In the fiscal year ending in March, Microchip Technology (NASDAQ:MCHP) posted record revenue of $1.93 billion, a 20% increase, year over year. This compares favorably with the overall semiconductor industry, which recorded much more modest growth of 5.2% in 2013, according to Gartner. Profitability at Microchip was also high for the year, with a gross margin of 58.4%, comfortably beating competitors Freescale Semiconductor (NYSE:FSL) and Texas Instruments (NASDAQ:TXN).
Thanks to favorable market trends, industry peers such as Freescale and TI are also doing well, but Microchip has the added distinction of having run a profit for the last 94 quarters. Taking a closer look at Microchip presents the picture of a remarkably solid and well-run business. Can Microchip continue to do so well, and will it continue to outperform the semiconductor industry?
Microchip's core business is microcontrollers, or MCUs, wich are basically tiny computers that combine a processor, memory, and input-output peripherals on a single chip. There are thousands of applications for microcontrollers, but the most familiar ones might be in consumer goods such as washing machines, digital thermostats, or driver-assistance systems in cars. Overall, the estimated market for microcontrollers in 2013 was a sizable $15.5 billion.
Microchip provides 8-, 16-, and 32-bit MCUs, and all three segments are doing well. The company is currently second in terms of market share for 8-bit MCUs and expects to win enough share to overtake the No. 1 spot in 2014. It is also healthy at 16-bit MCUs, with 44.2% revenue growth in 2013 and an increase in market share that currently puts the company in fifth place.
Microchip entered the 32-bit market later than some of its competitors, and it's currently ranked 11th in terms of market share. Nonetheless, it has been making good progress, with 66% year-over-year growth in 2013. In addition, it recently crossed the threshold of 100 products in the 32-bit sector, which CEO Steve Sanghi called a "magical critical mass," beyond which much more 32-bit business should become available.
Internet of Things
While MCUs made up 65% of Microchip's revenue in 2013, the company also has a significant business in analog, such as power-management products and interfaces for Ethernet or wireless. Analog made up 22% of the company's revenue in 2013, when the segment recorded impressive 39.1% growth relative to the previous year.
Perhaps more important, the analog business complements Microchip's MCUs in the growing network of connected, smart devices that's becoming known as the Internet of Things. Estimates for the growth of the Internet of Things are immense, with Gartner projecting 26 billion of such connected devices by 2020. Microchip looks well-positioned to benefit nicely here, but there is a worrying trend within the MCU market that might interfere with Microchip's plans.
Proprietary versus ARM
Thanks to an increase in industry standards, semiconductors in general have been susceptible to commoditization and falling prices. For a long time, the microcontroller market remained fragmented and largely proprietary, with customers finding it hard to switch away from one MCU provider to another. This has led to stable prices and continued profits.
However, the growth of microcontrollers based on ARM processors is bringing with it a standardized architecture that makes it easier to swap MCU providers, and thereby, a lower price. Freescale and Texas Instruments, both of which have MCU businesses on par with or larger than Microchip's, have comprehensive ARM-based portfolios. Though Microchip does have some ARM products thanks to its acquisitions, its core products remain based on its proprietary PIC architecture.
So far, Microchip's management says it is not concerned about the increasing popularity of ARM-based MCUs, and that its focus remains on the customer's needs, rather than on the processor technology. However, it's quite possible that several years down the line, it will see ARM-based controllers begin to take some business away and cut into its margins.
Microchip is a successful and growing company that's outpacing the rest of the semiconductor industry, thanks to its microcontroller and analog segments. It might profit nicely from the emerging Internet of Things, unless its proprietary microcontrollers suffer at the hands of more commoditized ARM-based devices.
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Srdjan Bejakovic has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.