TI's Growth To Slow In Q4'13 But Long-Term Prospects Are Bright

Texas Instruments ( TXN ), a leading semiconductor manufacturer, will report its Q4 2013 and full year earnings on January 21. It has been as transitional year, as the company exited its legacy wireless business. Yet underlying growth has returned. In the third quarter, revenue was $3.24 billion, up 6% seqentially as wireless contracted to just 2% of the business. Excluding the wireless revenue, TI's top line climbed by 10% sequentially and 3% annually, and it marked its first quarter of year-over-year growth since Q3 2012. Due to seasonal variations, the company anticipates its Q4 2013 revenue to decline by around 8% (excluding wireless revenue), and the consensus revenue estimate is $3.00 billion.

However, despite the weak guidance, TI remains confident that its business model is well-positioned to generate $0.20 to $0.25 of free cash flow for every dollar of revenue that the company earns in the future.

While we estimate revenue to decline marginally in 2013, we believe that a robust product portfolio, one of the best sales and field application teams in the industry, and strong manufacturing capacity will help spur TI's top line in the future. Additionally, as the company completely exits the comparatively lower margin wireless business, and increases the proportion of profitable analog and embedded products in its portfolio, it can report improving gross margins going forward.

Our price estimate of $36.71 for Texas Instruments is at a 15% discount to the current market price. We will update our valuation after the 2013 earnings release.

See our complete analysis of Texas Instruments here

Wireless Revenue to Phase Out

TI exited the wireless business in September 2012 on account of the intense competition in the market and declining profits. With Nokia as a major customer, it had once led the industry. Yet the emergence of the smart phone fostered the radical ascent of Qualcomm and Samsung, as the Android and iPhone platforms achieved dominance. As a result, the company generated just 10% of its revenue and earned the lowest margins (16%) from the wireless segment in 2012. The steep decline in wireless revenue is the primary reason for TI's diminishing top line. TI's legacy wireless revenues fell by $91 million to $57 million in Q3 2013 and now account for a mere 2% of the company's overall revenues. TI expects its wireless revenue to have phased out by the end of 2013.

Rising Proportion Of Analog & Embedded Products To Aid Growth

After its planned exit from the smartphone and tablet market, TI has been focusing on transitioning its operations to become a pure analog and embedded processing company, segments that it believes will offer it long term growth and less volatility, compared to the past. It derived 80% of its revenue from these segments in Q3 2013 compared to approximately 72% a year ago.

The continuous growth in communications infrastructure, automotive and industrial segments, as well a revival in computing, game consoles and handset markets is driving demand for TI's analog and embedded products. In the first half of 2013, communication, industrial, automotive, computing and consumer segments accounted for 27%, 23%, 13%, 23% and 11% of TI's revenue, respectively.

TI accounts for over 15% of the analog market and it expects to gain additional market share in 2013. With the acquisition of National Semiconductor, a strengthening product portfolio and growth in high volume analog and logic segments, we believe that TI is well equipped to leverage increasing demand for analog products.

With new product launches, TI continues to expand its embedded portfolio every quarter. It believes that the embedded markets (currently sized at $19 billion) offer greater potential for sustainable growth compared to mobile devices. In the last one year TI expanded its product portfolio by almost 20%. Generating strong cash flow and investment returns, the two divisions will drive growth for the company.

TI's Gross Profitability Will Remain Elevated

TI's gross margins declined from 53.6% in 2010 to 49.7% in 2012 during a period of significant transition for the company. The severe earthquake in Japan in early 2011 considerably reduced the revenue of both the industry and TI. Lower revenue and increased capacity underutilization charges (a common and unwelcome pairing in the industry) impaired gross profitability, as did the game-changing acquisition of its large analog competitor, National Semiconductor.

Though the impact of Japan abated, acquisition effects continued into 2012, when revenue growth was further undermined by management's decision to exit the cellular application processor business. However, TI has emerged as a stronger, and notably more analog-centric company in the last few quarters. Higher revenues combined with an improving product mix and better factory utilization increased TI's gross margins to 51.5% and 54.8%, in Q2 2013 and Q3 2013 respectively.

As TI derives an increasing proportion of its revenue from more diverse, more profitable and less capital intensive analog and embedded processing products, its gross margins to increase marginally going forward, in our view. The cost savings incurred from exiting the wireless business will further ease pressure off gross margins. (Read: TI's Gross Profitability Has Improved and Will Remain Elevated )

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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