NXP Semiconductors is a best-in-class semiconductor company trading at a meaningful discount to peers using conservative estimates of growth and margin improvement, driven by a broken merger, massive liquidity event, and show-me story that will play out over the next 1-2 years. High exposure to disruptive mega-trends such as autonomous vehicles,Internet-of-Things (“IoT”), computing at the Edge of the Cloud, and more should drive growth well into the future. In addition, large cash return and refocused management are near-term catalysts poised to re-rate the equity in-line with peers, if not at a premium. Under our base case scenario, we see NXPI re-rating to a price target of $105 (+39%) by the end of 2019, with a blue-sky scenario of $130 (+72%). Industry tailwinds and trough valuations support a downside of $67.00 (-11%), creating a 3.5x reward to risk with additional upside optionally.
One quick note. The initial model used for this report was created in Sept/early Oct. Since then, semiconductor reporting has been mixed, with certain players calling out no inventory/trade war issues (On Semi/TSMC/Infineon) while others have reported a slowdown (Texas Instruments). The below assumes no cyclical downturn or serious trade impact (we discuss these in detail below), but see model section for a second base case “short-term slowdown” implying a two quarter inventory flush and slight trade war related semi end-market slowdown. The price target even under this scenario is $89.70, implying NXPI is still almost 20% too cheap relative to comps factoring in results based on Texas Instruments expected slowdown and multiple change post-guidance of a semi downturn.
A variety of reasons explain why NXPI trades at a discount to peers, but the largest is the breaking of quite possibly the most crowded merger arbitrage trade in US history, leading to massive forced selling/de-risking. The natural buyer pool to offset this has been slow to react due to: (1) a lack of education on a company that has not been giving guidance, holding calls, updating their financial model, or generally engaging with the investment community in 2 years given the Qualcomm merger, (2) fear of an unengaged management (due to the same merger) and restrictions on business operation during the pendency of said merger, and (3) a lack of understanding of the NXPI that is emerging as a standalone company, given the evolution of the business over NXPI’s 8 year public life. NXPI IPO’d on 8/6/10 and was throughout much of its earlier years a much different company with lower margins, less disruptive end markets, and a shallower breadth of product offerings. The acquisition of Freescale (FSL) in 2015 changed the latter two, but led to a transformational year with margin erosion (integration) and higher debt. In mid-2016, NXPI set out to change this by announcing the divestiture of their lower margin Standard Products business (which targeted 30-34% gross margins and 20-24% operating margins vs their HPMS business they kept targeting 54-58% gross margins and 32-35% operating margins) in June of 2016 to Jianguang Asset Management and Wise Road Capital for $2.75bn. By the time Qualcomm entered the picture in late Sept 2016 (deal officially inked 10/27/16), NXPI was a much different company than it had ever been before. But, with the Standard Products divestiture not completed until 2017 and NXPI no longer holding earnings calls, marketing, or explaining the new value proposition to investors, most are still just now getting up to speed (NXPI held it’s first analyst day since 2016 on 9/11/18) on why this business deserves a much higher multiple than the NXPI of 2016.
NXPI operates in 4 main segments (the HPMS business), plus it’s Corporate & Other group. These are Automotive, Secure Connected Devices (“SCD”), Secure Interfaces & Infrastructure (“SI&I”), and Secure Identification Solutions (“SIS”). These four segments are exposed to the four major end-markets that NXPI targets: Automotive, Industrial & IoT, Communications Infrastructure, and Mobile. I break down, the four segments below by size, demonstrating the powerful revenue growth opportunities and leadership position of NXPI.
Auto (42.2% of 3Q18 TTM Revs [3Q18 est at midpoint of guide] at $3.98bn)
NXPI’s largest segment is it’s automotive segment, which focuses entirely on the automotive end-market as one would expect. NXPI holds the #1 global automotive semiconductor market position (~13% share, followed by Infineon at ~11%, Renesas at ~10%, and Texas instruments at ~8%) with key leadership positions in it’s core competencies (#1 market position in Connectivity, Radar [ADAS], Powertain & Vehicle Dynamics, Body & Comfort, Connected Infotainment, and Secure Network & Gateways).
Key products include in-vehicle networking (short range communication among vehicle systems and applications), entertainment (radio/audio such as amplifiers), telematics, keyless entry, radar sensors for ADAS functionality, and battery cell management for electrification of vehicles. NXPI is guiding for 7-10% revenue CAGR from 2018 – 2021, driven by positions in new applications (radar, network processing + Ethernet, ADAS, and EV) growing 20-28%, core applications (infotainment, powertrain, general purpose MCUs, secure car) growing 6-8%, and legacy products (8-bit MCU) falling -7 to -8%.