Salomon Smith Barney yesterday initiated coverage of DSP Group (Nasdaq:DSPG) with a high Risk Buy and a price target of $30. The target is 30% above DSPG's closing price yesterday.

The combined value of DSPG's two operating units, its cash and interest in AudioCodes (Nasdaq:AUDC) is greater than its market cap, wrote write analysts Victor Halpert and Robin Nazarzadeh. Conclusion: Given that, its reliable performance and its discount relative to peers, DSPG has upside potential. SSB set a target market value of $850 million or $30 per share, compared with DSPG's Wall Street market cap of $630 million, or $23.5 per share.

DSPG's core activity is developing chips for digital signal processing. Integrated digital telephony speech processors comprise 95% of these sales. The IDT chips are incorporated in more than 90 phone models, including mobile phones.

SSB evaluates DSPG's fabless semiconductor production at $435 million. The U.S. Semiconductor Industry Association estimates that DSP sales worldwide will rise 25.6% by 2004 to $8.1 billion, from $4.1 billion in 2001. The industry's main catalyst is digital cellular phones, which all contain DSPs.

Another key source of income for the Israeli company is licensing and royalties. Its chief customers include Intel (Nasdaq:INTC) unit DSP Communications (an Israeli company that Intel bought in 1999) and Infineon Technologies (NYSE:IFX) (formerly Siemens Semiconductor Group).

SSB believes that the SIP market will significantly grow as competition intensifies and new products roll out fast, at lower development costs.

DSPG ended the third quarter with $239.9 million cash. It owns 4.45 million AudioCodes shares (11%). The cash and AudioCodes stake alone call for a higher pricing for DSPG, say the analysts.

Granted, SSB rates DSPG as a Buy, but a high-risk one. One reason is the fierce competition in the DSP sector. Veteran players such as Texas Instruments (NYSE:TXN) could introduce parallel product lines. Because of their greater financial, marketing and development resources, they could engender rapid technological developments that leave the smaller Israeli company gasping their dust, or simply lead to lower prices.

Another risk is DSPG's reliance on one key distributor, Tomen Electronics, which is expected to account for 54% of DSPG's revenue in 2001.

The investment house predicts 2001 revenue of $114 million, climbing to $125.4 million in 2002. It expects earnings per share of 79 cents in 2001, slipping to 77 cents in 2002.