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2009 may be decisive for small-cap semiconductor companies

15 апреля 2009

This year may be make or break for small-cap semiconductor companies, many of which are in a vulnerable position as they compete in an environment where cash is in short supply, analysts say.

The sector is split between intellectual property, or IP, licensing houses, which design chips then license the designs to users, fabless chipmakers, which design chips, outsource the manufacturing, then sell the finished product, and semiconductor component manufactures which both design and manufacture bespoke components for chips which are then sold to chipmakers and incorporated in a finished product.

Analysts tend to favor fabless companies and wafer component manufacturers because their research and development costs are often lower than IP companies and they sell a physical product to an end market. This business model provides a better chance of sustainable profit generation, the analysts say.

"Fabless companies and wafer manufactures have large margins on their products which means they're not in the red for the same time as their IP counterparts, provided they can move their products," Paul Cornelius, a hardware analyst at institutional broker and corporate adviser Finncap said.

For IP houses, size matters."Large and established IP companies like ARM Holdings PLC are the exception; they have the advantage of consistent income because they've reached that critical mass where licensing royalties offset operating costs," Cornelius said.

"The smaller companies with this IP model are still cash burners that won't see profits until they sign a significant licensing deal," he said.

IP companies face cash-crunch danger

Companies operating IP models typically have to go through three phases of development: initial research and development, or R&D, licensing, and then finally receiving royalty payments. The time lag between these phases can be as long as 18 months, meaning such companies won't see profits for up to three years, trapping them in a debt cycle servicing R&D costs when they are not generating cash.

"Companies operating IP licensing models are finding it really hard to reach a critical mass where they can deliver a consistent return to shareholders," Cornelius said.

IP licensing companies offer investors enticing prospects of royalty harvests and even buyout possibilities but often disappoint, he said.

"People are drawn to these companies in bull markets because their products look innovating, and could be the next big thing," Cornelius said, citing advances in smart-phone technology, MP3 music players and satellite navigation systems.

It takes on average $50 million to develop a single chip from the R&D stage to eventual licensing. With this in mind, IP companies need to be sure that they have a product which they can move in high volumes if they're going to reach sustainable profitability.

"In a bear market investors want proof that a company can deliver profits at every step of the way," says Nick James, an analyst at Panmure Gordon."These small IP companies look unfavorable as there is no absolute guarantee of profits. They're high-risk cases," he said.

However, "they do offer the prospect of massive returns to shareholders," he said.

ARC International PLC, an IP company specializing in developing and manufacturing configurable processors, application subsystems and software for embedded system-on-chip design, typifies the sector.

Analysts say the company has remained loss-making throughout the nine years since its listing in 2000 which raises questions as to whether the company will be a mature profit producer.

"ARC is heavily geared towards the IP licensing model, right now R&D companies aren't cutting any expenditure on R&D programs," says Edison Investment Research analyst Andy Bryant."Continuing to burn cash when you've got an uncertain end market can be a dangerous move. However, the counter to that is a company like ARC will eventually get a significant royalties harvest."

The bright spot for ARC right now is its Sonic Focus technology, which enhances the sound quality of digitally compressed audio files. But "Sonic Focus is software-based and has nothing to do with semiconductor IP. The [software] IP has a shorter lag time than its hardware licenses," said Dan Ridsdale, an analyst at Singer Capital Markets.

When asked about its business model, ARC declined to comment.

More reliable returns from fabless chipmakers

While IP licensing houses might be facing liquidity problems, another small-cap area, fabless semiconductor manufacturers, offers more continuity in returns and visibility.

"Fabless semiconductor manufacturers are generally very cash-generative, have high margins and can supply unique technology to a niche market," Cornelius said.

These companies outsource the actual manufacture of their chips, but they still deliver a physical product to the end customer, whereas licensing companies purely sell IP to a semiconductor company which then manufactures a chip and sells it on.

For example, Dialog Semiconductor PLC, a German, Frankfurt-listed chip developer and supplier has delivered consistent profitability for the past year.

"We're in a good position at the moment; our business model is based around making custom chips for clients, so in that respect our end market isn't a general market, it's a niche," says Chief Executive Jalal Bagherli.

"The company benefits from targeting all the main mobile phone services," said Edison's Bryant. "Tapping into these markets gives the company resilience and a large market spread."

Bagherli said this approach gives the company a good level of revenue stability, albeit a short-term market outlook for new contracts and deals.

By building to order the company has created a highly cash-generative model with no debt and cash in hand.

But the problem for fabless chipmakers is that they are highly cyclical, analysts say, and feel the side effects of any downturn sharply, if their end markets are affected.

Dialog Semiconductor has recently seen declining orders from the automotive industry."We make chips for car windscreen wipers; it's no surprise that weakness in the automotive industry has hit our order books for these chips," Bagherli said.

Elsewhere, Edinburgh based fabless chipmaker Wolfson Microelectronics PLC lost a supply deal with Apple last year for iPod Touch and iPod Nano chips which accounted for around 15% of revenue, analysts said. Similarly CSR PLC lost a deal with Nokia last year and its revenue took a 18% hit.

Component makers best investment opportunities

The most solid investment opportunities, however, lie with component manufactures, analysts say. These companies have the advantage of manufacturing a wafer to order for a specific client, which gives them greater likelihood of contract renewals and stronger pipelines.

Cardiff-based IQE PLC, is a manufacturer and supplier of gallium arsonide-based wafer chips which are increasingly featuring in smartphones. The more advanced the handset then the more gallium arsonide used.

"Through this recession, although overall handset [sales] are forecast to reduce by about 10%-15%, smartphone sales are forecast to increase during 2009, so we're in a very important secular growth area," says Chief Executive Drew Nelson.

Nelson said that today's smartphones account for about 11-12% of the total handset market and that's forecast to increase to 30% within the next three years.

This is a highly cash-generative business."Once our fixed costs are covered, we start to generate cash and profitability very quickly. For every additional pound of revenue, 40-50% goes to our bottom line," Nelson said.

"The company is in a solid position, provided it can get the sales volumes out the door," says Noble Insight analyst, Arun George.

But while IQE currently remains profitable and cash-generative, the group has limited visibility and is still at the mercy of its end market.

"Should people end up spending less on smartphones the group will be hit. In a recession, it becomes difficult to predict the future of a business like this one," George said.

Analysts generally agree the current economic backdrop is not favorable for the sector generally. "The companies that survive the downturn will be the ones that do exceptionally well," says Finncap's Cornelius.

"Tech has always been a sector that's been tentatively funded, and there'll be few surprises if lots of these sorts of companies come cap in hand, asking for more capital," he said. "Those companies that survive this current downturn will no doubt emerge stronger and more robust."

Источник: Total Telecom

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