PMC-Sierra Powers Up

By Brian Graney (TMF Panic)
August 24, 1999

Broadband infrastructure chip supplier PMC-Sierra (Nasdaq: PMCS) was in the news this morning after agreeing to use its high-flying stock to purchase Abrizio Inc., a privately held developer of broadband switch chip fabrics. In exchange for $400 million in stock (or some 4,352,000 shares), PMC-Sierra is acquiring the chipset technologies that make up the technical guts of fast-growing broadband products such as asynchronous transfer mode (ATM) switches, digital cross-connects, and terabit routers. The market applauded the deal, sending the company's shares up about 3% this morning.

For investors new to PMC-Sierra, the company's progress this year is a textbook example of what it means to be in the right market at the right time with the right product.

PMC-Sierra's target market is networking products, where it is a leading supplier of chips for ATM and synchronized optical network (Sonet) gear. In case you've been living under a rock for the past few years, telecommunications players of all shapes and sizes have been trampling over each other to build-out their network infrastructures to support the growing demand for digital data transmission. With Internet Protocol (IP) data traffic doubling every 100 days, demand in this area is white-hot.

Infrastructure equipment heavyweights such as Lucent Technologies (NYSE: LU) and Cisco Systems (Nasdaq: CSCO) have been gobbling up an ever-increasing number of chips from PMC-Sierra and other broadband chipmakers to make sure these new systems work. In this sense, PMC-Sierra is benefiting from the outsourcing trend among telecom equipment makers. But instead of making the chips itself, PMC-Sierra in turn is outsourcing production from the big independent foundries such as Taiwan Semiconductor (NYSE: TSM) and Chartered Semiconductor.

This makes PMC-Sierra just another link in the broadband food chain. However, it is a very important and lucrative link, as evidenced by the company's eye-popping 78% gross margin in the first half of this year.

Not having to worry about the operational issues and capital costs of manufacturing allows PMC-Sierra to focus all of its energies on creating a technological edge in broadband chip development. Not surprisingly, nearly 60% of the company's 435 employees at the end of last year were involved in research and development. The better the technologies, the better the revenue stream becomes. So, developing and protecting a technological lead is of paramount importance to PMC-Sierra. This makes the firm's willingness to pony up a nice chunk of stock for a company like Abrizio more understandable than it may be at first glance.

Using top-notch technology to drive revenues is the name of the game, and PMC-Sierra has been playing this game better than almost anyone this year. Double-digit sequential revenue growth during the first two quarters of this year has created higher earnings. As the buzz on the Street about the company has turned into a roar, PMC-Sierra's share price has jumped 220% since the start of the year.

At its current price, the company finds itself trading at a rich 37 times trailing sales of $197 million and a staggering 115 times forecasted 1999 earnings of $0.88 per share -- enough to make even the most fervent go-go growth investor gulp. Still, few market segments are growing as quickly and offer so much promise as networking chips. Investors looking for a different way to play the broadband build-out should take a closer look.

Feedback about News & Commentary? Please send mail to news@fool.com.