Intel - No longer ideas, just wasted tweets

My friend Howard Lindzon's Twitter steam is genuinely his stream of consciousness.  He's usually funny and occasionally profane, and there are daily messages of wisdom.  One of todays tweets was:

Nice, a joke and some wisdom.

In an earlier post I made the case that Intel should buy ARM to maintain a dominant position in the microprocessor business. I have little doubt that we will unknowingly buy Intel processors buried in consumer electronics for decades to come and that they will maintain acceptable margins and moderate growth......but the story ends there.

Indeed....no longer ideas, just wasted Tweets.

Warning about warnings!

Given Japan's March 11th earthquake and tsunami's likely impact on the semiconductor and consumer electronics supply chain, I'm truly puzzled by how few revenue warnings have been released.  We just haven't heard much from the cell phone, PC and tablet companies........and their suppliers.

For component suppliers, this is NOT just a supply side issue.

Here is one of the Rumsfeldian "know unknowns" that haunts the consumer electronics supply chain.  Your semiconductor company may have escaped a disaster unharmed, but if there is supply disruption of ANY component (capacitors, resistors, inductors, specialty adhesives, packaging resins, flex connectors, LCD displays, etc.) for your customer's product (PC, cell phone, TV, etc.), production stops and your sales are slammed too!

In good times, semiconductor suppliers have horrible visibility into their sales channel. They typically ship into a logistics and distribution channel which provides supply to an ODM (Foxconn Compal, etc.), who in-turn supplies the name brand electronics company (Dell, HP, Nokia, etc.), who in-turn supplies retailers who sell to real consumers. When something goes horribly wrong, it can take weeks for inventories to back-up into the semiconductor supply lines and get then you get hit with order de-bookings.

It's not obvious if these risks are being priced into the market's recent retrenchment. As we move into the semiconductor industry quarterly earnings calls and forecasts...you have been warned!

Initial thoughts on Texas Instruments acquisition of National Semiconductor

While I cannot explain the 78% premium that Texas Instruments has agreed to pay for National Semiconductor, we can reasonably assume that they knew what it would take to get the deal done. As recently as January, dissident shareholder Ralph Whitworth and Relational Investors held 20.6M National shares (8.61% of outstanding) at basis of $16.29. The fundamental value in National Semiconductor is their position in Analog integrated circuits which are the highest margin (>60% GM) and longest lifetime (often > 20 years) products in the semiconductor industry. The market leaders are shown in a recent Analog Devices SEC 8K filing.

The hindsight is easy.  ADI, Maxim and Linear Technology closed today a P/E premium 30-300% compared to National.  Over the past eight years, National refocused on margins over top-line growth and shed many their less profitable endeavors.  TI and National have highly compatible business and technology cultures, where the second generation analog companies like Maxim and Linear could be very difficult to integrate.

I'm a bit of a broken record on the point, but the semiconductor industry is now 50 years old and consolidation will be a strategic play throughout the supply chain, from wafer fabrication all the way through distribution and logistics.  In the analog space, I own Intersil due to their technology, team and chosen markets and have long advocated that someone buy Micrel and tug that company out of the 1980's and into the new millennium.  I don't bet on M&A plays, but for the under appreciated analog companies wallowing at P/E's below 15, this news will be a welcomed boost!  

Why Intel must buy ARM

Last week Intel, the largest and most profitable semiconductor manufacturer, announced record sales and profit, but their performance by product segment combined with cataclysmic shifts in both retail and enterprise computing markets foretell Intel's growth to be in serious jeopardy if they do not acquire ARM.

Intel’s legacy PC processor business will never again be a growth engine. Consumers have an insatiable demand for electronics that enhance their experience in social networking, personal communications, portable gaming, electronic media (music, video, books, etc.), shopping, and financial management. In these markets the PC is losing badly to smart phones and tablets where ARM based processors dominate.  The decline in the PC's value (processor speed and data storage) will also be fueled by commercial customers moving their business management solutions to the cloud

The Data Center Group, which provides technology for enterprise servers and cloud computing, is Intel’s only promising growth business and delivered 23% of the top line revenue and 28% of the operating profit last quarter. But industry powerhouses like Nvidia, Marvell, IBM and start-ups like Calxeda (backed by TI, ARM, and the government of Abu Dhabi which also owns two of the largest semiconductor wafer suppliers) are preparing to launch very high performance ARM based products targeted to eclipse Intel in servers. There is little doubt that Intel will attempt to leverage supply and pricing of PC processors to retain server business with companies like Dell and HP, but they will have little sway over cloud computing companies like Google who develop their own server solutions. 

