Sigmatel

Billy and his friend Gary have written me about Sigmatel (SGTL). To quote SigmaTel.com "SigmaTel offers a wide range of mixed-signal ICs that convert real world analog signals, such as music and voice, to digital signals required by computers for processing and playback." In other words, they make MP3 chips and the like.

Billy writes (edited): How come Sigmatel seems to be making so much money and has such a low stock price? The interesting thing is Portal Player (PLAY) makes the chip inside the iPod, and Sigmatel makes the chip in the iPod shuffle. Portal Player has a much higher PE. Insiders are selling in both companies, but $$ amount for both is not much in either case. Sigmatel is going after the low end market mostly Chinese manufacturers. Next week Sigmatel announces earnings. I expect they will be good. Engineering is done. They are turning the crank now. This isn’t the next Microsoft, but I think the market has more lasting power than conventional wisdom suggests. Very few people saw cellphones as the mass market it has become. 775 Million phones will be built this year. They also make the chips that enable flash memory USB devices as well as AC ’97 codecs. All these are huge volume low margin chips that should be subject to serious competition. As their balance sheet looks good, they probably pay their bills at the FAB.

So what were the earnings? According to earnings.com, Q2 earnings were reported July 26th as $0.30 versus expected $0.31 and last year's $0.24. So up 25% on the year ago, but missed the estimate by a penny.

Gary writes (edited): The market believes the iPod phenomenon is nearing its end so they are cautious of their suppliers like SGTL and PLAY. If the mp3 market is going to replace the portable cassette/cd market, there is plenty of growth left. PLAY is still risky because they are dependant on AAPL. SGTL has a broad customer base.

My thoughts: SGTL is trading today at nearly $20. Book value is $6.34. P/E is 10. My Buffetology calculations show an estimated 5-year rate of return of 16.5%, which is good but not great. It's a solid stock, financially, but I have my doubts about their prospects. What is unique and good about their products? What are the barriers to entry in this market? Do they own significant intellectual property, or is it all standards-based? They hire out the chip fabrication. What's to stop any of the much larger semiconductor companies from muscling in if there are big profits to be made? All in all, the Pokeypine is neutral.

One interesting possibility is to do a spread: buy SGTL (forward P/E 13,35, P/S 2.29) and short PLAY (forward P/E 16.96, P/S 3.35). One should do an equal dollar amount of each. Assuming their prospects are similar, SGTL should rise relative to PLAY. SGTL closed today at $19.76, PLAY at $23.40.