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From the Small and Mid-Cap Survey: Avago Technologies Limited
Avago Technologies Limited (AVGO) was organized in 2005 by affiliates of KKR & Co. (KKR) and Silver Lake Group to acquire the semiconductor products business of Agilent Technologies, Inc. (A). Agilent had been spun off by Hewlett Packard (HPQ - Free Hewlett-Packard Stock Report) in 2000. Avago went public in 2008, and its two sponsors have reduced their holdings to about 4% each. The company is headquartered in Singapore and has design centers and fabrication plants in the United States, Europe, and Asia.
Avago is a major global designer and supplier of analog semiconductor devices, with a focus on III-V based products. III-V refers to compounds created from elements in the third and fifth columns of the periodic table, such as gallium arsenide (GaAs); III-V semiconductor materials conduct electricity better than silicon, permitting faster speeds and better performance in uses such as radio frequency (RF) and optoelectric components. The company offers about 6,500 products to around 40,000 customers worldwide; last fiscal year, which ended October 30, 2011, China accounted for 30% of sales of $2.34 billion; the United States, 17%, and Germany and Korea, 10% each.
The company has four segments. Wireless communications (38% of fiscal 2011 sales) sells RF amplifiers, filters and front-end modules, light-emitting diodes (LED), and optical finger navigation devices for cellphones, tablets and base stations. Major customers include LG Electronics, Huawei Technologies, and Samsung Electronics. Wired infrastructure (28%) offers fiber optic transceivers and application-specific integrated circuits (ASIC) for data communications and storage networking; leading customers include Brocade Communications (BRCM), Cisco Systems (CSCO - Free Cisco Stock Report), Hewlett Packard and International Business Machines (IBM - Free IBM Stock Report). Industrial and automotive electronics (29%) makes fiber optics, LEDs, and motion controllers for automotive displays, factory automation, and renewable energy; principal clients are ABB Ltd. (ABB), Schneider Electric, and Siemens (SI). Finally, consumer and computing peripherals (5%) sells optical mouse sensors and motion control encoders for computer mice, printers, and disk drives; main customers are HP and Logitech International (LOGI).
Besides the internal design divisions of Avago’s original equipment manufacturer customers, major competitors include Anadigics (ANAD), RF Micro Devices (RFMD), Skyworks Solutions (SWKS), Finisar (FNSR), IBM, LSI Corp. (LSI), Analog Devices (ADI), and Toshiba.
Avago’s strong fiscal 2011 earnings gain ($2.25 a share versus $1.76 in 2010) derived from the launch of next-generation smartphones, strong demand in renewable energy and spending on enterprise networking data centers. The company reported a roughly normal first fiscal quarter seasonal downturn in the January 2012 period as wireless revenues fell just a few percent but the industrial and automotive segment suffered from destocking. For fiscal 2012, we look for share net growth of around 10%, as carriers move to fourth-generation standards and demand for smartphones grows fast; further stock repurchases ought to help.
Longer term, Avago ought to outperform its industry, thanks to good market shares in third and fourth generation cellphone components and products for renewable energy and the smart power grid. Avago specializes in lower-volume, higher-priced components where it can add content, such as ASICs. It outsources a majority of its production, especially the older, more standard products. But Avago is also increasing its manufacturing capacity, which should give it a bit more control over production of its newest and most profitable products, while also protecting the gross margin. Since Avago will still outsource production of over half its volume, its own plants will probably run at near capacity. Further acquisitions will likely help, although the company made just $23 million of acquisitions over the last three years.
AVGO shares are near their 12-month high, reflecting investor optimism, with a forward price/earnings multiple around 15.5 times. While they may experience understandable volatility over the next year, they will likely outpace the broad averages over the long term.
At the time of this article’s writing, the author had a position in IBM.