The investment thesis is here a direct play on data connectivity, not only in mobile but also in emerging applications such as automotive, home and factory automation, infrastructure, defense, medical, smart energy, etc.
With data speed that is up to x100 faster than 4G, and much higher connection density, 5G and IoT represent secular tailwinds for top tier suppliers. In this context, Skyworks' revenue should shift to higher-margin products, while its integrated front-end solutions will become even more valuable to original equipment manufacturers.
These manufacturers — such as the likes of Apple, Samsung, etc. — have thus far shown a demonstrated willingness to pay for best-in-class, reliable and integrated technologies due to rising expectations from end-consumers and pressures from carriers, whose brand equity os at stake whenever network access or connectivity disappoints.
The increasing complexity of connectivity infrastructures — with each new standard requiring a wider variety of spectrum and frequency bands — also increases the amount of RF contents per device. Just for mobiles, and in average, the latter grew from $3 per device at the time of 2G to an average of $20 per device nowadays.
The 4G standard was introduced a decade ago. Skyworks has grown revenue at an average clip of 12% per annum over the period. While it is impossible to accurately quantify the impact of 5G on revenue, it seems reasonable to assume that this healthy dynamic will last, due to the larger volumes of devices and modules per device.
Furthermore, the RF semiconductor industry has consolidated and is close to turn into an oligopolistic setup. In conjunction with increasing demand, this could lead to additional economies of scale and insulate dominant players from pricing pressures. All in all, Skyworks has good reasons to believe that it will be able to safeguard its attractive margins.
Increasing complexity in architecture design is also acting as a barrier to entry, and should keep new entrants at bay. Without the technical know-how, industry reputation and industrial scale of market leaders, smaller contenders lack the capacity to absorb notoriously short product cycles.
As about risks, the said short life cycles of RF products, especially smartphones, means that trends in revenue and earnings may prove volatile. In the past, such cyclicality has created attractive entry points from time to time, but the market is nowhere near the bottom currently.
In addition, and obviously, technology companies are always exposed to losing relevance in the marketplace — if not outright obsolescence. Qualcomm, for instance, has long dominated the high-end 4G smartphones with its baseband solutions before getting displaced by RF technologies.
Finally, a very small number of original equipment manufacturers have historically accounted for a significant portion of Skyworks' business, with three names — including Apple — accounting for more than two-thirds of turnover. Customer concentration is by far the biggest risk in this case — one that prospective investors must carefully contemplate.
Still, Skyworks sits on a fortress balance sheet — with zero debt, and cash and equivalents covering all liabilities — and constantly delivers returns on equity above the 20% threshold. Capital allocation remains heavily geared towards share buybacks, as valuation has only exceeded x20 earnings last year.
(A word of caution here: to some extent, and as often with technology companies, the purpose of share buybacks is largely to offset dilution caused by hefty stock-based compensation; in that respect, shareholders pay management a loftier price than what appears at first sight.)
Assuming that growth continues at a similar pace, forward multiples — x20 earnings for 2021 and x19 earnings for 2022 — may prove unduly conservative, although in line with historical averages. It is true that consumers may soon be buying less smartphones — given high equipment rates — and that the 5G upgrade is taking time.
In effect, carriers worldwide are unsure about when to launch the next generation of networks. The boom in data demand will require another capital spending cycle, but paying for equipment implies that subscribers show some willingness to accept price hikes. As of today, that isn't exactly the case.
Nevertheless, analysts — whose consensus is surveyed in real-time by MarketScreener — have recently revised their short-term earnings estimates upwards, creating a positive price action that called for an addition of Skyworks's shares into MarketScreener's U.S. portfolio.