Red-Hot Embedded Processing Fueling Growth for Texas Instruments

Texas Instruments is rapidly growing its microcontroller product portfolio to help it tap into the strong demand being witnessed in the market. But, the company still needs its analog business to stabilize profit margins.

Jun 24, 2014 at 9:00PM

Texas Instruments' (NASDAQ:TXN) rapidly growing embedded processing segment has been firing the company's growth, and helping it to offset revenue declines in some of its segments. The company is now moving quickly to expand this segment, which has become a key revenue driver for the company, and recently introduced a raft of new offerings. Embedded processors are microprocessors used in embedded systems.

Embedded processing has been growing at a much faster clip than TI's other segments, powered by strong demand for microcontrollers, or MCUs. In fiscal 2013, Texas Instruments saw its revenue fall 5% year over year to $12.205 billion. In sharp contrast, embedded processing segment revenue was up 9% to $2.450 billion. In the first quarter of the current fiscal year, TI's revenue grew a modest 3% year over year to $2.983 billion, but embedded processing revenue jumped 17% to $656 million. Embedded processing now contributes 20% of TI's top line, and the company's analog division contributes 60% of revenue. Texas Instruments commands 17% of the analog semiconductor market.

TI's core analog division grew just 3% year over year in fiscal 2013 to 7,194, and 11% in the first quarter of the current fiscal year to $1,837. Strong embedded processing growth in the first quarter helped offset the huge 28% decline in TI's ''other'' segment, which consist of custom ASIC products, DLP products, calculators, and legacy wireless products.

Texas Instruments' analog devices peer Freescale Semiconductor (NYSE:FSL) has also been seeing strong embedded growth. The company's microcontroller sales grew 17% year over year in fiscal 2013 to $826 million, compared to 6% growth for the company's overall revenue to $4.19 billion. Freescale's microcontroller growth in the first quarter of the current fiscal year clocked in at 26% to $223 million, compared to 15% growth for the company's overall revenue to $1.13 billion.

Freescale has an analog and sensor division from which the company derives 17% of its revenue, much lower than the 60% generated from Texas Instruments' analog division.

New Texas Instruments' embedded offerings
Texas Instruments introduced two new 32-bit dual-core Hercules microcontrollers, or MCUs, in May. These diminutive microcomputers will be used in medical, industrial, automotive, and transportation applications. The two variants, RM57Lx and TMS570LCx, offer 50% better computational performance than any existing Texas Instruments MCU. The new Hercules MCUs also provide the largest on-chip memory along with several safety feature enhancements. The company also introduced two new CC3100 and CC3200 SimpleLink Wi-Fi platforms for IoT applications in June, which allow users to easily add embedded Wi-Fi and Internet to a wide range of industrial, home, and consumer electronics.

TI has been transforming itself into a pure-play analog and embedded processing company since it exited the smartphone and tablet market. These are areas that seem less volatile and have longer growth runways. The company plans to reduce its footprint in certain embedded processing lines that have either matured or do not offer good returns. The company has, however, clarified that it does not intend to exit any market or discontinue the production of any embedded products, but rather realign its portfolio to maximize its returns.

MCUs dominate the Internet of Things, or IoT, which includes all computing devices apart from PCs, tablets, and smartphones. With estimates that the IoT will grow to reach 26 billion connected devices by 2020, up from just 0.9 billion in 2009, the strong demand for MCUs looks set to continue for years to come.

What about TI's analog division?
Texas Instruments' analog division accounts for about 60% of its sales. The segment has been growing considerably slower than the embedded division. Despite this, TI's analog division remains very important to the company. The operating margin for the analog division is much higher than that of the embedded segment. In fiscal 2013, TI's analog division brought in an operating profit of $1.859 billion from sales of $7.194 billion. That translated into an operating margin of 25.8%.

In comparison, the embedded processing division made an operating profit of $185 million from sales of $2.450 billion, translating into an operating margin of 7.6%. The story was essentially the same in the first quarter of the current fiscal year, with analog operating margin of 27.1% vs. 7.9% for embedded processing.

MCUs sport a lower margin than analog chips because of current industry trends. For a long time, the microcontroller market remained heavily fragmented and largely proprietary. However, an increase in industry standards have led to commoditization and falling prices. The rapid growth of ARM-based processors has brought about a standardized architecture that makes it easier for customers to switch MCU vendors. This increased competitiveness has bitten into the profit margins of the MCU business, including ARM-based MCUs. However, both TI and Freescale have large and comprehensive ARM-based portfolios that help them exploit the growing demand.

TI, therefore, needs the high-growth MCU business to take care of its top line growth, and its high-margin analog division to cater to its bottom-line growth as well. This seems to be a better strategy than leaning heavily on MCUs alone.

Bottom line
Strong demand for MCUs is powering new growth for manufacturers such as Texas Instruments and Freescale. But, unlike pure-play MCU manufacturers, these companies also derive revenue from the higher-margin analog business, with products that are at lower risk of becoming commoditized, making these companies good long-term investments.

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Joseph Gacinga 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.

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