Atheros, the Giant Killer

The chipmaker has begun to sling stones at its competitors.
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For years,

Atheros

(ATHR)

has lived in the shadows of giants.

The list of primary competitors in its annual report is a who's who of silicon bruisers including

Intel

(INTC) - Get Report

,

Broadcom

and

Texas Instruments

(TXN) - Get Report

.

Now Atheros has another Goliath to contend with: Last week,

Qualcomm

(QCOM) - Get Report

jumped into the mobile wireless-networking market with its acquisition of

Airgo

.

For Atheros, which itself hopes to bulk up by expanding into a few carefully selected markets, such as Wi-Fi in cell phones, Qualcomm's purchase represents an unwelcome turn of events.

Instead of running for the hills, Atheros investors had bid the stock up more than 6% by the end of the week in which the news came out.

CEO Craig Barratt says the company has proven that it can hold its own with the big kids.

"We know how to play this game," Barratt says. "It's part of our DNA."

After all, the Santa Clara, Calif., company's core business consists of Wi-Fi chips for PCs, a market that Intel dominates through the Centrino chipset it pushes into notebook computers.

That hasn't stunted Atheros' growth: In its most recently completed quarter, sales were up 74% year over year at $79.6 million.

Atheros says it has benefited from the exposure that the Intel marketing machine has brought to the technology, stoking demand for various Wi-Fi products that Atheros chips sell into, such as the wireless home routers offered by Internet service providers.

And the rapid pace of innovation in the wireless-networking business leaves room for small companies like Atheros to serve the high end of the market, where average selling prices are richer.

"The bigger players tend to be slower when they come to market," says Barratt.

One Up on Intel

Today, for instance, Atheros provides Wi-Fi chips based on the draft standard of newer 802.11n technology, something Intel is not expected to have until next year. This allows Atheros to sell chips into certain

Lenovo

ThinkPad notebooks, even though much of the ThinkPad line features Intel's Centrino.

Barratt envisions a similar dynamic with its newest competitor, saying the Wi-Fi cell-phone market can accommodate big players, such as Qualcomm, without cutting Atheros out of picture.

Of course, until last week, Qualcomm was Atheros' ticket to ride in cell phones -- the companies have a partnership in which Atheros provides standalone Wi-Fi chips for a Qualcomm cell-phone reference design.

That partnership now looks doomed, say Wall Street analysts, given that Qualcomm will likely shift to using the technology it acquired with Airgo.

But given that the market for so-called dual-mode cell phones, which feature Wi-Fi chips, is still in its infancy, Atheros still has ample time to get designed into phones from other companies, says Deutsche Bank analyst Jonathan Goldberg, who rates Atheros a buy.

According to Barratt, Atheros' low-power Wi-Fi chips will be designed into a dual-mode handset offered by a major Japanese carrier next year. A digital camera from a top-tier company available next year will also feature Atheros' Wi-Fi technology.

Wi-Fi chips for mobile consumer electronic devices are one of several markets that Atheros has set its sights on in a plan to diversify.

In October, Atheros acquired Taiwanese network-equipment chipmaker

Attansic Technology

for $72 million in cash and stock. And showing a flair for suspense, Atheros has promised to unveil a mysterious new product line in January.

Barratt acknowledges that examples of chip companies successfully diversifying outside of their core business are rare.

Two oft-cited success stories,

Marvell Technology

(MRVL) - Get Report

and Broadcom, created businesses based on multiple product lines practically from day one, says one chip-industry veteran.

That means their mind-set, engineering resources and manufacturing strategy -- not to mention credibility with customers -- were all designed for efficient innovation across different markets, something that isn't necessarily the case with Atheros.

And while Atheros' skills and background make it well-positioned to move into related wireless markets, picking a wireless standard that evolves into a mass market can be a gamble.

There are various new wireless standards in development throughout the industry, including WiMax, ultrawideband and 60Ghz. A bet on the wrong horse could be devastating to the company.

Deutsche Bank's Goldberg speculates that the secret new product could involve Bluetooth technology -- not a particularly high-margin business but a safe choice, given that the market is already established.

"Bluetooth, in our view, would be a good start, especially if they announced design wins or at least an integrated WLAN/Bluetooth chip," Goldberg wrote in a recent note to investors.

Barratt expects the forthcoming product, which he says was internally developed at Atheros, to contribute to revenue by the end of 2007.

That would bring Atheros closer to its dream of growing into a bigger player. First, though, it must continue to duke it out with the giants.