TI Bets It All on Internet of Things

Dana is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Texas Instruments (NASDAQ: TXN) is a bit like me.

When I was in school I always retreated when subjects got hard. When math got hard I dropped math. The same with sciences.

The same with TI. Some 30 years ago, when competition heated up in processors with Intel, TI moved toward digital signal processors, or DSPs. Now that mobile DSPs are becoming a hard place to live, the company is moving away from them.

The question is whether this strategy will result in new momentum or whether the current stall will continue.

TI by the numbers

Texas Instruments rose despite a poor earnings report.

Revenue was actually down 9%, year-over-year, to $3.07 billion from $3.335 billion. Income rose nearly 50%, however, from $598 million to $906 million, because the company transferred some of its wireless connectivity technology to a customer,  presumably Amazon.Com, with whom it was working on the Kindle.

TI announced last fall it would close its Open Multimedia Applications Platform, or OMAP unit making low-power chips for tablets and smartphones, laying off 1,700 and saving $450 million.

The most important number for investors, the company's book-to-bill ratio, remained unchanged at 1.03, meaning it has just a few more orders than it has current manufacturing capability. That indicates slow growth ahead.

TI by strategy

TI is placing its bets on analog and embedded chips. Analog chips manage such things as frequency and power, the kind of work once done by tubes, and are key to things like amplifiers and managing industrial processes.

Embedded chips are chips that go into other products, not just computers. Here it's the auto companies that are the biggest customers. But embedded chips are also going into appliances and other devices as part of what's called the “Internet of Things,” in which single-chip sensors transmit real-time data to processors for analysis and deliver people such messages as “take the car in for service” or “get yourself to the emergency room.”

More than 10 billion such chips were shipped back in 2008, and many embedded markets are expecting faster growth than in the market as a whole.

TI's competition

The problem for TI is that it has a lot of competition for that business.

ARM Holdings (NASDAQ: ARMH), which is not a chip maker, is nevertheless a key competitor thanks to its low-power designs, which can be tweaked and turned into custom chips with intellectual property rights held by a product manufacturer.

ARM repeatedly has profit margins well north of 25%, and its balance sheet shows no debt. Its past success in selling its designs against Intel in the mobile market have given it a sky-high Price/Earnings (P/E) multiple, currently over 70. The company has been throwing off over $100 million per year in cash flow for years, allowing it to offer a small dividend and a market cap of $19.5 billion.

Qualcomm (NASDAQ: QCOM) is the company most often credited with driving TI out of the wireless business. They are known as a “fab-less” company, in that they create finished designs but don't own an expensive fabrication plant, relying instead on companies like Intel and Taiwan Semiconductor to actually produce chips for its customers.

Qualcomm, like ARM, also sports margins north of 25%, and it has nearly doubled its sales volume over the last two years, thanks to the growth of the mobile market. It has no debt, and delivers over $4 billion in cash flow each year to sustain a $108 billion market cap. Despite all this, its P/E ratio looks almost reasonable at 17.8 and its 35 cent/share dividend delivers a yield of 2.24%.

Intel (NASDAQ: INTC) is usually seen as the closest comparable to TI. Its margins are strong, about 20%, but well short of those held by ARM and Qualcomm, in part due to the cost of owning its own fabrication plants. The company has about $13 billion in debt, which would nearly wipe out its cash balances if it all came due, but for a manufacturing company that's a very small debt load. What makes it attractive is the $15 billion in cash flow it delivers to shareholders annually. Its 22 cent dividend also delivers a 3.96% yield, but investors should know this is primarily a yield stock – it's up only 5% in the last five years.

Now compare all this to TI's numbers. Its annual profit margins have been heading down for a few years now, toward the low double-digits, although the new quarter's results mask that, with the one-time gain giving it a margin north of 25%. The company has $1 in debt for each $4 in equity, which is more in line with what you'd expect for a manufacturing oriented company, and it delivers $3.5 billion in cash flow annually to sustain its $43 billion market cap. Its 28 cent dividend produces a 2.86% yield at current prices, but the stock has managed a gain of 46% over the last year, which is the best of those companies I've examined.

One Fool's take

All the stocks examined here have dividend yields, which should lead to investments by patient investors only.

What you think of TI really depends on what you think of their strategy, whether you believe in the market for analog and embedded chips, as opposed to mobile chips. That's where the company has placed its bets.

Personally, I think that's a good bet, but so do many other investors. Otherwise the stock would not have had such huge gains while it was killing its mobile business. Right now, with a P/E near 22, TI is more than fully priced, and I think the nearly 5% gain after earnings is speculative. I might be interested in it on a pullback to $35, but in the current market I may have to wait for that.

As to the rest, Qualcomm remains the best positioned for organic growth, ARM Holdings has had a great recent run (which I took advantage of) and Intel continues to do nothing – I sold my own holdings in it last year, and I'm glad I did.


Dana Blankenhorn has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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