Article in Saturday's G & M!!IMO Dunnery is usually right on the money! Happy reading! Cheers!!!
ATI cheap by tech standards
Thornhill, Ont., specialty chip designer a good bet
Dunnery Best
Saturday, July 31, 1999
Broadcom Corp. designs and sells computer chips used in communications equipment. The company's areas of specialization include networking chips, digital subscriber line technology, terrestrial/satellite TV broadcasting and the new frontier of cable set-top boxes, which merges cable services with the Internet. This is cutting-edge stuff, and Broadcom has fared well. It's trading in the $120 (U.S.) range, having lately retreated from a high of $149.
Even after the price set-back, its shares still trade at lofty multiples. Broadcom is forecast to earn 75 cents a share this year and $1.04 in 2000. In other words investors in Broadcom are paying 160 times current year earnings estimates, and 115 times the 2000 estimates.
Now, consider ATI Technologies Inc. of Thornhill, Ont., which designs specialized computer chips and software that enhance the visual experience in computer games and other PC applications. The company sells its chips to original equipment manufacturers (OEMs) such as Compaq, Dell and IBM.
ATI is one of Canada's most successful companies. Its revenue is forecast to rise to $628-million in 1999 from $369-million in 1998, and to $785-million in 2000.
Moreover, ATI has been canny in finding areas for growth, including creation of a new chipset specifically engineered for the new set-top box market (remember, that's Broadcom's terrain). This company has $90-million of cash, no debt and worldly, proven management.
And yet, ATI now trades at 19 times the current fiscal year's earnings forecast of 72 cents a share, and 16 times estimated fiscal 2000 earnings of 85 cents, well below its estimated five-year compounding annual growth rate of 25 per cent.
This brings up the question of why ATI's earnings potential is so inexpensively valued.
In fact, comparing valuations on two impressive companies such as ATI and Broadcom provides an insight into the sometimes arcane process by which investors value growth stocks.
First, there's the issue of mailing addresses: Thornhill versus Irvine, Calif. Mostly, Canadian companies trade at a discount to U.S. players.
As well, despite its steady growth, clean balance sheet and other indicators of financial stability, the sector ATI occupies is considered to be quite volatile. That's because of the frenetically short product cycle in the chip business. A new generation arrives every six months or so.
In the brutally competitive world of PCs, you're only as good as your last chip design. So far, ATI has been very good.
And then there's the Intel factor. Mighty Intel, arguably the most powerful force in the global microprocessor business, is a small player in the graphics business. Some investors worry that Intel could suddenly switch strategies, and attack. The more reasonable view is that the Intel threat has actually subsided. ATI is now so large, and owns such a commanding lead in its niche, that Intel will likely stay away.
The particular style of high-tech investing also helps determine price. The price setters are the momentum guys. They're little troubled by valuations. The phrase price-to-earnings would never grace their speech. Instead, they look for the element of surprise, as revealed by earnings revisions. A company that stuns the street on occasion (as has been the case with Broadcom) is more likely to attract a premium price. ATI, in contrast, has become somewhat more predictable.
Despite a market cap of about $3.7-billion, ATI is relatively small. Broadcom, with a market cap of about $13.4-billion, attracts a pricing premium because of its liquidity.
And finally, there's an element of seasonality in ATI's valuations. Now we're in a quiet period, as engineers beaver away on designs for an October release. That's when heavyweights such as Dell and Compaq are in the throes of planning their Christmas campaigns.
The bottom line: ATI looks like good value. In an industry where multiples often reach nosebleed territory, it could actually be considered a conservative play.
Dunnery Best is a senior vice-president and director of Merrill Lynch Canada Inc. Merrill Lynch Canada may provide advice or underwriting services to companies mentioned in this column.