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Will Xilinx's Hot 5G Catalyst Fade Away?

By Harsh Chauhan – Updated Apr 25, 2019 at 12:17AM

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Investors in the high-flying chipmaker need to watch this potential headwind.

Xilinx (XLNX) is probably one of hottest semiconductor names on the stock market. Shares of the chipmaker have defied the broader market weakness over the past year and as of this writing trade very close to their 52-week highs.

Those who have been following Xilinx for a long time wouldn't be surprised at the company's rapid rise, as it was pulling strings in the right areas to boost long-term growth. The company's latest third-quarter results, quite expectedly, gave it yet another massive boost thanks to the early ramp in the 5G business, as well as continued strength across other segments such as automotive, data centers, and industrial.

But with Xilinx stock now trading at a rich trailing price-to-earnings (P/E) ratio of 34, which is nearly double the industry average and the broader S&P 500 index, does it make sense for new investors to jump into the stock based on the 5G excitement? Let's find out.

Stressed woman sitting with her hands on her face.

Image Source: Getty Images.

Something to be afraid of

Xilinx had always expected that fifth generation (5G) wireless networks would be a catalyst, but it probably didn't expect this space to start paying off so soon. Its 5G chip platforms moved from the prototyping phase to the early production phase during the fiscal second quarter. So, the 41% annual jump in its communications business, thanks to early 5G deployments, was a welcome surprise.

CEO Victor Peng credited "5G deployments in South Korea and a very early start of the ramp of 5G deployments in China" for Xilinx's strong performance in the communications business, which supplied 35% of its revenue last quarter. As such, the proliferation of 5G networks in the coming years should be a long-term tailwind for Xilinx, though that might be easier said than done.

Xilinx is known for making field-programmable gate arrays (FPGAs). These are programmable chips that aren't made with a specific purpose, so they can be easily configured after being bought off the shelf, which saves on both time and costs. FPGAs work for early stage 5G deployments as carriers need to test the new networks and the related algorithms, and that may require regular tweaks and updates.

That's where Xilinx's FPGAs excel, since they can be reprogrammed multiple times, giving developers a low-cost option to test new technology. However, demand for these programmable chips starts waning in a couple of years once the standards are set and application-specific integrated circuits (ASICs) are designed for those tasks.

Development of ASICs usually takes around two years and a lot of money, so Xilinx's FPGAs are in strong demand in the early 5G deployment phase. But once a custom chip comes out, the chipmaker could lose market share to rivals because the former are supposed to perform faster and also cost less since they are already programmed for that purpose.

Cavium, which was acquired by Marvell Technology in 2018, already showcased its next-generation 5G chips at the Mobile World Congress last year. Nokia, meanwhile, launched its ReefShark 5G chipsets last year in January, claiming that they can reduce the size of 5G antennas considerably and also reduce power consumption of baseband units by 64%.

However, the good news is that Xilinx has found ways to beat this inevitability by ingraining itself deeply into the 5G ecosystem.

Check out the latest Xilinx earnings call transcript.

Xilinx's smart play

One way to remain in the 5G play is by offering something extra to customers. That's why Xilinx is offering not just chips that help developers develop 5G-specific applications, but also a multiprocessing system-on-a-chip (SoC) that combines radio frequency chips and a processing system that it claims to be an industry-first.

According to Xilinx, its integrated 5G chip platform reduces system power consumption and size by 50% to 75% by integrating analog, digital, and embedded software design into one design instead of separate systems. Xilinx management believes that products like these will help it take advantage of 5G deployments for a long time despite the eventual move to ASICs.

As such, Xilinx could sustain its 5G momentum for years to come, which could be a big deal for the company as the 5G network infrastructure market is estimated to increase at a annual pace of 118% through 2022, according to IDC.

That's probably one of the reasons why Xilinx's earnings are expected to grow at a nice clip over the next two fiscal years and beyond. Analysts expect the company to triple its earnings growth rate for the next half-decade when compared to the last five years, and that could be possible thanks to the 5G tailwind and the other catalysts Xilinx is sitting on.

As such, those who have missed Xilinx's run so far can still consider buying the stock despite its rich valuation because it has the potential to grow at a faster pace in the future.

Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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