Texas Instruments' Long Road Back

Analysts say the worst is over for the market leader in smart silicon, but that doesn't mean they see good times just around the corner

By Olga Kharif

When 2001 is gone, execs at Texas Instruments (TXN ) won't be sorry. The worst year in the semiconductor industry's history saw TI's sales drop 40% to 50% and immersed the company in red ink. That's quite a fall for this maker of consumer electronics and silicon components for cell phones, after logging sales of $11.9 billion in 2000, when it earned a net income of $3 billion.

Now for some good news: Orders for some of the company's products, those used to perform complex mathematical calculations inside devices, are picking up. Then, on Oct. 17, TI reported revenues of $1.85 billion, down 41% from the year-ago period but slightly better than the Street expected. And while fourth-quarter sales are expected to dip further, down 10% from the third quarter, that'll be the worst of it, predicts Chief Financial Officer Bill Aylesworth. Chip orders, which had been falling, have stabilized, he says, adding: "We think that we have turned the corner."


  The market appears to believe him. On Oct. 25, TI stock closed at $31.26. But considering that the company isn't likely to turn a profit until 2003, when analysts expect to see earnings somewhere in the range of 60 cents to 70 cents a share, TI would be an attractive buy at if it were closer to $16 a share, says Paul Leming, analyst with ABN AMRO. Bear Stearns figures the right price at about $22, with a 12-month target of $45.

Despite Aylesworth's optimism, analysts don't believe TI can count on a soft landing. The $204 billion global semiconductor market might not bottom out until late in 2002, says Mario Morales, analyst with tech consultancy IDC. And when it does, the market could stay flat through the end of the following year.

If that's not enough, the same price pressure that has already depressed sales of many TI products by 30% to 40% continues. And the company faces stiffer competition in wireless, its largest market, with nearly half of the world's cell phones carrying TI components.


  The continuing market contraction is the most serious concern. Wireless silicon, which boasts the smallest inventory backlog in the semiconductor market, will be the first to bottom out in mid-2002, says Morales. One sign of recovery is that the world's largest cell-phone maker, Nokia (NOK ), began shipping new wireless phones, to be used with upgraded wireless networks, at the end of September.

TI will depend on that market for much of next year's growth, says Aylesworth. Yet, when it does bottom out, it could stay there until early 2003 because customer and enterprise spending will remain weak, says Alan Nogee, analyst with Cahners In-Stat. That could mean a slow recovery for TI as well.

The company also faces increased competition for silicon used in cell phones that operate on next-generation (3G) wireless networks, which allow fast transmission of data and voice calls and also make possible such nifty applications as sending video clips from one mobile phone to another. "3G designs are substantially different," says Marcus Levy, senior analyst with Cahners Microprocessor Report, who adds that some of TI's rivals like Infineon Technologies (IFX ) "have as good or better capabilities."


  Maintaining market share in components for current-generation and upgraded wireless networks, "is going to be a challenge," says Greg Sheppard, analyst with electronic-components consultancy iSuppli. With TI rivals like Qualcomm (QCOM ) representing stiff competition in the promising Asian market, Sheppard believes TI could see its dominant market share shrink by as much as 10% over the coming year.

Another source of concern to analysts: About 10% of TI's revenues come from products whose prices have been in free fall over the past 12 months. Prices on products like Standard Logic are down 25% to 30% so far in 2001, estimates Sheppard. Noncommodity product prices also have fallen 15% to 20% in the same period. And the pressure could continue into 2002, though analysts see it easing somewhat compared to this year's downdraft.

As a result, says Merrill Lynch's Joseph Osha, TI might not break even until the third quarter of 2002. On Oct. 18, Osha downgraded the company from buy to accumulate. TI offers no estimates as to when its revenues will start covering costs and charges again. Although TI laid off 2,500 employees -- roughly 6% of its workforce -- in April and is now closing two plants, it needs to engage in further cost-cutting if it's to hasten a return to profitability, says Osha.


  Despite the challenges, few doubt that TI will remain one of the chip industry's leading players in 2003. "They have a big following of engineers who use their products," says Nogee. TI also has a reputation for excellent service, something that impresses long-term customers looking for more participation and input from suppliers. "TI is similar to Intel in that, for many years, vendors have attempted to take market share away," says Levy, who is quick to point out that many competitors "have come and gone."

TI believes its current customers -- Nokia, for one -- will stick around. Aylesworth says this loyalty is due, in part, to the fact that they've developed special programs for IT chips destined to be used in next-generation networks. Notes Sheppard: "It will be hard to knock [TI] out."

Meanwhile, TI's revenues will continue to grow, since demand for its components is expected to expand. The market for programmable silicon processors, TI's bread and butter, will nearly triple, from $4.6 billion this year to $14 billion in 2005, according to market consultancy Forward Concepts. Predicts a confident Morales: "The market is large enough to support Qualcomm, Motorola, TI, and others."


  Merrill Lynch cut its 2002 estimates for TI from revenues of $8.7 billion and earnings of 46 cents per share to revenues of $7.5 billion and a loss of 4 cents-per-share. Yet despite TI's woes, analysts aren't worried about cash flow. At the end of the third quarter, TI had $387 million in cash and cash equivalents, and was generating more cash than it used. The right perspective for taking TI's measure, says ABN AMRO's Leming, is to forget about the next 12 months or so and concentrate on performance in 2003.

Looking long-term, on Oct. 1, Morgan Stanley upgraded its rating from neutral to outperform. "They've done an above-average job here navigating through the perfect storm," says Sheppard. TI might have to weather a few more rough quarters before the storm is over.

Kharif covers technology issues for BusinessWeek Online in New York

Edited by Beth Belton