Potential to emerge as a renowned player
Headed by a long-term industry veteran and run by an experienced management team, MACOM Technology Solutions (MTSI) is an emerging name in designing and manufacturing semiconductor products. MACOM’s products primarily target data center, telecommunication and industrial and defense applications. The company boasts a track record of 65 years in its arena and offers foundry services for customers. Recently, the firm has lowered its Q3 guidance to reflect the impact of discontinued shipments to Huawei Technologies and, as a result, took a little hit on its stock price. But a growing demand for IT infrastructure and forecasts of increased orders in the second half of this year have placed MACOM on track again.
Key catalysts are present, but short-term uncertainties remain
Recent inventory correction in the data center segment had put MACOM and similar firms under pressure, but the pressure is temporary because the future of data centers is highly dependent on high-speed connectivity. However, the pressure is continuing as the plant operators are clamping down on new orders to digest inventory. Industry analysts are seeing some improvement in chips as inventory corrections look to come to an end, and there is a bridge between analyst’s views and MACOM’s management as the latter feels that the industry could hit a strong rebound in the second half of the calendar year. Jefferies analyst Mark Lipacis said that the recent rally looks like a classic semiconductor trading pattern associated with earnings revisions and the end of an inventory correction.
Consider the example of the next-gen hyper-scale infrastructure built by Facebook (NASDAQ:FB) which provides massive growth of data traffic inside of its data centers and delivers 1.6 terabytes of bandwidth of top of the rack switch based on 100 gigs CWDM building blocks. Although large projects like these are not often developed, there will be a sizable explosion in the launch of standardized sizes of these technological facilities and will result in massive need for high-speed connectivity. This is where MACOM and similar firms come into play because its customers will try to match new industry standards of speed and bandwidth.
The management expects that architectural shift will drive a 4x increase in the number of 100 gigs CWDM employees on Facebook while also providing a migration pass to 200 and 400 gig in the future. Now, there is a high probability of MTSI’s cloud customers to follow similar patterns. MACOM’s products are also renowned in the field of radar development, and the firm actively pursues new opportunities in this arena. This is another area which will provide high growth for the company.
Image: Data center growth is a key catalyst for MACOM
“This is an excellent example of why we continue to believe that 100 gig has a long life cycle ahead. Customer forecast tells this out predicting strong growth for both 100 gigs CWDM4 and PAM-4 in the remainder of 2019 and 2010, while 200 and 400 gig on top of that demand starting next year.” – John Croteau, President and CEO, MACOM
5G technology is also one of the key catalysts for MACOM’s business. The applications range from larger macro-cell base stations to millimeter wave fixed to wireless networks. Large wireless operators have their antennas in field trials that can be twice the target power consumption and three times too expensive. The president outlined that they will gain capacity expansion and will be able to service over 80% of global demand for 5G base stations exclusively through MACOM and its pending joint venture in China.
5G applications are critical for MACOM’s success, image from Pixabay
“The world’s leading radar customers and government agencies understand the value that we’re bringing to bear with scalable plenary better than anyone and our team would make precisely that reason. We view Global and Homeland Defense to be a strong domestic secular growth engine stretching for arguably decades to come” – John Croteau, President and CEO, MACOM
Financials and valuation
In the fiscal period of 2013-2018, MACOM’s revenue grew by double, but negative earnings have put pressure among the investor base. For the last two fiscal years, the company could not deliver positive earnings. A string of growing expenditures related to R&D and operations are some of the key reasons behind that. But I believe MACOM is going through a phase of deliberate development during which the expenditure structure is just high. However, as the company grows, the benefits related to economies of scale, new acquisitions, and partnerships will take it forward.
Right now, revenue growth is very important for the firm because it shows the capacity of expanding its market share in a highly competitive industry. Another important thing is its current valuation. MACOM’s price to sales and enterprise to sales looks cheap like NeoPhotonics (NPTN), II-VI Inc (NASDAQ:IIVI), and Fabrinet (FN). On the other hand, Inphi (IPHI) and Acacia (ACIA) look expensive. As the inventory situations recover and MACOM continues to utilize the rapid growth in data center and 5G industry, the company will have higher valuation ratios. Once the macroeconomic corrections are adequate, the competitors will also become expensive. As a result, entry prices will no more look attractive.
New product development is a crucial factor for MACOM because average selling prices of its products usually decrease over time. Failure to introduce new products that can be manufactured at lower costs or can be sold at higher prices, based on superior performance, can significantly hurt the firm’s position in the market, leading to a substantial impact on its financials. MACOM’s new product design effort could last 12 to 18 months or longer and requires high investments in engineering. Failing to successfully launch these products could put high pressure on the firm. Another key risk factor is MACOM’s highly concentrated customer base. MACOM typically depends on orders from a limited number of customers for a significant percentage of its revenue. Although the composition of its top 10 customers varies from year to year, the company expects that sales to a limited number of customers will continue to account for a significant percentage of its revenue for the foreseeable future.
MACOM’s purchasing arrangements with its customers are usually conducted on a purchase order basis that does not require the customers to purchase any minimum amount of our products over a period of time. So, there is a possibility that one or more of its major customers could easily terminate their purchasing arrangements without no warning and/or penalty. The customers could also delay the amount of the products they order, or purchase these from its competitors without any significant hassle.
MACOM is a big lineup of products designed for data centers and telecom industry. Currently, there are multiple long-term catalysts for the firm. Some of these include high-speed connectivity and improved networking and telecommunication technology infrastructure. However, the industry is highly competitive, and the firm hasn’t delivered positive earnings in the last two years. Although this is understandable from the fact that the firm is a growing one, there are competitors who are delivering good growth along with acceptable profitability scores.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.