RF Micro Devices (UNKNOWN:RFMD.DL) seems to be on a roll as of late. The past two earnings releases have been stellar, with the company handily beating analyst estimates on all fronts, and margins are sitting at decade-highs. Meanwhile, the stock has been surging so far this year, up nearly 160%. I recently discussed a few reasons RF Micro's stock could continue to rise, but there are also a handful of issues that could ultimately send the stock lower.
1. Margins may not be sustainable
During the most recent quarter, RF Micro posted record profitability. Gross margin rose to 46.2%, compared with typical values between 25% and 35% over the past decade, and operating margin surpassed 20%, quite the shift from the single-digit percentages of the past few years.
These margins were driven by both an increase in revenue, in part thanks to the launch of high-profile devices like the iPhone 6, and cost-cutting that removed about $150 million in expense over the past 18 months. What's more, management sees continued margin expansion going forward, with a 50% gross margin expected within a year.
This all sounds great, but historically RF Micro has been unable to maintain profitability for very long. Operating margin has fluctuated wildly over the past decade, and the company lost money in four of the past 10 years. Peaks in profitability during fiscal 2007 and fiscal 2011 were followed by dramatic declines in profitability and eventually losses, and it's not clear what makes things different this time around.
2. The merger with TriQuint could disappoint
RF Micro's merger with TriQuint Semiconductor (UNKNOWN:TQNT.DL) is set to close before the end of the year, and a company with greater scale will emerge. RF Micro expects to be able to realize $150 million in cost savings within two years after the merger is completed.
Mergers rarely turn out exactly as planned, and there's the potential that the true cost savings end up being far below this value. Another problem: TriQuint has the same sort of inconsistent history as RF Micro. Over the past decade, five years have been unprofitable, and any periods of profitability have not been sustained. Both RF Micro and TriQuint have now returned to profitability, but there's no guarantee that it will last.
This wouldn't be as concerning if competitors weren't far more consistent. Skyworks Solutions, for example, has been profitable in all but one year in the past decade, and it's managed operating margins in excess of 10% during five of those years. Combining two companies with spotty records doesn't automatically fix their respective problems, and the merger could ultimately end up disappointing investors and sending the stock price lower.
3. The Internet of Things may not pan out
The drive to connect all manner of devices to the Internet is in its early stages. Cisco Systems predicts that by 2020, 50 billion objects will be connected to the Internet, from automobiles to household appliances, as well as PCs, tablets, and smartphones. RF Micro is set to benefit from this explosion of Internet-enabled devices, and the potential is enormous.
However, there are inherent problems with putting wireless chips in everything. The biggest issue is probably security, and a recent story about a Russian website that hacked into thousands of webcams around the world, displaying the feeds for all to see, by simply taking advantage of the fact that many people didn't bother to change the default password, is a demonstration of the dangers associated with connecting these types of devices to the Internet.
Whether security issues like this will deter people from buying smart, Internet-enabled products is an open question. The Internet of Things is one of the biggest long-term growth opportunities for RF Micro, but it's not hard to imagine Cisco's predictions vastly overestimating reality. If the Internet of Things doesn't take off, RF Micro's stock could suffer.
Timothy Green owns shares of Cisco Systems. The Motley Fool recommends Cisco Systems and owns shares of Skyworks Solutions and TriQuint Semiconductor. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.