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A "fabless" brain play on Silicon Laboratories, Inc. with double-digit IPO returns!
by Siu-Yee Ng
My family, friends and I were sitting at our annual Chinese New Year's dinner. We had some of our usual symbolic dishes for a profitable and healthy New Year. I'm not a superstitious person, but it never hurts to have a little luck on your side. And it seems that making money off the stock market requires a bit of luck. Internet-related companies are trading above their valuations and word is that many haven't even made any profits.
Recent IPOs have doubled and even tripled in their debut. I wouldn't buy into this stampede, because not all are going to be around in a few years. Even a start-up online cattle company is up 180% from its IPO. Online cattle auctions — what will people think of next?
This month's IPO pick is a play on the "brains" of computers.
According to Dataquest, the overall worldwide analog and mixed-signal integrated circuits, or IC, market, surpassed US$21.2 billion in 1998 and is expected to grow to more than US$39.1 billion by 2003. Think about some of the things you use on a daily basis. Computers, cell phones, pagers, cable set-top boxes, fax machines, and automated teller machines all require a "brain."
Digital communications devices typically require mixed-signal circuits that provide analog-to-digital functionality to access the communications networks to which they are connected. Traditional designs for communications devices have used mixed-signal cŚrcuits built with numerous discrete analog and digital components. These can be inefficient and inadequate for use in markets where size, price and performance are increasingly important product differentiators.
To improve their competitive position, communications device manufacturers need advanced mixed-signal IC solutions that reduce the number of discrete components and required board space to create smaller products with improved price/performance characteristics. These manufacturers also require programmable ICs that can be reconfigured for international communications standards without altering the design of a product.
Take a look at cell phones these days. Remember the whole story with Iridium last year, when they defaulted on paying their loans? Have you looked at their cell phones lately? Iridium's satellite connection can only be used on huge old phones that weigh a ton. Who's going to carry one of those ancient phones when one can carry a smaller cell phone with more and clearer functions?
This is what communications devices face in a market that must adapt to evolving industry standards and new technologies. Mixed-signal ICs are electronic components that are capable of processing both digital signals and real-world analog signals, such as sound and radio waves.
Because analog-intensive, mixed-signal IC design expertise is difficult to find, these manufacturers increasingly are turning to third parties to provide advanced mixed-signal IC solutions. Designing the analog component of a mixed-signal IC involves complexity and difficulty, because the performance of an analog IC depends on the creative analog expertise of engineers to maximize speed, power, amplitude and resolution within the constraints of standard manufacturing processes.
In this tight job market, good help is already hard to find. But finding engineers with the required level of expertise and skill to develop the analog design is practically impossible. Many third-party IC providers lack sufficient analog expertise to develop mixed-signal IC solutions. So manufacturers of communications devices are often faced with inadequate mixed-signal solutions and are challenged to find third-party providers that can supply them with mixed-signal ICs with greater functionality, smaller size and lower power requirements all at a reduced cost and time-to-market.
Brain storming
Silicon Laboratories, Inc. (SLAB-NASDAQ) designs and develops proprietary, analog-intensive, mixed-signal integrated circuits, or ICs, for the growing communications industry. Silicon expanded its effort from not only initially developing IC solutions for the personal computer modem market but are now applying its mixed-signal and communications expertise to the development of innovative IC solutions for other communications markets with high growth potential, such as cellular telephones and network access applications. Silicon's customers include Intel, Lucent, Motorola, PC-Tel, SmartLink and 3Com.
Within the semiconductor industry, Silicon is known as a "fabless" company, meaning that it does not fabricate the semiconductors that it designs and develops, but instead relies on third parties to manufacture its products. Silicon designs and creates analog-intensive, mixed-signal IC solutions that communications device manufacturers use. Silicon combines this analog and mixed-signal expertise with standard CMOS manufacturing process technology to develop innovative mixed-signal IC solutions.
Smaller is better
Silicon is organized into two principal divisions, the Wireline Products Division and the Wireless Products Division. Its Wireline Products Division commenced research and development for its first IC solution, the direct access arrangement, or DAA, in October 1996. Many of Silicon's wireline products are designed for use in analog modems, which enable the transmission of digital data signals over wireline telephone networks and are used in a majority of Internet connections.
Three fundamental components of the modem provide software algorithms, a direct access arrangement, or DAA, and an analog/digital converter. Complex software algorithms reduces noise interference and echoes in the telephone network. Since the telephone lines fundamentally transmit analog signals, and computers use digital transmissions, modems require analog-to-digital and digital-to-analog converters, or coders/decoders, that are referred to as codecs.
A modem transmits analog signals from a codec to the telephone line through a DAA. Silicon offers a variety of modem products that include the DAA and codec functions, which are software programmable to meet international regulatory specifications. The company introduced its DAA solution in the first quarter of fiscal 1998, and first received acceptance of this solution in March 1998. The first commercial shipment the DAA solution was made in April 1998.
