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The Rise of the (Tiny) Machines

By Benjamin Shepherd on April 18, 2016

How to ride the $1 trillion explosion in the Internet of Things

It the Internet of Things weren’t reality, it would sound like the plot of a science fiction movie. Silently, and all around us, our devices are starting to talk to each other. Trading information, planning and alerting each other at crucial times.  

The Internet of Things (IoT) is bits of computers embedded in everything from appliances to roads to clothing. Roads are being built with embedded sensors that alert smart devices to weather and traffic hazards; cars have sensors that collect data to warn of impending failures; an IoT-enabled house can warn about fires or water leaks; and your fridge can tell you if you’re low on milk. 

Globally, the IoT market is about $700 billion today, and will grow to $1.7 trillion in just four years, according to research firm IDC. The number of gadgets or machines with IoT technology, called “endpoints,” will triple from 10.3 billion in 2014 to 29.5 billion in 2020, the firm predicts.  

But as ubiquitous as the IoT is, riding that $1trillion boom can be frustratingly elusive for investors, because it is so ubiquitous. It’s a part of so many companies you’re only getting a faint taste of IoT if you invest in a company like an Apple or Whirlpool. And many purer play IoT companies are overvalued. 

But then there’s Silicon Laboratories.

With a market cap just shy of $2 billion, Silicon Laboratories(NSDQ: SLAB) it isn’t the biggest player in the IoT but it makes microcontrollers (MCU) – the little chips that power the IoT – that can be used in a whole host of applications and low power sensors.

It also has other products used in big applications like infrastructure controls and factory automation. You’ll find its chips and other products in a host of smart devices, televisions and radios, cars, factories and data centers. 

And like IoT, it is ready for a breakout.

As we all know, timing can be everything when it comes to buying tech stocks. Especially when it comes to companies like SLAB whose financial success is largely dependent on how quickly the other participants in its ecosystem are able to develop products that use SLAB technology.

A quick peek at SLAB’s five year trading history reveals that for most of that time its share price has been range bound between $40 – $50. That type of temporary holding pattern is not unusual for tech stocks, and similar droughts can be found in the charts of companies like Apple and Microsoft that eventually busted through to greater heights.

The best time to buy companies like SLAB is just when the rest of the field catches up to it, because that’s when earnings can explode to the upside. Apple didn’t invent the smartphone, but once it was able to assemble all of the apps necessary to make it something much more useful than just a mobile telephone its profits shot through the roof. 

The company is a great play on IoT because it addresses many of its potential limitations: power, connectivity and flexibility. SLAB’s products use relatively little electricity, so they are not a power-suck and last longer periods without recharging. They are capable of connecting to the Internet in a number of ways.  And they offer a suite of tools to help designers integrate their MCUs into new products and applications. So while Silicon Laboratories is a growing player in the IoT field, and investors can get good participation in the revolution, it’s not the company’s only line of business so it can weather the ups and down of this burgeoning industry. 

The IoT is still evolving. So companies that will be using the MCUs that drive it will be coming and going for a while. That makes Silicon Laboratories revenue mix a real asset for investors since while there are going to be bumps here and there, but it shouldn’t be anything major for the company.

Since 2008, the IoT has gone from 17% of revenue to 41% last year. Infrastructure is also up from 8% to 19% over the same period. More traditional applications, like the chips used in radio and television tuners and voice and data applications, have declined steadily as a portion of revenue, down from more than half to only 30% in 2015. 

Of course, no company in this industry is going to post cash flow and sales with metronome-like regularity like an insurance company. Silicon Laboratories has been cash flow positive since 2000, though its earnings have been lumpy despite steady revenue growth. Revenue has grown annually at an average rate of 4.3% over the past decade, though earnings have declined 2.2% over the same period. That’s a function of the company’s heavy investment in research and development, which typically runs at about 30% of revenue, and the higher expenses that have come along with Silicon Laboratories fairly rapid growth. 

I have no doubt that Silicon Laboratories will take a nice slice of that $1 trillion IoT pie being delivered over the next four years. All that IoT data is going to have to be stored and processed somewhere. So demand for Silicon Laboratories’ MCUs, sensors and data center equipment is only going to continue to grow. 

But also, it’s a takeover target. 

I wouldn’t be surprised to Silicon Laboratories bought out by Alphabet, Apple or many other major tech companies. As a pioneer in mixed signal and radio frequency technology, the company is rich in intellectual property with more than 1,500 patents. While those patents are already valuable, as the number of smart devices grows someone will eventually want to simply own those patents instead of paying to use them. That’s especially true since Silicon Laboratories invests so much in R&D, so its intellect property value will only grow.

Enabling the rise of billions of tiny machine to increasingly connect our world, Silicon Laboratories is a buy up to $55. 

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