Atheros Communications, Inc. (ATHR)

Atheros Communications (ATHR) develops solutions for wired and wireless communication products. With competencies in developing radio frequency (RF) products along with mixed signal and digital semiconductor chipsets, Atheros is a market leader with a large target market, spanning personal computer, networking device, and handheld consumer device manufacturers.

Competitive Advantage

Atheros is at the cutting-edge of wireless technology, developing wireless semiconductor products based on a variety of standards including IEEE 802.11n wireless Ethernet and Bluetooth 3.0. Atheros is also in the process of developing solutions utilizing the 802.11ac standard, which sets potential improvements over 802.11n and caps throughput at 6 GHz. As both 802.11n & ac standards are relatively new, promising wider area coverage and higher bandwidth throughput by adding multiple-input multiple-output (MIMO) technology over more traditional 802.11a/b/g variants, demand for Atheros’ mainstream Ethernet products are set to rise. While the environment for wireless communications companies is extremely competitive, we foresee marketing and cost advantages in Atheros’ technological expertise.

As a leader in wireless technology, Atheros targets a very large market through three main channels: the PC market, networking market, and consumer products market. According to Atheros, the PC market, which includes desktop, notebook, and netbooks, is approximately 300 million units large. Networking devices, such as gateways, routers, and Aps, ranges from 200 million to 500 million units. Consumer devices, which encompass cellular devices, gaming units, portable media players, and cameras, are greater than 1 billion units. The potential growth in this market is tremendous.

Financial Performance

Atheros continues to press ahead through the economic downturn with rising revenues, with a CAGR of 26.18% between the fiscal years ending December 2004 and December 2009. Profit margins remain stagnant, however, due to scaling costs, specifically SG&A and Research & Development expenses. As such, operating margins have taken a slight descent over the years, ranging from 5.7% in FY2004 to 3.8% in FY2009. We believe that as Atheros begins taking advantage of improving economies of scale, and as consumers and corporate entities alike begin adopting modern wireless standards, that Atheros will be able to cut their relative cost.

At present, Atheros is reinvesting a significant portion of its retained earnings to research and innovation. While the amount has tapered out between FY2008 and FY2009, these costs may continue to rise as Atheros pursues the development of new products, particularly in the high-bandwidth line.

Rising costs may be offset by exceptional growth in revenues. Atheros competes on leading product cycles. For example, market share of 802.11n technology has gained tremendously from Q1 2008 from less than 20% to more than 50% of in Q4 2009 over 802.11g and 802.11ag. Additionally, Atheros has developed consumer-level products that utilize the power grid for data bandwidth. As a provider of complement technology to a strong line of household electronics and portable consumer devices, Atheros will undoubtedly ride the wave of the PC replacement cycle and growing popularity of OEM wireless chips in popular handsets.

Recommendation

We believe that Atheros Communications, Inc. (ATHR) will outperform the market within the 12 months moving forward. Atheros is well placed to take advantage of rapidly changing conditions that affect the information technology sector and particularly companies that primarily deal with wireless semiconductor technologies. With rapidly rising revenues, we believe that Atheros can recover its recently falling margins by taking advantage of greater economies of scale. Atheros is also set to take advantage of improving economic conditions and changing consumer trends. Improving levels for technology replacement cycles and a booming handheld device market will drive demand for wireless technology to new heights within the foreseeable future.