A Small-Cap Chip Maker With Upside Potential

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The biggest story in tech, if not in business, over the last few years has been the smartphone war between Samsung and Apple, as these two giants have been duking it out for dominance of this huge market. Yet, companies that are lucky enough to count these two among their clients are uniquely positioned to profit whoever wins the war. Most articles on this subject focus on the larger chip suppliers such as Broadcom (NASDAQ: BRCM) and Qualcomm (NASDAQ: QCOM). However, there is one small and relatively unknown chip maker that could be able to deliver big profits in the near future. In this article I will examine RF Micro Devices (NASDAQ: RFMD).

Company overview

RF Micro Devices designs, produces and markets radio frequency components and semiconductor technologies, which are used for mobility and connectivity for mobile devices and wireless infrastructure. Notably, the company supplies technology for Apple as well as Samsung. With a market cap of $1.37 billion and under 4,000 employees, the company isn’t a huge player like Qualcomm, but this does mean it might have more growth potential. The stock has a surprisingly low beta of 1.41 and is just about flat over the last twelve months.

Earnings

A quick look at RF Micro’s earnings shows a rather choppy progression. Topping out at $0.62 per share in 2011, annual EPS plunged down to $0.19 in 2012 with two misses in the second half of the year. Things do seem to be rebounding a bit in 2013 though, with two-cent beats in Q2 and Q3. For the latest report, revenue was up 29% sequentially, beating expectations, and management expects more revenue growth above the consensus for the next quarter. Earnings are furthermore expected to double between 2013 and 2014.

Competition in the LTE race

The company’s early lead in the LTE space allowed it to acquire significant market share, gaining a slot in Samsung’s phones in August last year. However, with the LTE space getting increasingly crowded, it may be difficult for the company to maintain this early lead.

Broadcom, the world's fourth largest supplier of baseband chips, with a market cap of nearly $18 billion, recently announced its own LTE chip, which will reportedly be considerably cheaper, lighter and more power efficient than most comparable models. The company is becoming increasingly competitive in securing iPhone slots, and poses a serious threat to RF Micro.

After a few years of fairly decent earnings growth, going from $1.22 in 2009 to $2.92 in 2012, things are expected to slow down a bit in 2013. However, with the 4G LTE solution scheduled for production in early 2014, this could prove an important catalyst for the company that is looking to rival Qualcomm's lead. An important advantage that Broadcom has is its high degree of product integration, which allows it to bundle several components into a single solution, and offer lower prices across the board.

Skyworks (NASDAQ: SWKS), another supplier of RF chips and a direct competitor of RF Micro’s, has similarly been able to profit from the surge in global LTE market, and gets about a quarter each of its revenue from Samsung and Apple. The rally in RF Micro and Skyworks shares was briefly interrupted when Qualcomm announced it would begin production of its own RF chip, but resumed a day later when it became clear that $114 billion circuitry powerhouse would not endanger its existing chip partnerships with the move.

Qualcomm is currently the undisputed leader of the LTE arena, with a market revenue share of roughly 52% in 2012. In fact, the company is the world's fourth largest manufacturer of semiconductors in general. The company has consistently been hitting earnings out of the park, beating by 12% in Q1 2013, and is expecting a very profitable full year. Until competitors like Broadcom begin production in 2014, the company is expecting to maintain its prime position in LTE baseband chips. In summary, while RF Micro appears to be doing a pretty good job of maintaining its slots in the iPhone and Galaxy, it is clear that competition in the space is tough and heating up further. 

Valuations and Metrics

Currently, RF Micro is trading a negative earnings multiple, but the forward PE is around 15.11x. The price to sales and price to book are both quite reasonable at 1.58 and 2.12 respectively. Operating margin and return on equity are also both in the negative at the moment, but I expect that these will turn around in the next few years. The company´s balance sheet looks pretty good with a total debt to equity ratio of under 13 and around $190 million in cash.

The bottom line

While most analysts and investors focus on the larger names that supply chips to smartphone makers, the opportunities might currently lie with some of the smaller names. RF Micro Devices has been struggling in terms of earnings in the last few years, but looks like it´s turning things around. As such, the company might be a good way to play the smartphone war, whoever wins in the end. 


Daniel James is long Qualcomm. The Motley Fool owns shares of 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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