In September 1998, Silicon introduced an international version of its first DAA product. Based on the success of its DAA solution, Silicon became profitable in the fourth quarter of fiscal 1998 and has been profitable in each succeeding quarter through the quarter ended January 1, 2000.
In fiscal 1999, Silicon's Wireline Products Division introduced two additional IC solutions, the voice codec and ISOmodem solutions
The subscriber line interface circuit, OR SLIC, provides the analog telephone interface on the source end of the telephone line. The primary functions of a SLIC are to ring and provide power and signaling (such as caller ID, dial tone and busy tone) to the telephone. Traditionally, SLICs have been produced with an expensive high voltage IC accompanied by a CMOS codec IC and requiring as many as five voltage sources.
In January 2000, Silicon's Wireline Products Division introduced its ProSLIC product. Silicon's ProSLIC has been designed as one integrated CMOS chip, eliminating the need for a high voltage IC and requiring only two voltage source. The result is a smaller, more reliable and less expensive solution.
Wireless penetration
A variety of cellular communications standards are employed around the world. The most popular standard used today is the Global System for Mobile Communications, or GSM, standard, which was first deployed in Europe and is now available in several countries throughout the world.
Manufacturers continue to introduce new cellular phone models that offer smaller form factors and longer battery life at lower costs. These market dynamics drive a need for new highly integrated electronics that reduce component count and consume less power. And Silicon's Wireless Products Division introduced its RF synthesizer solution designed to serve this need.
Still growing
Silicon markets its products to original equipment manufacturers and other solutions providers for applications in both the wireline and wireless communications markets.
Most sales are done through a direct sales force. Three sales offices are maintained in North America, and European direct sales are conducted through its United Kingdom subsidiary. Independent sales representatives and distributors are also used to generate sales.
The percentage of Silicon's sales to customers located outside of the United States was 7% in fiscal 1999 and insignificant in fiscal 1998. All of Silicon's sales to date have been denominated in U.S. dollars. But expect a greater international penetration as Silicon's products gain acceptance.
It worries me a bit to see that a small number of customers accounted for a large portion of Silicon's sales. During fiscal 1999, three customers accounted for 84% of Silicon's sales. I expect to see more customers with the introduction of Silicon's new products.
But if any of these major clients decrease its order it can adversely affect Silicon's profits. PC-Tel recently announced that, while Silicon Laboratories is currently the sole supplier of the direct access arrangement, or DAA, IC solution used in PC-Tel's products, PC-Tel is in the process of qualifying a second source for its DAA IC requirements. If this in fact happens, Silicon may be forced to lower its prices and sales volume could decrease.
Despite these worries, the numbers look good. Sales increased US$41.3 million, or 736.4%, to US$46.9 million in fiscal 1999 from US$5.6 million in fiscal 1998. Gross profit increased US$27.9 million, or 861.7%, to US$31.1 million in fiscal 1999 from US$3.2 million in fiscal 1998. Gross margins improved to 66.4% in fiscal 1999 from 57.7% in fiscal 1998.
Going to court
Another factor that worries me a bit is the lawsuit filed on January 12, 2000, against Analog Devices and 3Com claiming that Analog Devices has infringed, and is continuing to infringe, on the U.S. patent to Silicon's DAA technology. The lawsuit also claims that Analog Devices and 3Com have misappropriated Silicon's confidential information, know-how and trade secrets.
3Com is one of Silicon's key customers, and 3Com may decide to cease its purchase of Silicon's DAA solution. But I like what Silicon has to offer and I expect the company to be a major competitor in the semiconductor industry.
Teamwork
I like seeing that the management team has been working together prior to Silicon Laboratories. The CEO and Chairman of the Board co-founded the company in August 1996. From March 1985 until founding Silicon Laboratories, he held various positions at Crystal Semiconductor/Cirrus Logic, a designer and manufacturer of integrated circuits, including vice president of engineering, as well as product planning manager of strategic marketing and design engineer.
Another co-founder has served as Silicon's vice president of engineering and as a director since its inception. From October 1989 until founding Silicon Laboratories, he held various positions at Crystal Semiconductor/Cirrus Logic, including vice president of engineering (computer products), design manager and design engineer.
The third co-founder has served as the company's Vice president of technology and as a director since its inception. From November 1991 until founding Silicon Laboratories, he held various positions at Crystal Semiconductor/Cirrus Logic, including senior design engineer.
The Vice President and CFO has served since December 1996. From February 1985 to September 1996, he held various positions at Crystal Semiconductor/Cirrus Logic including vice president of finance and division controller.
Directors include a general partner of various funds associated with Austin Ventures and a general partner of InterWest Partners, a venture capital firm. We'll keep an eye for any new additions. Morgan Stanley Dean Witter, Lehman Brothers and Salomon Smith Barney are the underwriters. Silicon is expected to raise US$80 million in its IPO but no price or date has been set yet.
For more information after the quiet period contact Silicon Laboratories, 4635 Boston LN., Austin, TX 78735; phone: 512-416-8500 or 877-444-3032; fax: 512-416-9669; website: www.silabs.com.
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