Silicon Laboratories Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Silicon Labs is a fabless semiconductor company focused on designing and selling integrated circuits (ICs), software, and solutions for a broad range of IoT applications, offering both hardware and software.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Silicon Laboratories Inc. (SLAB) operates within the highly competitive and rapidly evolving semiconductor industry. A critical aspect of the company’s approach to stock investing is its reliance on “economic moats,” focusing on factors that grant a competitive advantage and sustainable value creation. This approach emphasizes a long-term investment philosophy centered around identifying companies with strong economic moats and capitalizing on their potential for sustained high returns on capital.

Business Overview and Competitive Landscape:

  • Revenue Distribution: Silicon Labs reports their revenues across the Industrial & Commercial and Home & Life segments. For the year ended December 31, 2021, the Industrial and Commercial segment accounted for 78% of net sales, with Home & Life making up the other 22%. In the first 9 months of 2022 Industrial and Commercial is still dominant with 74% of net sales.
  • Key Technologies and Focus: They specialize in embedded processors, wireless connectivity, and sensor technologies, with the goal of enabling smarter, connected devices. The company uses a variety of mixed signal technologies, including CMOS. They focus on developing solutions rather than simply making and selling components, and sell to a very broad range of applications including smart homes, connected medical devices, and industrial automation.
  • Industry Trends: The semiconductor market is characterized by a few trends:
    • Growing Demand for IoT Connectivity: There is a growing demand for connectivity solutions as more devices become connected, creating a demand for low-power, integrated silicon solutions.
    • Increasing Focus on Security: Security is increasingly important, because of the increase in data breaches and more sophisticated cyber attacks. Security and cryptography on chips is seen as key requirement.
    • Shifting to Software-Defined Solutions: A trend towards software-defined functionality that provides a competitive edge and more customization over hardware has made software more important than ever.

Silicon Labs competes in a crowded field, including large semiconductor companies, specialized analog companies, and fabless chip companies. In each area they have competitors who are already well established. In the last earning calls management has mentioned: NXP, Texas Instruments, Broadcom, Qorvo, Analog Devices. Given this, they need to rely on their moat to give them an edge in this intense competition.

Moat Analysis: Silicon Labs is attempting to build a moat that will increase the duration and persistence of their high returns on capital. The main components that could potentially form a moat are:

  • Switching Costs: For many customers, the value of a supplier goes beyond a component price. Switching vendors can be time-consuming and expensive to clients with existing, proven, software design. Although Silicon Labs is focused on offering solutions that can be integrated seamlessly, there aren’t a lot of switching costs.
  • Intangible Assets: Intellectual property is part of the company’s core strategy. The design of innovative and specialized mixed-signal technologies can be a form of intangible asset that allows them to have more value per customer, and be able to charge a premium relative to similar chips. However, since patents are not always a durable source of competitive advantage due to expiration and legal challenges, patents are not reliable moat components.
  • Economies of Scale: In terms of economies of scale, this is not a structural advantage. The market is too big for any one firm to achieve a low-cost position.
  • Cost Advantages: Although Silicon Labs attempts to provide cost-effective solutions, they are not a low-cost producer in the commodity market. There are cheaper companies out there.
  • Network Effect: The company sells their products in a wide range of applications, so there is not a network effect where other customers are drawn to them due to their existing customer base.

Moat Rating Justification: Given these factors, a moat rating of 2 out of 5 is given. Even though they have some strong points they are not enough to form a wide or medium moat. The moat is weak and is mostly created by switching costs that don’t completely lock in the customer, and intangible assets that may not stand the test of time. They need to show their ability to achieve high returns on capital to be considered as a company with a higher moat.

