Msf 8640 - Skyworks Solutions Valuation

MSF 8640

Portfolio Theory & Applications

Stock Analysis

Skyworks Solutions, Inc. (SWKS – NASDAQ)

Siddhesh Surve

Professor: Ms. Aimei Zhong

1

Overview

Skyworks Solutions, Inc. is a semiconductor manufacturer headquartered in Woburn, MA. The firm was incorporated in Delaware County in 1990. The company manufactures semiconductors for use in Radio Frequency (RF) chips in mobile communication devices. Key product lines of Skyworks Solutions include front-end modules and amplifiers, wireless infrastructure, power management, precision analog components, smart energy and Wi-Fi connectivity. Company has gradually shifted its product lines from lower margin products to higher margin and higher long-term growth products from year 2011 to 2014(Appendix I).

Skyworks Solutions Inc. stock trades on NASDAQ and its ticker symbol is SWKS. The current market capitalization is $15.29 billion and the 50-day average trading volume is 4.03 million shares. Current number of shares outstanding is 190.47 million. The current IWF rating for Skyworks Solutions Inc. is 49. The 52 week price range for the stock is $50.45 to $112.88. Current Beta of Skyworks Solutions is 1.23.

Business Quality

Skyworks Solutions, Inc. holds a competitive advantage due to its diverse product lines. It is a major supplier of RF chips to smartphone manufacturers like Apple and Samsung. The firm is also foraying into Internet of Things (IOT) market which analysts estimate has a potential to grow into a $19 trillion market over the next decade. It has production facilities around the globe. These attributes make Skyworks well-positioned to exploit the growth in smartphone industry in emerging markets.

Porter’s Five Forces analysis of the semiconductor industry displays a high threat of rivalry due to large number of suppliers and short product life cycles. The threat of buyers is high due to high bargaining power of customers and large number of suppliers competing for business. Threat of substitute is high due to short product life cycle. Barriers to entry in this industry are high due to high initial capital investment. Threat of suppliers is medium due to large number of suppliers and price competition among suppliers (Appendix II).

Mr. David Aldrich has been the CEO of Skyworks Solutions Inc. since year 2000. Firm was listed by Forbes magazine as one of the best managed firms in 2014. Low insider ownership (1.00%) is a cause for concern. However a large institutional ownership (77.00%) of Skyworks’s stock is a positive sign for individual investors.

Financial quality of this firm is good due to high reserves of excess cash. The firm currently has zero debt on its balance sheet. It is currently generating more cash than its capital expenditure which is impressive given high R&D costs associated with the industry. Skyworks Return on Assets (ROA) is 23.85% (Appendix III) and its Return on Equity (ROE) is 28.05% (Appendix IV). Operating margin of Skyworks has been consistently higher than the S&P 500 index and semiconductor industry (Appendix V). Large cash reserves also give Skyworks a competitive advantage during M&A transactions. This attribute was recently highlighted when Skyworks beat Microsemi Corporation in the takeover battle of PMC-Sierra Inc. The primary reason for Skyworks’s success was that Skyworks was willing to pay cash for buying PMC-Sierra.

Growth

Skyworks Solutions displays high revenue growth since year 2012(Appendix VI). Earnings per share (Appendix VII) and free cash flow (Appendix VIII) display the cyclical nature of semiconductors industry. Even during the down cycle Skyworks outperformed its industry peers. However Skyworks has been diversifying their revenue stream since the last down cycle of the industry. Thus we expect Skyworks to sustain its growth in the future. The decrease in free cash flow growth in 2014 is mainly attributed to Skyworks’s capital expenditure to increase their production capacity by 34%. The new production facility is located in Japan. Revenue growth is based not only on increase in the sales of smartphones but also on introduction of more advanced generation of smartphones and tablets. The RF content on every subsequent generation of phones is more expensive than the previous one. Thus even if the smartphone industry is reaching a stage of maturity, every subsequent generation of phone introduced will lead to an increase in revenue even if the sales figures of phone manufacturers remain steady (Appendix IX).

Chinese market is one of the major revenue sources for Skyworks (Appendix X). Our analysis shows that large unpenetrated 4G market (81%) in China will offset any demand related fears due to declining economy. Skyworks’s operational excellence and increased production capacity makes the firm well positioned to capitalize

2

on growing demand in the emerging markets. Although Apple Inc. is still one of the major clients of Skyworks (Appendix XI) it has been diversifying its revenue stream by adding Chinese manufacturers like Xiaomi and Huawei to its portfolio.

Momentum

Skyworks stock performance is promising. Skyworks’s stock has consistently outperformed the S&P 500 and the Semiconductors industry (Appendix XII and XIII). This relative strength is a good indicator for future price performance of the stock. Moreover recent price correction of Skyworks’s stock since its June 2015 high of $112.88 suggests a bottom. Skyworks Solutions also displays a positive trend in the earnings momentum. Skyworks was recently able to meet market expectation regarding the 2015 Q4 earnings despite the fact that some of the major suppliers of Apple Inc. like NXP Semiconductors issued weak 2015 Q4 earnings guidance. This recent development indicates that their strategy of diversifying their products and revenue stream away from Apple Inc. is starting to reap benefits. Moreover the firm has been consistently beating market predictions regarding its earnings. The recent earnings surprises have been positive (Appendix XIV). The Price to Earnings Growth (PEG) ratio of Skyworks is less than 1 (Appendix XV). This means that the stock will potentially be able to surpass markets current valuation.

Valuation

For the intrinsic value calculation we used Discounted Cash Flow model. We estimated the 5 year growth rate to be 27%. Since Skyworks does not have any debt, the cost of equity was used as WACC. The cost