NXP Semiconductors’ strategy does not impress

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NXP semiconductors (NASDAQ: NXPI) spent much of the last two years in limbo while Qualcomm worked to get approval to buy the business. Now that this deal has been scuttled by Chinese regulators, the Dutch chip company must find its own way forward.

A massive $ 5 billion stock repurchase plan announced shortly after the failed buyout was the first step. NXP executives explained their strategy in more detail during an Analyst Day presentation Tuesday, including a new dividend and plans to increase gross margin. But investors and analysts were not impressed. Stocks fell on Tuesday and opened lower on Wednesday, and the stock was downgraded by Stifel, who now views NXP as an expectation.

Image source: NXP Semiconductors.

NXP’s growth plan

NXP’s activity is oriented towards the automotive industry. The company is the world’s leading supplier of automotive semiconductors and generated 49% of its revenues over the past 12 months in the automotive end market. About 21% of revenue comes from its industrial and Internet of Things (IoT) segment, 17% from communications and other infrastructure, and 13% from mobile.

NXP aims to grow its total revenue through 2021 at a rate greater than 1.5 times that of the semiconductor industry as a whole. The company expects its revenue to grow by 5-7% per year, with the following split among end markets:

Final market

Expected growth rate

Automotive

7% to 10%

Industrial and IoT

8% to 11%

Mobile

4% to 6%

Communication infrastructure and others

0% to 2%

Data source: NXP Semiconductors.

In the automotive sector, the core business of infotainment, powertrain and secure access to cars is expected to grow along with the market. New businesses, including advanced driver assistance systems, radars, vehicle networks and electrification, will drive above-market growth in NXP’s automotive segment.

Along with faster-than-market revenue growth, NXP plans to increase its non-GAAP gross margin to 55% by the end of 2019. Gross margin was 53.4% ​​at the end of the second quarter of this year, up from 50.4% in 2016. The company can sell low-margin businesses to achieve this goal.

Significant investments in research and development will help stimulate this growth. NXP plans to increase automotive and industrial R&D spending by 15% per year, as well as a 3% annual increase in mobile R&D. This will be financed in part by reducing R&D spending for communication infrastructure by 6% per year.

By 2021, NXP expects non-GAAP gross margin to reach 57%, with non-GAAP operating margin as high as 34%. Assuming annual revenue growth of 7%, non-GAAP operating income could reach $ 3.9 billion, up from $ 2.7 billion in 2017.

Compose the debt

One of the possible reasons for the negative reaction from analysts and investors is NXP’s plan to put more debt on the balance sheet. The $ 5 billion share buyback program was partially funded by $ 2 billion breakage fees from Qualcomm, but the rest will likely be funded by debt. At the end of the second quarter, prior to the takeover announcement, NXP had long-term debt of approximately $ 5.3 billion.

NXP plans to increase its debt from $ 2 billion to $ 4 billion. In addition to the $ 7-8 billion in cumulative free cash flow the company plans to generate through 2021, this will create between $ 9 billion and $ 12 billion to invest in the business and return to shareholders over the next three years. years.

NXP has already spent $ 3.76 billion on share buybacks since announcing its plan, and it plans to complete the $ 5 billion program by the end of the year. More buybacks may be in the cards, with NXP saying it has “the ability to continue to make substantial buybacks” in its Analyst Day presentation. A new dividend will also consume part of this available cash. NXP launched an interim dividend of $ 0.25 per share, payable Oct. 5, and expects to pay between 20% and 25% of its operating cash flow in the future.

Accumulating debt to get money back to shareholders is a risky business that will end up making NXP more fragile if there is a downturn. The company is doing well right now, but warning signs are starting to appear in parts of the semiconductor industry. Some analysts warn of an oversupply of memory chips next year, and Morgan stanley predicts a significant correction in the semiconductor industry, however severe the escalation of the US-China trade war is.

In other words, NXP can take on more debt at the worst time to do so. You want a strong balance sheet in a downturn, not a leveraged balance sheet.

It is almost certain that the amount of semiconductors in automobiles will increase in the years to come. NXP is well positioned to take advantage of this growth. But investors should be, and appear to be, at least a little concerned about the company’s return on capital plans. NXP should pay off debt when times are good, not increase it to fund share buybacks.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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