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WirelessSemiconductorIndustryInitiatingCoverageSeelastpageforimportantdisclosuresEQUITYRESEARCH1July7,2004BlaineR.Carroll,CFA(617)[e-mail]:Thewirelessindustryisundergoingamajorupgradecycleasoperatorsrolloutnext-generationnetworksthatoffercustomersenhancedfeaturesontheirwirelessdevicessuchasInternetaccess,colorscreens,cameraphonesandaudioandvideocapabilities.Theindustryisshowinghealthygrowthinhandsetshipmentsasdemandhasincreasedandreplacementtimehasshortened.Ourpreferrednameswithinourcoverageuniverseappeartobewellpositionedtotakeadvantageofthisupgradecycleastheycontinuetostrengthentheircompetitivepositionwithinthemarket.Assuch,weareinitiatingcoverageonRFMD,SLAB,SWKSandTQNTwithBuyratingsandANADwithaNeutralrating.UpgradeCycleHasBegun–Thelonganticipatedupgradeinthewirelessindustryhasfinallybegun.Theindustryexhibiteditsfirstdownturnduring2001witha7%declineinhandsetshipmentsto380million.Afteraslightuptickin2002to400millionunits,theindustryreboundedin2003witha28%increaseto510millionand2004looksbrightwithprojectionsnowsetat610million,or20%growth.IncreasedFootprintDrivesImprovedRevenueTrends–Oneofthemaindriversofrenewedrevenuegrowthforthewirelesssemiconductorcompanieshasbeenitsexpandingfootprintwithinthehandsetmarket.Companiesaredrivingtheirdollarcontentperphoneupfromthe$1.50/handsetrangeto$10-15perphone.ProfitabilityMainAreaofFocus–Oneofthemajorconcernsforinvestorshasbeentheabilityforcompaniestodeliverprofitablegrowthinanenvironmentwherethesupplychaincontinuestobesqueezed.Allcompanieswithinourcoverageuniversehavemajormanufacturingandoperatinginitiativesunderwaythatwilldriveprofitabilityinthefuture.SLABhaspostedpositiveEPSforseveralquartersandRFMDandSWKShaverecentlyreachedpositiveEPS.TQNTshouldreachitnextquarter.ValuationsVeryCompelling–Thewirelessnamesaretradingatverycompellingvaluations,withthepureplaynamestradingatlessthan1.9XCY05sales,wellbelowhistoricalvaluationsof5-7Xandrecentvaluationsof3.0X.BUYRFMicro(RFMD,$6.46)SiliconLabs(SLAB,$42.11)Skyworks(SWKS,$7.71)TriQuintSemi(TQNT,$4.52)NEUTRALANADIGICS(ANAD,$4.54)2InvestmentOverviewHandsetMarketResumesGrowthTrajectoryThe1990’sprovedtobeanhistoriceraforcellularcommunicationsastheindustryrealizedmeteoricgrowth.However,asweenteredthenewcentury,theindustrywasplaguedbyanumberoffactors,suchasthemarketcorrection,anindustry-widecapitalcrunch,SARSandothereventsthatstalledthebuildoutofnext-generationnetworksanddevices.Asaresult,in2001,theindustryrealizeditsfirstY/Ydeclinesincellularhandsetshipments.Althoughshipmentsreboundedduring2002,theindustrywasstillsomewhatlimpingalong.Itwasnotuntiltheendof2003thatmeaningfulgrowthreturnedtotheindustryandweonceagainexperiencedstrongY/Ygrowth.Aswemovethrough2004,carrierhealthisstrongeraswirelessoperatorsrealizethevaluepropositionofferedbythesenext-generationservices,whichincreasetheusageontheirnetworks.Additionally,duringthedifficulttimesoverthepastcoupleofyears,componentsuppliersandequipmentmanufacturersalikehaverealignedtheircoststructureandtheindustryseemspoisedforstronggrowthasconsumerspurchasenextgenerationdeviceswithcolorscreens,Internetaccessandcameraphones.Weestimatethat2003shipmentstopped500millionandweexpectthat2004cansurpassthe600millionmark.HandsetsOnceAgainontheRise0100200300400500600700WirelessHandsetMarketForecastWCDMA01282040PDC/PHS253032424535TDMA1205546302010GSM/GPRS210225230290335355CDMA556990140190220200020012002A2003A2004E2005E380400510610660410Source:CompanyreportsandOppenheimer&Co.Inc.estimates.3FinancialsBeginningtoImproveWiththeresumptioningrowthwithintheindustry,wehaveseenanuptickinthefinancialconditionofthecomponentsuppliers.Specifically,weexpectrevenuetogrow29%and18%,onaverage,during2004and2005,respectively.Additionally,anumberofthecostinitiativesthatthecompanieshaveincurredoverthepastcoupleofyears,bothwithintheirmanufacturingfacilitiesandtheiroperatingactivities,arebeginningtoflowthroughtothebottomline.Asaresult,companiesareonceagainpostingpositiveearnings,whichhasbeenamajorconcernofinvestorsovertheyears.Astrendscontinuetoimprove,webelievethatinvestorswillgravitatebacktowardthesestocks,enablingtheirvaluationstorise.ValuationAnalysisThenewsfromthewirelessindustryhasbeenfavorableoverthepastseveralmonthswithindustrygrowthratesreturningandmanyofthesemiconductorcompaniesre-iteratingguidance(RFMD,TQNT).However,thereappearstobeanegativeundertone(OEMpricingpressures,sequentialgrowthrates),whichhaveplacedthevaluationsunderpressure.Assuch,allthenamesinourcoveragelistaretradingofftheirhighsearlierthisyear.ThetraditionalRF-ICcompanies(RFMD,SWKS,TQNTandANAD)aretradingbelow2.0Xsales,wellbelowhistoricallevelsof5-7Xandrecentvaluationsof3.0X.Wefeelthat,aswemovethroughtheyearandthenewsflowintheindustryremainspositive,investorswillreturntothesestocks,enablingtheirvaluationstorise.Assuch,weareinitiatingcoverageofRFMD,SLAB,SWKSandTQNTwithBuyratingsandANADwithaNeutral.CommunicationsICValuationAnalysisCommunicationsICsResearchUniverse7/6/2004BlaineR.Carroll,CFAEPSRevenue($MM)Mkt7/6/2004CapCYCY