Risks to the Moat:

  • Technology Disruption: The semiconductor space is fast moving, and companies must constantly innovate to stay ahead. A new player can create a better product (faster, cheaper, better) and completely upset the market. For instance, their focus on mixed-signal technology could become obsolete. As Graham has said, “In the long run, everything is a toaster”.
  • Intense Competition: Competition might commoditize the products in the long term. There is also a risk of companies copying their products, making it harder to have a moat. The ability to charge a higher price over the competitors can be severely damaged.
  • Economic Downturn: A downturn in the global economy could hurt sales and margins, which have not been particularly impressive recently.
  • Supply Chain: Chip supply has been volatile in the recent years, and a company that has trouble producing and delivering their products will greatly lose value.
  • Geopolitical Risk: Tensions between US and China could have a negative impact on them since they have operations and sales in Asia.

Business Resilience:

  • Diversified Customer Base: They sell their products across different industries which limits the impact from a downturn on one specific sector.
  • Product Diversity: They are in a number of different product lines that could provide a cushion when some are not performing well.
  • Focus on High-Value Markets: Their focus on high-growth and profitable markets with long-term sustainability will help improve their balance sheet.

Financials (In-Depth):

  • Income Statement Trends: Revenues have increased substantially over the past few years, with a slight decline in growth in the recent quarters. However, the company’s cost of revenue has also increased, impacting the gross profit. Furthermore, operating expenses are high (especially in R&D) which negatively affects operating income. While their net income has been positive in the last years it has dramatically declined in the last quarterly reports, even resulting in a loss.
  • Revenue: Silicon Labs has seen a large increase in revenue from 2019 onwards, mainly due to growth from the industrial and commercial sector. However, the most recent quarters have seen a decline in revenue growth and an actual decline in revenue from one quarter to another. While sales of IOT chips have been high, it hasn’t translated into a profitable business because their margin is low and their operating expenses are high.
  • Margins: In the recent quarters, their gross profit margin has remained between 57% and 60%. However, Operating Profit Margin (EBIT margin) has been much more volatile in the past five years, ranging from below 10% to above 20%. They have done a great job in lowering their R&D expenses which positively impacted the most recent operating profits. On the other hand, selling, general and administrative expenses continue to increase and are more than double that of R&D.
  • Debt Levels: Currently, the company’s debt stands at $267 million and their current liabilities equal to $173 million. They also have $494 million in long-term liabilities. As a result, they will not be able to take advantage of growth opportunities that need massive capital requirements.
  • Cash Flow: Their free cash flow is volatile, as their sales have been affected by the current recession. It can be as low as -$12 million. When analyzing their cash flow statement there are large amounts for stock-based compensation and investment expenses.
  • Valuation: According to the DCF valuation method, their value is around $140 a share. Currently, their stock trades around $125, implying that there might be some upside. However, their most important growth metrics are not very high, especially given their industry which may require more growth than the current valuation represents.
  • Recent Problems: As stated in the latest earnings call they had some problems with supply chain, especially in China, that will continue in next two to three quarters. Although management stated they have confidence they will be able to reach their forecasts, the uncertainty in the market may be higher than it was before.
  • Management outlook : The company is planning on increasing their sales in more high-growth and profitable segments, like software. They believe their new software will become a core part of the company’s strategy and future. They are also focusing on cutting costs and are investing more in R&D. This is expected to lead to better returns on invested capital.

Understandability: The company is a moderately complicated business, not very difficult, but also not easy. Their operations depend on a deep understanding of semiconductor manufacturing and the rapidly growing IoT market and many of their technical innovations. However, the general principles of the company can be easily understood by any person. The complexity arises when one tries to understand the nuances of their semiconductor designs and software. Given this, I am giving them a understandability rating of 3 out of 5.

Balance Sheet Health Rating: The company has an okay balance sheet with relatively high cash and good equity, but high debt. Their net cash is less than the debt burden. While the total debt is not too high, there are possibilities for an economic downturn or unexpected economic factors affecting their future income. Overall, they are not a company that seems financially unstable. Given this, I am giving them a balance sheet health rating of 4 out of 5.