Image source: MACOM.
A couple of months ago I profiled deceptively boring analog semiconductor maker M/A-COM Technology Solutions Holdings (MTSI 1.31%). The company popped up on my radar due to its strong growth and outperformance. Digging deeper, there seemed to be some nice growth drivers as the company has switched into higher-margin products. After its recent analyst day, it appears MACOM may have even more growth coming down the pipe.
Exciting things ahead, but read the fine print
MACOM's analyst day on March 10 outlined a number of opportunities for the company, specifically three areas that could each double the company's revenue in the next three to five years, according to management. Currently MACOM's revenue is expected to be a little over $500 million this year. So revenue could surge to over $2 billion by 2020 if these work out.
If you look at slides from the presentation, you will indeed see a chart showing 400% growth coming from three areas. But the fine print below the graph states "Represents long-term growth targets that assume perfect execution on our current growth strategy." (emphasis mine.)
Investors should remember management will always be optimistic about their company's prospects, and take these projections with a grain (or perhaps a small rock?) of salt. Nevertheless, I do think there are some exciting developments ahead for the company. Let's look at the three areas of expected growth.
More data means we need bigger data pipes
One opportunity for growth is in 100G optical networking. This refers to the speed of optical networking equipment -- in this case, 100 gigabytes per second. MACOM's products are used to build long-haul networks (between cities and countries), metro networks (networks within cities), and optical networks contained within data centers.
Currently, most of these networks are still using 10G and 40G equipment. With the continued explosion of data flowing over networks, especially driven by high-definition video, these networks need to be upgraded. Market research firm IHS reported 100G shipments were expected to grow 118% in 2015, and are "poised to explode in 2016."
However, on the last earning call, management did note that the implementation of 100G, especially in data centers, will not be immediate. CEO John Croteau said, "This is the year of walking for 100-gig in data centers." So while the revenue potential might be an additional $500 million, don't expect to see that popping up on the balance sheet in an instant.
Gallium what?
A second area for growth is in gallium-nitride circuits, or GaN for short. GaN has different properties than regular silicon, with the ability to make transistors that can turn off and on (switching frequencies) up to 10 times or even 100 times faster than traditional silicon circuits. This could make devices faster, lighter, smaller, and lower cost.
Already GaN is being used and tested in self-driving cars, smartphones, LED lights, and cell phone base stations. MACOM is now getting ready to produce it commercially this summer, with first production revenues coming as early as late 2016.
The market for GaN power semiconductors is expected to grow to $1 billion by 2020, and then up to $3.7 billion by 2025 -- a massive increase from the current market of only $210 million. MACOM believes it can get 40% to 60% of the base station power amplifier market in the next three to five years. Therefore their $500 million opportunity in the next few years is within reason, but only if they capture 50% of the $1 billion market expected by 2020. It's certainly possible, but you can start to see how their projections are relying on flawless execution.
More wireless means more antennas
The third area of growth on the horizon is in active antennas. The term "active" antenna means it is powered and contains electronics to try to boost signals, as compared to a passive antenna that collects signals without the help of the electronics. Active antennas can therefore be smaller and more accurate.
Applications for MACOM's antennas are largely military, and the company signed an agreement earlier this year to work with defense contractor Northrop Grumman Corporation (NOC 1.88%). While a dollar amount was not specified, MACOM will be an exclusive partner in helping develop and manufacture radar arrays that will use MACOM's active antennas. However, at the analyst day the company noted some new applications they see for their antennas, such as 5G cellular base stations, and providing Internet on airplanes.
As an investment
One of the most impressive charts from the analyst day illustrated the change in gross margins from the fourth quarter in 2012 to the most recent first quarter in 2016. Overall adjusted gross margins have gone from 48% to 60%.
High-margin products -- those with gross margins greater than 70% -- have experienced a 42% compound annual growth rate over this time. This means the company is getting into more specialty products, and as one of the very first few companies that will be capable of producing GaN chips, margins should remain high.
In terms of valuation, with the recent rally the stock is not looking any cheaper than when we last observed it. It is currently trading at a trailing P/E ratio of 58 times, compared to the semiconductor industry of only 19 times. But looking out just a bit further to the end of the fiscal year, which ends in September, the forward P/E is around 22 times.
MACOM is a small-cap chipmaker that feels like it is under the radar for most investors, but is increasingly getting more attention. The stock isn't without risks. Management is aggressive in their estimates, and any number of things could go wrong to derail some of these growth drivers. For example, transitions to upgraded technology like 100G optical could take longer than expected, or companies could curtail their upgrade spending if they hit any kind of a rough patch.
Or the production of GaN is still in its infancy, and this summer's plans to ramp into commercial production could be rocky given this is an entirely new material to use in chips. But the company is on the right track to take advantage of some big industry changes over the next few months and years. Therefore, it may deserve a look.
