While I’m recovering from my surgery this week I asked a fellow Atlanta blogger to provide a guest post. Zachary D Scheidt, CFA blogs at ZachStocks.com and is the Principal and Chief Investment Officer at Sound Counsel Investment Advisers. With a background managing capital for both individual clients and hedge funds, Zach focuses on new issues and rapid growth opportunities. Contact Zach at growth@zachstocks.com. You can sign up for his newsletter at here.
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As US indices continue to climb higher, it is becoming increasingly difficult to find buy candidates that are trading in healthy patterns and can still be bought for a reasonable fundamental price. Many of the speculative names have been bid to levels that imply too much risk, and stocks that are trading at a lower PE are usually priced that way because of a problem with future growth.
But not Atheros Communications (ATHR). The technology firm has a very unique product that allows consumers to use the electrical grid in their house as a means of bandwidth. Imagine plugging your home router into the socket in your office, and streaming video to your television in your bedroom. All without the headaches and service disruptions of a wireless router or some other form of transmission!
Far from a “one hit wonder” ATHR actually creates chips for a number of different communication mediums such as Bluetooth, WiFi, Eithernet etc. But the recent $240 million dollar acquisition of Intellon in December allows ATHR to now market this new electric grid technology. While the acquisition is only expected to contribute $20 million in revenue for the first quarter (about 10% of expected sales), the long-term potential for this cutting edge technology is exciting.
Most of Atheros’ previous growth has been from designing wireless chips for low-end laptops. That market can continue to be a cash flow driver, but management expects future growth to come from the explosion in smart mobile devices and the need for these devices to communicate on multiple types of networks.
Most new smart phones today have the capability to connect to WiFi networks as well as cellular telecommunications networks. And consumers are increasingly considering these devices to be “staples” or non-discretionary items in order to stay in communication from both a personal and a professional standpoint. Atheros is seeing demand accelerate both domestically and internationally which has led to a sharp increase in revenue and earnings.
Atheros considers itself to be a “fabless” chipmaker, meaning that they do not actually own their manufacturing facilities. This can be either a wise business decision, or a liability depending on the market environment. For difficult periods like the credit crisis of 2008, firms without heavy overhead burdens (such as the debt that usually accompanies a manufacturing plant) found themselves under huge fiscal pressure. Atheros was able to escape that issue and continued to grow earnings in 2008 and 2009.
However, during periods of rapid economic growth and full capacity utilization, it might be hard to find a fabrication facility that would be willing to contract out for a reasonable price. Supply and demand issues cause a little bit more uncertainty, but I would take that uncertainty over the financial burden of purchasing a new facility.
The stock is currently attempting to push through $40 which is a new all-time high. But despite the rapid stock increase, ATHR is still trading for less than 20 times 2010 expected earnings. And with a growth rate of 55% this year, the multiple certainly looks attractive.
Next year analysts expect growth to moderate to only 11%. The view is that the expansion of mobile phone purchases will back off a bit and ATHR will see its revenue stabilize. But the potentially huge market for electric grid chipsets could turn out to be the growth driver in 2011. And while there is uncertainty surrounding the 2011 revenue stream, the market appears to be accumulating the stock with mutual fund managers adding to their positions.
I would recommend buying ATHR as it breaks through this level, but only risking about $4.00 per share on the purchase. If ATHR backs off and hits $36, it means there is less institutional support than I expected and it will be worth stepping away from the position until the future earnings stream becomes more concrete. But if ATHR continues to push higher as I expect, we could soon see ATHR trading at 30x the 2011 estimates which would put the price north of $65.
Risking $4.00 for a potential $25 gain is a fairly good trade in my opinion.
FD: Author does not have a position in stocks mentioned
I trust all went well with your surgery… a good post too from your friend… I’ll have to do some looking on this one!
I had some complications after the surgery and had to go back into the hospital for a couple of extra nights after they did some clean up. I got back home on Friday, 4/9. I hope to be back to trading/blogging soon. I’m still on a liquid diet as of 4/11 though.