More Citigroup Commentary out this evening:
C o m m u n i c a t i o n I C ( B R C M , M R V L , S L A B )
Sector Thesis and 2008 Stock Opportunity - While CommIC was a source of significant volatility and repeated disappointment 2007, we expect a forming R&D pay-off in wireless investments to deliver some of the best YY revenue comps and operating margin expansion in semis in 2008. In addition, both BRCM and MRVL benefit from solidifying new management (BRCM = CFO, MRVL = CFO, COO, new Board members).
While investor confidence was significantly damaged in the past 18 months, it can recover if margin leverage returns as we expect. A near-term risk is aggressive January quarter Street estimates for MRVL, though as these rationalize the shares should continue to trade higher on 2008 and 2009 prospects.
* Our BRCM investment thesis is that 2008 will be a year of modest though accelerating base band pay-off, accelerating YY comps (to the high-20's) and that visibility into 2009's revenue growth and target margin model attainment (helped by WLAN, DTV, Bluetooth, and navigation demand) can drive strong share appreciation. We believe shares over-reacted to 4Q07's revenue and margin outlook, and based on our valuation analysis are now within 10-15% of trough levels, trading at 22.8x our 2008E EPS estimates and at 3.9 EV/Sales (31% and 27% below long term medians). The 45% ETR to our $49 target(comprehends full Verizon licensing payments (Street estimates do not) creates an attractive risk/reward equation in this long-term call. Upcoming milestones include November 8th Analyst Day, and product news at CES and 3GSM in January and February, 2008 key events ahead.
* Our MRVL investment thesis is that broad-based revenue growth, steady sequential operating margin expansion totaling 500 bps next year (to 16.1%), helped by improving handset gross margins and controlled operating expenses, can drive share appreciation into the low-20's on a 12-month basis. Recall we trimmed revenue estimates last week on Marvel's January quarter, recognizing the predilection for more conservative than modeled guidance and also anticipating that a new CFO would take a conservative tack in setting expectations. The stock could be volatile in the next month as competitors take this same approach, though the shares are up 12% QTD (vs -8% for the SOX and 1% for SP500) suggesting that investors are starting to look through near term estimate revision risks toward a more material and longer-duration fundamental turn for the company. MRVL remains rated Buy, though with potential for a negative Street reset we would look to add to positions following the next call.
Investment Framework - Our investment framework rests on potential for company-specific new product revenue growth drivers and operating margin expansion against a backdrop of favorable secular communications applications drivers (handsets, home and enterprise networking, digital TV), and technologies (WLAN, Bluetooth, DTV, navigation).
Reporting Outlook and Implications - Company-specifics came to the fore in 3Q07 results and 4Q07 outlooks, a theme that should persist in 2008. On the positive side, the demand backdrop looks healthy all- around (ATHR (NR), BRCM, SLAB). Further small companies (ATHR,SLAB) are generating growth and leverage, in SLAB's case, harvesting a pay-off from 2006 and 2007 microcontroller, broadcast, and networking R&D. The flip side of this coin is that BRCM and MRVL are presently struggling with high handset investments which are deflating gross margins (MRVL), inflating operating expense (both), and therefore muting operating margins (both). However, we think both companies will begin to better harvest top line growth and margin leverage in 2008, a basis for our constructive stance on both names.
