Description

Nordic Semiconductor (NOD.NO) is a best of breed fabless semiconductor designer based in Tondheim, Norway.  The company specializes in chips for wireless communications, with products focused on Bluetooth Low Energy, ZigBee, Thread, ANT, and most recently, cellular chips focused on LTE Cat M1 and NB-IoT.  The Bluetooth Low Energy, ZigBee, Thread, and ANT are short-range wireless standards while Cat M1 and NB-IoT are long range protocols.  The company has grown mostly at mid-teens rates over the past five years but we feel this rate is poised to accelerate going forward.

Nordic is a leader in the Bluetooth Low Energy space.  An industry expert, DNB Markets, tracks the number of design wins in the space and in Q1 2020, Nordic had 142 wins representing 49% market share in the market.  The rest of the market share is fragmented between competitors such as Texas Instruments, Dialog Semiconductor, Qualcomm, Infineon, and Silicon Labs.  Nordic wins because it has the best performance at the lowest power consumption in the category.  Power consumption is exceedingly important in this space because most of these chips are going into battery operated devices and semiconductor power consumption correlates directly with battery life.

How are Nordic’s chips so good?  The company has a wealth of engineering talent with many experienced engineers who came out of nearby giants Nokia and Ericsson.  Nordic Semiconductor has a tightknit culture and offers a smaller platform on which to showcase your skills than do Nokia and Ericsson.  Norway also has a number of colleges with good engineering programs from which to develop new engineers.  Nordic is a specialist in the wireless communication space while many of its competitors are more diversified with less specific focus on this area.  Finally, management has executed well on its product development plans over the years.  Svenn-Tore Larsen, the CEO, has driven the company’s leadership in the space since 2002 and we have been impressed with him both for his execution but also the vision he has laid out for us when we have spoken to him.   

Bluetooth Low Energy chips are ubiquitous in wireless devices, such as cellphones, smart watches, wireless keyboards, wireless mice, wireless ear buds, smart home devices, asset trackers, telehealth devices, etc.  As these devices proliferate, the market grows at a 10-20% rate.  Nordic breaks up its revenue into five end markets:  Consumer electronics (35% of revs in Q1, grew 16% YoY), Wearables (16% of revs, grew 49% YoY), Building / Retail (19% of revs, grew 64% YoY), Healthcare (8% of revs, grew 28% YoY), Other (17% of revs, grew 38% YoY).  It is a pretty well-diversified mix for a mid-sized company.   

Nordic grew revenue at a 33% clip in Q1 (off an easy comp) and forecast revenue growth of mid-teens for Q2.  Gross margins came in at 51.9% which is a bit above guidance due to positive mix.  EBITDA margins came in at 7.5% in the seasonally slow quarter.  We are expecting 13.7% EBITDA margins for the year.  Covid-19 is having a mixed-impact on the company.  Some of its end products, such as wireless mice and keyboards, benefit from the work from home (WFH) trend while others are hurt by the downturn in consumer spending.  The company saw order strength in Q1, with an ending backlog up 39% year-over-year and 16% sequentially although the company attributed some of this to early ordering by customers to secure supply.

ZigBee, Thread, and ANT are used in smarthome applications but make up a small part of Nordic’s revenue stream.  Its support for these protocols is important in case customers want to use them but they are less in demand that Bluetooth currently.  Nordic also has a proprietary chip, where it started its business, that makes up 20% of its revenue stream.  This chip is a shrinking part of the business but is still used by some customers in legacy designs.

Nordic’s stock has had a big run from the bottom and now sits near 52-week high levels.  As a value-players, why are we interested in the stock here?  The reason is that Nordic is at the inflection point of a massive product cycle that will both help revenue growth and margins.  Over the past three years, the company has been developing cellular chips for the Internet-of Things (IoT) market.  These chips, for the Cat M1 and NB-IoT standards, area targeting a huge market for long-range connectivity.  Examples of end uses for these chips include smart meters, smart street lighting, fleet management, smart agriculture, etc.  The incumbent in this market is Qualcomm but this market is not the focus of its business given its relatively small size next to Qualcomm’s smartphone business.  As in the Bluetooth market, Nordic has lower-power, higher performance chips.  These chips were only launched at the end of last year and contributed $1 million in Q1 revenue (out of $70.2 million total) but the design wins are starting to ramp which will lead to higher revenue down the road. 

Given the company is currently growing revenue at a mid-teens pace, a bolus of new revenue from the cellular chips could accelerate growth above 20% per year.  Profitability is also poised to improve as well, beyond SG&A leverage from increasing growth.  Nordic has been spending 10% of its revenue over the past few years on R&D for its cellular chips, which haven’t been generating any revenue.  Now that the chips are out, this spend level can come down at the same time when cellular revenue is ramping, creating massive R&D leverage.   

We are expecting $333 million in revenue in 2020 (15.5% growth) and $400 million in revenue in 2021 (20% growth).  We expect EBITDA margins to ramp from 13.7% in 2020 to 18.7% in 2021.  We look at Nordic on an Enterprise Value to Revenue basis to compare to its peers.  On our 2021 estimate, Nordic trades at 2.8x, a discount to its peers at 4.5x and above.  Compared to its peers, it has more growth and margin expansion potential but leaving that aside, at 4.5x Nordic would trade at 104 NOK or 60% appreciation from current levels.

Catalyst

The ramping of Nordic's cellular chips should accelerate revenue growth and expand operating margins, leading to a re-rating of the stock.  It could also be an acqusition candidate given its relativeley low valuation compared to peers.