Key Concerns Impacting Our Texas Instruments $39 Price Estimate

by Trefis Team
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Texas Instruments
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Posting revenues of $3.39 billion in Q3 2012, Texas Instruments (NASDAQ:TXN) marked a 2% sequential increase but a 2% annual decline due to a sluggish macroeconomic environment. Witnessing poor demand on account of low inventory levels at OEMs and distribution channels, the company saw a 5% sequential decline in orders in the third quarter, and as a result, it expects to see a significant downside in revenue this quarter.

While we believe that TI will continue to post negative growth this year as well, we estimate it to bounce back thereon. Though the future of its wireless business is uncertain, we believe the company’s strength in analog and embedded processors will pave the way for a potential stock upside. Our revised price estimate of $38.53 for Texas Instruments is at a premium of over 30% to the current market price.

Here we highlight certain key trends in the company’s Q3 2012 earnings results.

See our complete analysis of Texas Instruments here

Wireless Business Restructuring

TI’s future strategy for its application processor and connectivity business is perhaps the most prominent question concerning investors. With a view that its baseband business offered less promising growth prospects, TI ceased all R&D efforts for cellular baseband in 2008. We were of the view that with innovative product offerings, wireless connectivity and application processors could become the new revenue drivers for the company’s wireless division.

However, earlier last month, TI declared its intention to reduce efforts to further leverage OMAP processors in smartphones and tablets. It will instead divert its focus on expanding the OMAP footprint in embedded applications such as automotive, industrial, enterprise communications, vision and robotics. We consider this to be a bold move as mobile growth is slated to fuel future growth in the semiconductor industry.

While TI has scored significant wins in this segment – Amazon’s (NASDAQ:AMZN) Kindle Fire HD, Barnes & Noble Nook Tablet, and a number of Motorola phones – it has been struggling to hold its ground in face of intense competition from Qualcomm (NASDAQ:QCOM) and Nvidia (NASDAQ:NVDA). While many tout TI’s exit from this business to be a bad long-term strategy, few believe that the same could augur well for its valuation.

An Israeli newspaper recently reported that Amazon might acquire TI’s mobile chip business though the two companies have yet to confirm the news. If the acquisition does take place, TI could make billions from the sale of its OMAP business. Since the company has not yet divulged the details of its long-term plan for OMAP processors, we think it is too soon to make a judgment call.

Concern Over The Excess Manufacturing Capacity

Texas Instruments has added around $7 billion worth of incremental revenue generating capacity in the last few years with the acquisition of National Semiconductor and some other companies’ fabrication and equipment and factories. Amid a slowdown in the semiconductor industry, the additional manufacturing capacity has led to lower factory loading which has increased TI’s underutilization charges.

However, at 51.3%, gross profits increased by 5% sequentially in Q3 2012. Comparatively higher revenue, which included the $60 million business interruption insurance proceeds from the Japan earthquake settlement, and lower operating expense benefited gross margins this quarter. While the insurance proceeds are a one-time gain, the company is confident that it can manage its operations efficiently and keep margins in control.

The excess manufacturing capacity might be detrimental to TI’s short-term growth, but we believe that as demand picks up, it can provide a competitive advantage to the company. At the start of the year, TI announced its decision to close down two old factories in Japan and Texas by the second half of 2013. The company claims that it has no plans to take any more capacity offline. However, it looks to further reduce its operating expense in light of the lower revenue target this quarter.

Outlook For 2013

Regulatory changes in the US, a government change in China and the debt crisis in Europe are factors that have contributed to greater uncertainty in demand in 2012. While the exact timing of a market revival is difficult to predict, TI thinks that it is capable of growing whether or not the economy rises and prices stabilize. The company believes that with better products and manufacturing capability it will be able to compete successfully against competitors.

Since its manufacturing footprint is taken care of, the company will be affected neither by a flat environment nor strong growth. It is confident of managing it operations efficiently and intends to keep its operating margins in check. Since around 70% of TI’s revenue comes from its core business of analog and embedded processors (the divisions that enjoy robust margins and generate healthy cash returns), the company is confident of retaining its position as one of the leading semiconductor companies in the industry.

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