Trend -- miniaturization of electronics. how? Tessera has developed packaging technology that allows semiconductors to be packed very tightly into a device like a handset without heat or interference worries. Other uses for their technology include packaging DDR II DRAMs because previous packaging technology could not operate at the speeds or with the level of input/output required. Tessera is coming out with next gen technology that allows even smaller electronics as well as a complete solution for handset cameras.
Packaging technology takes years to be developed and deployed because of the capital investment required by the packaging industry -- not to mention any new packaging tech has to be designed into products. The good news is that once the industry picks a solution, that technology will be in place for many years -- say 10 years.
Business Model: Of all the ways to play the growth in semiconductors I think TSRA is the best long term investment -- obviously if you want to trade the cycle this stock is not for you. Tessera is a IP royalty company meaning they license their intellectual property to those that use it. Their IP is their packaging technology. Their licenses are on a per pin connection per unit basis -- roughly 2 cents per unit given current pin counts. That means if semiconductor prices fall -- which they generally do -- Tessera's royalties do not change -- or if anything they go up because falling chip prices should mean higher unit volumes. Tessera's costs are not that great -- easily a 50% operating margin business without the need for expensive manufacturing either -- lots of free cash flow.
In 2004, the company's royalties were based mostly on handsets -- the products most concerned with miniaturization. As chips get smaller and faster, even areas not thought of as miniature -- like PCs, find that Tessera's packaging is necessary. So in addition, to the growth of handsets, the company has benefited from gaining new products that use their technology called Chip Scale Packaging (CSP). With their latest announcements, Tessera is dramatically expanding their area to include NAND flash, microprocessors, package on package, and other areas of the industry -- a potential incremental $200 mill in royalties per year.
Valuation -- I continue to think the stock is attractively valued given the high profitability, the high growth and the relatively high odds of success. I assume TSRA can earn around $3 in EPS in 2010 -- put a 24X PE on that and the stock is in the low $70's not counting a few dollars in cash. With a 50 mill shares outstanding, a 40% tax rate, a 50% operating margin goal -- to reach $3 requires over $500 mill in revenue in 2010 vs. only $200 mill in 2006. pretty good growth but its all based on the number of units that will be using their technology by then -- if you have seen a demonstration of their technology, you would agree it is very impressive. At $40.5 the stock is around 13.5X 2010 EPS -- that low $70's stock price works out to a 21% annualized return over the next 2.5 years assuming all goes as planned.
Tessera is a skate to where the puck is going kind of a company -- they pay attention to the road maps for semiconductors and by understanding physics they can predict the packaging challenges their customers will face. they then develop solutions to meet those challenges -- their customers generally do not have the resources to solve all engineering challenges -- letting Tessera do some for them speeds time to market on an area that is generally not value added (certainly not compared to the chips design or functionality). That's the beauty of Tessera's position -- to them its a great niche market with big potential but to any of their customers its not an area they can really add value -- perfect for a buy vs. build decision.
The stock has pulled back primarily in my view due to a lack of near term catalysts -- most of their new technologies will begin deployments in 2008 and their main litigations (to get some customers to start paying for using Tessera technology) are also in 2008 -- so not as much can really impact the company's numbers this year. If you can time your purchases that's great -- for me I am playing the double in 3 years and not worrying about the daily noise.
hope this helps explain my philosophy and why I like TSRA.
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