in the analog market with a market share of 13%. In spite of this strong presence, however, it is still subject to substantial volatility stemming from changing demands for new technologies, uncertainties in pricing, and low margins of commodity chips.

From 2004 to 2007, net revenues increased from $11.55 billion to $13.83 billion, and operating margin percentages have risen from less than 9% to approximately 25%. In addition, the revenue from TI's semiconductor division, its largest and most important division, increased 16% in 2006, compared to only 9% for the industry as a whole.

History

Texas Instruments was founded in 1941 through the purchase of Geophysical Service Incorporated, a seismic exploration company, which the founders turned into a company that built electronics for the US Army and Navy. 10 years after its founding, the company changed its name to Texas Instruments. Over the years, TI, as it is popularly referred to, has made numerous advancements in the field of electronics, including the first transistor radio in 1954, the integrated circuit (patent filed in 1958), the hand-held calculator in 1967, the single-chip microcomputer in 1971, as well as the nearly simultaneous invention of the microprocessor, along with Intel, the patent for which was granted to TI in 1973. Today, Texas Instruments continues to be a leader in the semiconductor and education technology sectors.

Business Divisions

Semiconductors

TI's semiconductor division (SC) is by far the largest in terms of 2007 revenues, at 96%, and is divided into two primary subdivisions: 1) analog semiconductors and 2) DSPs or digital signal processors.

Analog semiconductors process inputs such as sound, temperature and pressure and subsequently convert and amplify those inputs into digital signals. The analog segment has been performing and growing strongly over the past few years, from under $1.5 billion in revenues in 2004 to well over $2.0 billion in 2006. Analog revenue increased by 18% in 2006. TI sees the most long term opportunity coming from analog because it is used in almost every electronic device. Q1 2008 analog revenues increased 20% y.o.y.

DSP technology, on the other hand, uses algorithmic and compression techniques on existing data streams in order to modify and/or enhance them. A processor such as this, for example, could help eliminate echoing or static for voice application. Revenues increased by 16% in this division for 2006, and TI is still the clear leader in DSP, which was a technology that it pioneered. Another pioneering technology for Texas Instruments is DLP, or digital light processing, which is used in video projectors. Semiconductors have a wide variety of uses in many different industries, including audio, automotive, broadband, industrial, medical, military, and wireless, and a graph of the industry breakdown for semiconductor sales can be seen to the right. Also, after TI's divestiture of its Sensors & Controls segment in January of 2006, its RFID (radio-frequency identification) operations have been consolidated into SC.

Texas Instruments has currently embraced a "fab-lite" manufacturing strategy for its semiconductor division that has proved to be quite successful so far. According to the Fabless Semiconductor Association, a "fab-lite" company is one that outsources 40% - 50% of its production. Doing so enables a company to significantly lower its "capex," or capital expenditures by letting foundries with the existing machinery to do the actual manufacturing of the chips. TI outsources about 50% of its CMOS production to these foundries, whose sole job is manufacturing. These foundries include TSMC (Taiwan Semiconductor), UMC (United Microelectronics), and SMIC (Semiconductor Manufacturing International), all of which TI uses to outsource its semiconductor fabrication. By doing this, TI hedges itself against the down cycles of the semiconductor industry, although it does sacrifice some of the "potential margin upside" during up cycles. During the down cycles of 2004 and 2006, this strategy has helped TI to successfully mitigate some of this inherent volatility. Further information regarding fab-lite manufacturing can be found at http://www.future-fab.com/documents.asp?grID=208&d_ID=1635.

Educational Technology

The educational technology division (ET) accounted for only 4% of TI's 2007 revenues but many consumers' familiarity with Texas Instruments name comes through the ubiquity of ET's hand-held graphing calculators. These calculators are seen in high schools and colleges across the United States, the most popular of which are the different variants of the TI-8x series of calculators. This segment's continuing success can be seen through its 4% revenue growth in 2006 compared to 2005, record-breaking gross and operating profit, as well as the milestone of selling its 40 millionth hand-held graphing calculator in 2006.

Trends and Forces

Semiconductor Cyclicality

The semiconductor industry is deeply cyclical. Demand in up cycles is so high that chip manufacturers have trouble keeping up. Similarly, if electronic sales, particularly PC sales, are slow, demand for chips can plummet. The fact that the semiconductor industry is more subject to the whim of consumer demand more than corporate demand, also adds to the overall volatility. The backdrop of this high market volatility, however, has been continual growth. Over the last 20 years the semiconductor industry has seen about a 13% average annual growth rate.

Semiconductor sales have shown about an 80% correlation with GDP growth trends, meaning a downturn in GDP growth could very likely be accompanied by a downturn in semiconductor sales.

