We’ve been significant investors in Zarlink (ZL) since this fall and feel it is one of the stronger examples of an undervalued comm-semi asset poised to benefit from an inevitable consolidation in the industry. Followers of this site know this is a key theme for us.
Zarlink CEO Kirk Mandy managed to echo our logic in the Zarlink FQ307 financial results conference call last week.
At the equipment OEM level, we have Alcatel and Lucent merging, Eriksson buy Marconi and Redback, Nokia and Siemens forming a joint venture, and these are some of our customers and they are dealing with a great deal of uncertainty in their businesses. This uncertainty directly impacts our order book.
The other thing that is happening as a result of this consolidation phase is that each of the new entities is evaluating which platforms stay and which go as they have at least two sets of everything after merging. Two digital loop carriers, two DSLAMs, two media gateways, et cetera, et cetera. Again, this is a disruption to the usual OEM business and impacts suppliers.
The other thing that is missing in this cycle is the significant R&D projects that we have seen in the past. Instead of large-scale R&D projects that spur the development of new platforms, for example what many have said BT’s 21st Century project will eventually encourage, the OEMs are making incremental changes to their existing platforms, what is typically called value engineering, focused on reducing product costs.
The semiconductor industry is going through its own fundamental change as well. We have lived in an environment for the past 30 years that enjoyed double digit growth year over year. This is no longer the case. A new expectation has to be set and this industry will have to come to grips with working with single digit growth rates. In addition, there are too many players at the moment, all competing in markets that are too fragmented and earning a market share that is too small.
This type of communication is remarkable only in sense that other companies like AMCC (AMCC), Transwitch (TXCC), Vitesse (VTSS.pk), Exar (EXAR) and PMC-Sierra (PMCS) have been silent about these trends, and why their business models have failed to return to significant profitability. While the message isn’t surprising, the fact that the participant companies are finally delivering it is.
Though few like to admit it, wireline communication is rapidly becoming a commodity business, from the component level right up to the service delivery of broadband itself. Unique widgets, protocols, and boxes tied to the transport layer are a liability, not a strength, unless they deliver a ridiculous amount of upside, and I can think of no such examples.
Full Disclosure: The author is long VTSS and ZL.