Conexant Meets Its Maker (Fool Plate Special) December 20, 1999

An Investment Opinion

Conexant Meets Its Maker

By Brian Graney (TMF Panic)
December 20, 1999

In its recently filed fiscal 1999 10-K financial report, diversified communications chipmaker Conexant Systems (Nasdaq: CNXT) presaged that it "intends to continue to explore investment opportunities into various companies in fiscal 2000." Today, the company put its money where its regulatory filing mouth is, picking up fabless high-performance communications processor developer Maker Communications (Nasdaq: MAKR) for about $990 million in stock, or $45.96 per Maker share based on Conexant's closing price on Friday. Predictably, Maker's shares jumped this morning while Conexant's stock headed south.

Conexant is definitely paying a premium price for Maker, which will be folded into the company's fast-growing network access division. Maker's 50 or so processor and software engineers are effectively being valued at almost $20 million a piece, or more than twice the per-techie price that chip giant Intel (Nasdaq: INTC) paid earlier this year for the engineering crew of communications chip company Level One. The new workers will hardly make a dent in Conexant's total payroll, which already includes some 1,500 engineers. But the transaction will have an effect on the bottom line, reducing Conexant's fiscal 2000 earnings "slightly" before becoming accretive thereafter.

Despite the short-term accounting effects from the deal, the addition of Maker is being sold as a long-term positive for Conexant. "This acquisition strategically extends Conexant's network access product portfolio into high value, software-intensive, protocol processing applications,'' commented Conexant chairman and CEO Dwight Decker. Already serving heavyweight customers such as Cisco Systems (Nasdaq: CSCO), Lucent (NYSE: LU), Nortel (NYSE: NT), Alcatel (NYSE: ALA), and Nokia (NYSE: NOK), Conexant's network access products business represented 19% of total revenues in fiscal 1999 and 24% in fiscal Q4 alone. The business is growing rapidly, with 29% sequential revenue growth in the most recent quarter.

Maker serves many of the main customers as Conexant, so the merger makes sense from the point of view that it extends both companies' ability to offer critical, problem-solving alternatives to the major networking box makers. Some observers have suggested that Conexant has the making of a communications chip version of PC microprocessor dominator Intel, but the comparison is a weak one. In contrast to the standardized Wintel architecture in PCs, all networking box makers have their own product architectures that they keep in house. This leaves the communications chip companies to fill in the blanks and act as outsourced problem-solvers, not architecture suppliers.

While standardization may be out of the question, the best communications chip problem-solvers can still create substantial value for shareholders down the road through sheer ubiquity. This is the tact being taken by Maker, whose CEO commented in a recent Wall Street Transcript interview that his goal is to "get our processors onto every single port card on every single piece of high-performance communications equipment in the world." That's pretty ambitious for a firm with only 80 employees. Combining with Conexant transforms the goal from dreamy to quite possibly attainable.

Competitors in the physical-layer (PHY) communications chip business will have plenty to say about that, of course. But the beefed-up Conexant will be a formidable competitor in this space, complementing its strength in other growing semiconductor areas such as wireless, personal imaging, and digital infotainment.
For investors, Conexant's breadth of product offerings sets the firm apart from the other communications chip companies out there. That fact alone makes the company one to watch as the communications chip business grows into its high expectations and high valuations in the years ahead.