has been left on the sidelines as shares of its communications-chip competitors have soared. So Exar figured focus was the answer.
To move headfirst into the steaming communications-chip business, the Fremont, Calif., firm sold one of its analog divisions in November. That divestiture was just one part of a two-year turnaround aimed at extricating Exar from the business of building custom products and positioning the company in higher-margin standard-products markets. Communications chips help speed the transfer of voice or data over communications networks. Exar also makes chips for low-power, high-performance digital cameras, scanners and other gadgets.
The long-term potential of communications chips has sent the sector soaring. Competitors
have seen their shares roughly triple since October, and
, in its largest acquisition ever,
bid $2.2 billion last week for network chipmaker
. Exar initially saw some gains in late October but has sunk back. It closed Friday off 1/4 at 14 3/4, just above its 52-week low of 12.
The transition hasn't been easy. Along the way, the stock was chopped in half, revenue dropped by 40% in the most recent quarter as the company sold product lines and the workforce shrank 25%. All those factors helped push the stock out of the minds of many money managers. But some value investors are sticking it out, and Exar executives are convinced that the worst of the transition is behind them.
"We have hit the bottom and see upward movement," says CEO Donald Cliffone. "We're encouraged from a design perspective and new product perspective."
In just two years, the proportion of revenue generated by communications chips jumped to about 70% from about 30%. Of that, about 40% is from the hot broadband communications area, making chips for telecom equipment makers.
Some of Exar's largest customers in this market include
. And Ali Far, an analyst with
who rates the stock accumulate, expects communications-chip revenue to account for 75% of Exar's total revenue by the end of fiscal 2000. Prudential has done underwriting for Exar.
Exar expects earnings for the year ending next March to climb 15% to 20% from 1999 levels. That growth rate is slightly more bullish than analysts expect: According to
, the company is expected to earn 57 cents a share this fiscal year ending in March, and 64 cents a share in fiscal 2000, representing a 12% increase. In fiscal 1998, Exar earned $8.2 million, or 85 cents per share, excluding charges.
Exar's trailing price-to-earnings ratio is 23, compared with an industry average of 35. Competitor TranSwitch has a P/E of 94. Exar's price-to-book value ratio is 1.2, compared with an industry average of 8.5. TranSwitch's price-to-book value ratio is about 15.
And Exar has $78 million in cash. That should rise to between $80 million and $90 million during the next quarter, says CFO Ron Guire, and the company could look for acquisition targets.
Exar also expects 20% annual growth in the communications business. As it completes its transition by eliminating older products, revenue from those operations is expected to decline by about $1.3 million in the fiscal fourth quarter and $1 million per quarter through most of fiscal 2000. That loss of revenue will likely offset growth from the communications business, which means revenue could be flat through fiscal 2000's end.
"But they are getting better quality revenue as they transition out of the legacy products," says Mitali Prasad, equity analyst and assistant portfolio manager for
David L. Babson & Co.
, which owns 1.3 million shares in its
Babson Enterprise II fund.
In the March quarter a year ago, the company reported revenue of $25.1 million, and, in the most recent quarter, Exar reported revenue of $15.8 million. But the overall revenue decline is behind the company, says Far at Prudential, and the gross profit margin will continue to improve as newer products make up a larger percentage of the business. Prior to the transition, the gross profit margin was about 40%; in the December quarter, it reached 53% and should climb to the mid-50s by year-end, says CEO Cliffone.
"It's a neglected turnaround story: Investors want the hot stocks," says Prasad. "Going forward, they have the right products in place. Now they need to get the orders."
Even a pessimist who doesn't see a huge upside (and even called the company "the
Rodney Dangerfield of analog") doesn't see much downside. "It's a solid company, and it's not going anywhere," says a buy-side analyst who requested anonymity. "But would I buy it? No. Would I short it? No."
But he thinks it would make a great acquisition target for a company that needs more analog expertise. "They do have some products and do have some revenues, but
on their own they haven't been able to generate returns on their assets," the analyst says of Exar. "And you can buy it for two times book value."
And an acquisition at two times book value would represent a hefty premium over the current price. The company is open to that option. "I don't think anyone's immune to the consolidation that's occurring," says CEO Cliffone. "Long-term, that is a possibility. But we're focused on driving the business forward."