Buyer (End Market) Demand

As the business mix chart above demonstrates, a significant portion of Texas Instruments' revenues come from the wireless sector, which is great news for the company, since cellular phones now make up the second-largest end market for chipmakers. However, TI must be careful to anticipate changes in demand from its primary end market. For example, in 2006 there was some weakness in the market for high-end handset chips (75% of TI wireless revenues), in spite of growth in low-end handsets (only 25% of TI wireless revenues). It is also noteworthy to point out that in 4Q07, key customers Nokia (NOK) and LM Ericsson AB announced that they will no longer be exclusive customers to TI in wireless, but will also buy from competing suppliers. This could threaten TI's market share in wireless.

Some new technologies that will likely increase demand for chips include 3G wireless, portable medical devices, and digital video.

• 3G refers to the third generation of wireless technology, on which many phones of the future will be based. The technology enables the support of a greater number of customers and also faster data transmission. As these new networks proliferate, and demand for 3G-compatible phones increases as a result, TI will likely find itself as a major player in the market, although Qualcomm (which pioneered the predecessor technology for 3G) will be a significant rival.

• Increasing use of portable medical devices in the future, although a less consequential trend than 3G, will help TI's performance in analog. Portable, mobile electronic devices rely heavily on analog technology, because analog chips can help deliver not only longer battery life, but also a higher level of efficiency. With the market for medical devices steadily growing, which augments the demand for analog technology, Texas Instruments could very likely continue increasing its analog revenue, as it has done every year since 2004.

• In today's world of increasingly higher level of home entertainment, DLP has been a significant player in the market for video projectors and television screens. DLP, for example, is currently one of the leading technologies for rear-projection TVs, which compete with LCDs and plasma screens in the market for high-definition television sets, or HDTVs. As the HDTV market thrives in response to increasing demand for better and better display technologies, TI will likely benefit as a result of increasing demand for their DLP chips.

Pricing Pressure from End Markets

In addition to end market demand, end market or buyer power can also play a significant role in influencing Texas Instruments through pricing pressure. Because such a substantial portion of TI's revenue comes from the wireless market, handset chip buyers' demands for lower prices could prove detrimental to TI if the demands are coordinated. This is in contrast to the following trend, in which the semiconductor companies themselves are lowering prices.

Lower Margins of Commoditized Products

While this segment of Texas Instruments' business now makes up a much smaller percentage than it did in the past (about 25%), declining margins for commodity products could quickly erode revenues if competition increases. Commodity products, such as corn, wheat, or certain types of semiconductors, are characterized by their uniformity and large quantities of production. Because of the uniform nature of certain "generic" semiconductors, semiconductor companies are compelled to compete on the basis of price, rendering them vulnerable to decreasing margins.

Increasing demand for Low End Headsets

Developing countries like India and China have seen tremendous economic growth over the last five years. Although incomes in these countries is still well below the United States and other developing countries (lest than a 10th), their is significant for low cost headsets. In fact mobile adoption rates in some developing counties, is well into the double digits. TI which manufactures chips for low cost headsets is well positioned to benefit from this trend.

Competition

Texas Instruments has been the number three sales leader in semiconductors since 2004, and has been in the top five since 1997. Its competitors, however, have varying degrees of relevance to TI because of different market focuses. Analog Devices and STMicroelectronics N.V. (STM), for example, are much closer competitors for TI than are Intel or AMD, which make chips primarily for computers. Texas Instruments, on the other hand, offers a differing array of products.

TI, for example, holds a very strong position in wireless, with a 50% market share in digital baseband processors, as well as a 70% in application processors (down from 76% in 2005). TI will likely hold on to a great deal of this market share because it has built up switching costs for its buyers and has also been able to differentiate its technology from its competitors. Nevertheless, there is still strong competition from others serving wireless handset manufacturers, such as Qualcomm, Freescale, Infineon, Rensas, Broadcom, Marvell, and the aforementioned STMicro.

HPAs, or high-performance analogs, however, may be TI's strongest business currently. Texas Instruments ranks number one in the amplifiers/comparators and interface sub-sectors, and number two in power management and data converters for 2005, with other major competitors including Analog Devices, Linear Tech, Maxim, and National Semiconductor. Overall, TI ranks as the leading company in a fractured analog market, which includes HPA, mixed signal, and commodity semiconductors. As of 2007, TI had the leading market share in the $37 billion analog market at 13%.

In the DLP market, TI holds a 50% market share in projectors, followed by 30% for Epson and 20% for Sony. As for DLP chips for Digital TVs, Texas Instruments holds an 19-20% market share for TVs 40 inches and up and sells its chips to Magnavox, Mitsubishi, RCA, Samsung, and Toshiba.

As seen from the chart below TI is low to mid-range among its competitors in terms of inventory days. Inventory days measure the amount of unsold product (e.g. DSPs DLPs, etc.). Given the rapidity with which technology advances, high levels of unsold inventory can be construed as a negative factor for manufacturers of semiconductors and other technology products. Processors which may be cutting edge now may be outdated 6 months later, when the next model comes out. As new models enter the market demand for the older products driving prices down.

References