Is Intel A "Value Trap"?

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

In light of the innovation in technology markets, investors have reason to eye chip makers. But before jumping into the lowest multiple stocks, you should consider the markets that they produce chips for and the extent to which they are penetrating mobile devices (LTE). I recommend buying stakes in those that have a strong potential to boost free cash flow yield while penetrating this high-growth market. In addition, I urge you to invest in smaller semiconductor makers that could be, and possibly already are, takeover targets. Those that are far behind in the LTE market, like Intel, may be interested in using their large cash chests to scoop up undervalued targets for greater exposure. Below, I review three stocks with these considerations in mind.

Is Intel (NASDAQ: INTC) A Value Trap?

After falling 30% from the 52-week high, Intel has seen many of its bulls start to lose their faith and possibly regard the semiconductor maker as a "value trap." The fundamentals look compelling: an 8.8x PE multiple, a 0.8x PEG ratio, a clean balance sheet, and expanding margins. Share in the total chip market has reached a decadal higher at 15.9%. This hasn't stopped Sterne Agree and MKM Partners from lowering the price target to $24 and $18, respectively, earlier this month.

There are several reasons why the outlook is weak. First, the company has very been late in producing LTE capable chips and is now well behind peers Broadcom, Qualcomm (NASDAQ: QCOM), and Texas Instruments. Intel's stake, for example, is only 1/240th of Qualcomm's near 50% share. Snapdragon MSM8960, Qualcomm's family of chips, are in everything from the Droid RAZR M to the upcoming Nokia Lumia 920. Even though the company has raided $5 billion, margins are coming under pressure to 55% from as high as 65% as a result of greater competition from ARM-based chips. One analyst even puts the odds as "likely" that Apple will replace Intel for ARM-based chips, because using the former could save the tech company $100 per unit. Investors are also concerned about an internal hire replacing the current CEO, since new blood is needed to catalyze value after a long duration of being out-innovated.

And with Qualcomm trading at 13.5x forward earnings with no debt on the balance sheet, investors are more likely to go for this mobile chip leader. A recent November report by FBR Capital has the stock as "outperform" and a $77 price target. Deutsche Banke and Cantor Fitzgerald are not far behind with $74 and $69, respectively. In fact, 37 of 42 reporting analysts say a "buy" or better--11 of which say "strong buy". Only 1 analyst has a "sell" report. Qualcomm is, after all, a solid investment. It has a return on invested capital of 19.6%, which is 740 bps above the industry average and even more above the average cost of capital. Although free cash flow has trended downwards from a pair of nearly $6 billion by the beginning of this year to $4.7 billion today, it has strong secular catalysts from smartphone innovation.

Making Sense of MIPS Technologies (NASDAQ: MIPS) Takeover Bids

This producer of semiconductors for networking, mobile, and digital home applications is on the takeover radar of several large companies. On November 20, the company disclosed it received a hostile bid from CEVA to purchase the remainder of the business after its patent sales to a variety of buyers. The bid for $75 million in cash was above what Imagination Tech was offering ($60 million) for 82 patents and the CPU core licensing segment.

Both CEVA and Imagination Tech would generate tremendous revenue synergies from staging a buyout. Imagination Tech, because it will enable the company to better compete against ARM. CEVA, because the CPU business would complement the suitor's core DSP business and better spread out costs across fixed assets. ARM Holdings has joined the Bridge Crossing consortium of buyers who have purchased the other $350 million of MIPS, which includes 580 patents for microprocessor chips, among others. At an implied buyout valuation of $425 million, MIPS is at least 4.5% undervalued based on current suitor prices. However, there is likely to be increased speculation that will drive up the premium takeover price. In any event, a 4.5% guaranteed return over less than a few months is a strong and nearly risk-free return in today's otherwise uncertain environment.

A recent discussion between Benchmark's Gary Mobley and MIPs management made the analyst that a deal could be reached within the "next four months"… and that was in late August. This yields an adjusted return of 18%, so if investors would be hard pressed to find a safer takeover investment.

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