In the past 30 years, Intel has only done one thing well; microprocessors. If they are to maintain their dominance in the microprocessor business and grow shareholder value, they must acquire ARM while they can still afford the valuation. Too bad they have recently inked deals to acquire McAfee for $7.7B (strategically puzzling) and Infineon’s Wireless business for $1.4B (returning to a market where they have repeatedly failed). Capital poorly invested.

Let the consolodation begin

I've pontificated for the last 18 months that the semiconductor industry is poised for firestorm of consolidation, but there has been very little action due to the stalled capital markets and executive leadership teams focused on revenues, cost cutting, balance sheet clean-up and falling stock prices. Small M&A deals have been closing quietly, much to the satisfaction of a handful of boutique advisory firms. In the last six weeks though, several larger mergers and carve-out acquisitions have been announced:

• QLogic acquires NetXen
• NetLogic acquires "search engine" carve-out from IDT
• IDT hijacks Tundra from suitor Gennum
• Microsemi acquires "defense and security" carve-out from Endwave
• Ikanos acquires "broadband access" carve-out from Conexant
• Broadcom launches unfriendly acquisition of Emulex
• Microsemi acquires "rad hard" carve-out from Spectrum Control
• Microchip acquires R&E International
• Rambus acquires packaging patents from Inapac
• LSI acquires "RAID adapter" carve-out from AMCC
• Trident Microsystems acquires "frame rate conversion and audio" carve-outs from Micronas
• Western Digital acquires SiliconSystems
• Microchip accumulates 9.2% of Supertex
  

The stage is now set with irrationally low market valuations, very poor (wafer, assembly & test) capacity utilization, a maturing industry where scale is attractive and revenues having declined significantly. Seems like very dry kindling waiting for a spark........

Will the semiconductor industry consolidate in an orderly and logical progression resulting in bigger and healthier competitors benefiting all parties? Or, will we follow the path of other 50 year-old industries and consolidate in a fury of ego and hubris which transfers shareholder equity into the ether?

We pay for the illusion of safety; are we getting a good deal?

In what warped universe does a mutual fund that has lost 30% in the past 14 months deserve a 5-Star rating?

Selling is the act to convince a buyer they will receive good value for money. It is important that we consider the actual value of safety, as it is a key selling point for every transaction. Our purchases of food, medicine, automobiles, airline tickets and investments rest on a foundation of safety.

We fund government agencies (SEC, FDA, USDA, DOT, etc.) to regulate some products and their sales with the belief that a high level of safety will be established and maintained, or at least the open disclosure of risk will allow buyers to make informed decisions. The conspicuous public outrage directed at Bernard Madoff and his $50B Ponzi scheme is a societal response to an individual’s outrageous behavior and the failure of our government’s regulation. While investors were lured by their own greed to obtain impossibly consistent returns, all confidence schemes require the perpetrator to sell the illusion of safety to retain their investors. Today Madoff is under house arrest, his known assets seized, and all of his family and business associates are being compelled to answer, “what did you know and when did you know it?”

Our desire for reassurances of safety compel us to fund independent rating agencies such as Underwriters Laboratories, Moody’s, Standard & Poor’s, Morningstar, Insurance Institute for Highway Safety, etc. I’m personally astounded that after catalyzing a global financial disaster, Moody’s and S&P have not only survived, but seemingly thrive today. This leads me back to Morningstar that provides equity research and ratings services to investors. In what warped universe does a mutual fund that has lost 30% in the past 14 months deserve to maintain its Morningstar 5-Star rating which it has held for 10 years? By any rational measure, a 5-Star rating is intended to engender safety and encourage investment in a particular fund. Does the fact that it limited its losses compared to the broader market garner the 5-Star rating? Let us now all acknowledge that the measure of safety provided by the financial ratings agencies was a very poor deal and maybe their CEO should be under house arrest! By the way, how many of us received calls from our “maintain a balanced and diversified portfolio” investment advisors in 2007 telling us to get the hell out of the market? Not I!

What do I look for when building a team?

I've shuffled the priority of these hiring criteria over the years, but this list has served me well:

1. Very high level of professional and personal integrity.  This is profoundly difficult to measure in an interview, but it is the primary value of hiring people with whom you have previously worked and now trust. 
2. Intellectual brilliance.  I'm living proof of how someone can compensate for his shortcomings, but you must surround yourself will the brightest people you can attract to solve the great challenges your business will face.  Aspire to be the dumbest guy in the room.  I've often described this quality as hiring intellectual athletes.  A candidate's work experience might not be precisely what you were seeking, but a keen intellect and a willingness to take on new challenges are much more valuable.
3. Great student.  Loves to learn new things every day.
4. Great teacher.  Loves sharing their knowledge to help others succeed.
5. No jackasses. This is not the same as "no ego" or "team player."  Life is just too short to work with jackasses no matter how valuable you might think they could be to your business.
6. Great work ethic.  Great technologists and business people work hard because they enjoy the challenges and want to succeed.