On April 21st Texas Instruments (TXN) issued disappointing Q2 guidance that sent the shares down nearly 7% the next day, per Barron’s Tech Blog:
CEO Rich Templeton noted the forex problem and the areas of weakness:
Automotive and industrial markets were strong, as we expected they would be. Revenue, however, was in the bottom half of our range for two reasons. First was weak demand in the last month of the quarter in our personal electronics market, particularly PCs, and in our communications equipment market, particularly wireless infrastructure equipment. Second was a steep decline in the currency exchange rate for the euro relative to the U.S. dollar.
For the current quarter, the company forecast revenue in a range of $3.12 billion to $3.38 billion, and EPS of 60 cents to 70 cents, which is below consensus for $3.44 billion and 73 cents a share.
Templeton noted that the company is assuming “continuing weakness in our communications equipment and personal electronics markets, particularly for wireless infrastructure equipment and PCs, respectively.”
“We also do not expect a near-term rebound in foreign currency exchange rates,” he said. “The annual effective tax rate for 2015 is expected to be about 30 percent.”
In the current year consensus is calling for 8% earnings growth and only 1% sales growth. The company has an active buyback and pays a dividend that yields 2.45% annually. Unlike large cap semi peers Intel (INTC) and Qualcomm (QCOM) who sport very large capital to debt ratios, TXN only has $3.3 billion in cash on their balance sheet, vs $4.6 billion in debt, with a market cap of $57 billion. For comparison sake, QCOM has a $110 billion market cap, $29 billion in cash, and only $1 billion in debt.
This is important as it appears most large cap semis are focused on M&A for growth, and I am hard-pressed to see how TXN could outbid QCOM for any asset given their respective balance sheets.
Since March there have been three announced mega mergers, starting with NXPI paying $12 billion for Freescale, Avago paying $37 billion for Broadcom last month and earlier this month Altera agreeing to be sold to Intel for $17 billion. Nearly $70 billion spent for three companies with a combined $15 billion in expected sales, vs the acquirers having an expected combined $70 billion in sales. Currency headwinds, commoditization, maturation of end markets, the end of Moore’s law, to name a few issues plaguing electronics component suppliers right now. So when all else fails, buy growth. I suspect TXN is an acquirer of a smaller faster growing company that sells into a hot new buzzwordy sort of end market, like the Internet of Things (IoT).
Barron’s recently reported some analyst sentiments after attending an IoT conference in Silicon Valley earlier in the month, suggesting among others that TXN “possess all the basic building blocks for IoT applications”. Who knows if connected devices will be a profitable end market, as it may include low cost, low margin components, but it sure could cause some M&A. What is clear is that TXN would most definitely be a suitor, not a target, and given the expense and scale of the recent deals I am not sure the potential accretion of a similar deal for TXN would outweigh the weight of said acquisition on the company’s capital base.
MY VIEW: TXN is not a particularly cheap stock trading 20x, and does not exactly seem to be in the catbird seat as it relates to large acquisitions. Technically the stock has reached what I beleive to be an inflection point heading into Q2 results in late July. The 3 year chart below shows the stock’s impressive uptrend, but April’s earnings gap places it below that uptrend:[caption id="attachment_54680" align="aligncenter" width="600"] TXN 3 year chart from Bloomberg[/caption]
On a nearer term basis, the stock has now approached the downtrend that has been in place from the 52 week and 15 year highs made in early March, a failure hear could have the stock quickly in the low $50s:[caption id="attachment_54681" align="aligncenter" width="600"] TXN ytd chart from Bloomberg[/caption]
With an eye towards another guide down in late July, I wan to look to finance the purchase of downside puts in a way we have not employed in a while, a diagonal calendar, where we buy a longer dated put strike and finance by selling a shorter dated lower strike put. This is different from a straight calendar where we buy the longer dated and sell the shorter dated option of the same strike.
Here is the trade:
TXN ($55.35) Buy July / Aug – 53 /55 Put Spread for 1.50
-Sell to Open 1 July 53 put at .35
-Buy to Open 1 Aug 55 put for 1.85
Break-Even on July Expiration:
Profits: max profits if the stock is at or near $53 with a gain of only .50 if the stock is substantially lower than $53
Losses: losses on the trade if the stock is higher than where it is now with total loss of 1.50 if it’s substantially higher
Rationale: This diagonal calendar plays for a slight move lower in TXN for the next month and finances a put for earnings that come just after July expiration. If the trade is profitable at July expiration we can further reduce premium risk in August by turning the August puts into a straight vertical (e.g. selling Aug 50 puts)