SWKS - My Mid-Quarter Review
Who is Skyworks? .
SWKS was founded in 1962 and is headquartered in Massachusetts. They design and manufacture their own complex analog semiconductors that power wireless connectivity in everything from smartphones to medical devices. They are sometimes lumped as an “Apple supplier” but they sell their chips to just about every smart phone manufacturer there is, and their products are in almost every model produced by every manufacturer. They are also expanding into the Internet of Things and are in automobiles, smart homes, etc.
What is your history with them? .
I’ve been a stockholder for roughly 19 months now. They are my second largest position, and have been one of my top three for a long time. My SWKS position size is probably larger than it’s prudent to have for a position in any one stock. Yes, I’m aware of that.
Don’t chip manufacturers become commoditized? .
Yes, that usually happens because competitors make cheaper competing products, causing the company’s margins to fall and fall. Skyworks has taken a different route, however and have become a “Master of Complexity”. They plan with the manufacturer from six months to two years ahead of time what the manufacturer wants and needs in a future model, and then Skyworks combines multiple functions in the same chip. They make themselves indispensible to the manufacturer. Their gross margins have been rising consistently, not falling. They had set a medium range goal of 50% gross margins but have already surpassed that so they have raised their goals to 55%. Their operating margins were 39.6% last quarter. Does that sound as if they are being commoditized? .
Here’s what the CEO said when asked how margins will stay strong in a weak smart phone environment:
"It’s relatively simple. It isn’t a year-over-year, part-to-part comparison. We are increasingly integrating more functionality as these devices get more complex, and we’re seeing fewer competitors able to do it. Customers can’t handle discrete components any longer, nor the level of integration required to have a product:
that consumes low current,
that is small,
that is highly integrated,
that requires many, many different functional blocks with process technology know-how pulled together in a low-cost manufacturing platform with great system architectures.
So, we are able to work with our customers to give them a differentiated system performance which is increasingly becoming analog and RF-dependent. Less digital and more analog and RF-dependent. And, that’s our sweet spot. And so, its not as if we’re charging our customers more per function, it’s that they’re giving us more of the system. And, they’re paying us for it because we add a great deal of value for them."
It amazes me how many people still don’t get it!
How does this benefit their customers?
In the past, as I understand it, the customer (phone manufacturer XYZ) had to buy, let’s say five commodity chips, for five functions, from different manufacturers, and then XYZ’s engineers had to figure out how to make them work together in the best way to do what XYZ needed. Now, XYZ works in advance with SWKS (who already knows a lot about what XYZ wants from working with XYZ on earlier models), plans ahead for the next model, and then the complex chip arrives. It combines all five functions in advance so they work together, it’s smaller (important), uses less power (very important), and it’s cheaper than buying five separate chips (I think). All in all, this is a very important relationship for XYZ.
Can’t they just be designed out of the next model in a few weeks if someone else comes along with a cheaper chip?
You’ve got to be kidding! Did you read the paragraph above?
But how can they keep 50% gross margins and rising? Why don’t the phone manufacturers pressure them to cut margins?
Because the phone manufacturer is getting a tremendous bargain and benefit. They don’t have to have engineers trying to jerry-rig the integration of five different functions at the last minute. They get them all on one chip, and it’s smaller, less energy consuming and cheaper. If someone came along and said “We’ll sell you a chip that can do function three for 15 cents cheaper,” they’d laugh at them. Company XYZ simply doesn’t care how much money SWKS is making because SWKS is saving XYZ a lot of time, energy, money and headaches. (That’s how I see it anyway).
One problem is that smart phone sales are slowing down, especially iPhones. However they are in all the smart phone manufacturers, and lots of people in China and elsewhere are still upgrading from 2G and 3G to 4G. Skyworks acknowledged that growth would slow next quarter, but said that they’d be off to the races in the second half of the year.
If they are already in all the phone manufacturers, where do they go from here?
First of all, they get more content in each new phone model. For example if their chip is already performing five functions, they may say to XYZ, we can tie in function six in our next chip and you won’t have to buy that commodity chip six separately and integrate it yourself. How can the manufacturer of chip six compete against that offer? Say they’ll cut 10 cents off the price of the chip? Who cares?
Second, their most rapidly growing area is the Internet of Things, which is just starting out.
How has SWKS stock been doing?
Let’s see. I initially bought 16 months ago at $52. Eight months ago they were at $112. Since then they’ve fallen as low as $55 and they are now at $57 something with an adjusted PE of 10.3 !!!
Wow, they are almost 50% off the high. And with a PE of down to 10 they must be doing terribly!
Yes, they are only growing their trailing 12-month earnings by 46%. It’s terrible! Let’s see, why did the price drop so much in the last five months? Well for the June, Sept, and Dec quarters, their revenue was only up 38%, 23%, and 15% year-over-year, and 6.2%, 8.8%, and 5.2% sequentially. And for the same three quarters, their adjusted earnings were only up 61%, 36% and 27% year-over-year, and 16.5%, 13.4% and 5.2% sequentially (!!!) And this is when the other chip makers have been crying nbitter tears about cut-backs and falling revenues and earnings.
Their (GAAP) gross margin percentages for the past nine quarters have been:
Does that look to you as if they are being commoditized?
They had had a goal of making $7.00 a share by 2017, and they just raised it to $8.00. During 2015 they’ve doubled their quarterly dividend from 13 cents to 26 cents.
No wonder they fell to a PE of 10.3.
How else do they reward shareholders?
They have a policy of paying out at least 40% of free cash flow to stockholders in the form of dividends and stock buybacks.
I’d heard were trying to acquire another company?
Yes they were trying to acquire PMC-Sierra, but another company kept trying to outbid them and PMC-Sierra accepted the other company, in an attempt to make Skyworks keep raising their bid. Instead, SWKS walked away with the $85 million earnest money (which is added to GAAP results but not adjusted, as it is definitely a one-time deal).
To summarize, here’s an excerpt from a great post by othalan on our board which explains SWKS advantage:
"Computers are digital, however many inputs and outputs are analog. Any wireless communication is an analog signal (WiFi, cell phone, AM/FM radio, etc.). Even digital wireless signals (e.g. 4G) use an analog signal for transmission (e.g. 1900 MHz).
Processing analog signals (such as the 4G signal coming into an iPhone) requires a minimum amount of analog circuitry to convert the signal into digital data. A lot of signal processing can only be done on the analog signal before it is converted to digital. Even with operations that could be handled after the digital conversion, analog signal processing frequently offers many benefits. The drawback to analog signal processing is that it requires more expertise. This expertise has always been somewhat rare but is far more rare in today’s digital world
This is where Skyworks comes in with their analog expertise. Because analog signal processing is a lot more difficult (compared to digital) not many companies bother with building up the needed expertise, especially if they are primarily interested in digital data. Skyworks not only provides this expertise but also integrates a large amount of analog circuitry in prepackaged IC (integrated circuit) chips. The result is that their customers (like Apple) do not need any analog expertise, do not need to figure out how to integrate multiple analog chips, and can trust that the incoming digital signal is high quality ready for use. [I’d suggest you go back and re-read this paragraph]
SWKS has every earmark of what Buffett would call a durable competitive advantage (at least, to the best of my limited understanding - othalan). I see this expertise in analog circuitry, combined with their market positioning, as the source of this durable competitive advantage."
My kind of company!
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