Thursday, 26 September 2013

Semiconductor Chips and Telecom Sector

There was a time in 80’s when our home grown car makers Hindustan Motors/Premier padmini were the kings of the Indian Roads due to closed economy and licence Raj...they were the dreams of any young man who wants to lead a life full of utter luxury. Today they are nowhere...even fallen back beyond horizon. Then enters in the scene were, Maruti and Tata and they make Indian cars competitive enough to be exported out globally, give . Today, the scenario is such that all of world’s major car makers like Ford/Toyota/GM/Volkswagen etc. want to set up manufacturing units in india due to much improved infrastructure which can cater to their export market potential. 

Switch over to mobile handset market and we find ourselves on same footing with a different environment. Today like old car makers, Indian mobile hand set makers are very few with no technology of their own, cheap and crude processing power and design. The only change is that we are not restricted to purchase only these...we can buy high tech, costly imported hand sets from the houses of world’s best. Although some like Nokia, LG has set up manufacturing facilities in india but these are more of assembly units than real manufacturer which just assemble the imported parts of a mobile handsets.

Our local warriors like Micromax, karbonn, spice, Zen, intex also don’t manufacture anything in india...they just source everything from china or elsewhere. Also there is an increasing fight all over the world for Intellectual property rights for various components/applications/design among all the leading handsets makers, recent fight between Samsung and Apple is the one of. Indian companies are just copy cats. So far big MNC’s were not treating them worthy of competition but as these Indian makers are beginning to bite their share, the space is heating up and anytime we’ll see fights over infringement of IPR by these companies.

India imports telecom equip/mobile handsets valuing around 100000-150000 crores with little production in india. It is estimated that at current pace it’ll outpace our oil/gas imports by big margin in 2020. To have a figure, our oil/gas import this year was around 7-8 lakh crore. With recent havoc in rupee depreciation due to high imports, india is looking to lower its import bill. So this is one big sector which can’t be ignored at all. India is trying for long to set up Semiconductor chip manufacturing fab in india, but it never succeeded due to policy paralysis. At present, semiconductor IC’s comprise for around 10-20% of cost of every electrical item (for mobile handsets IC’s count for almost 30-40% of cost of production). Also all of today’s electronic items have an IC which control its entire operation.

Just when i was studying this sector...Govt has announced setting up of two Semiconductor chip fabrication facilities in india. These two will be set up by Jaypee group and HSMS india in technological collaboration with foreign companies. It will entail an investment of around 50000 crores. But yet india can’t compete with cheap chips manufactured by giant factories in china Taiwan and Singapore. Chip making is a very difficult and capital intensive sector which also requires huge amounts of power and water...the easy availability of which in india is always doubtful. 

The compacting of chip sizes, driven by the inexorable stretching of Moore’s Law, which postulated long ago that the number of transistors on a microprocessor would double every two years, has had a dramatic impact on the industry. The number of transistors on a device — defined as transistor count in industry parlance — has increased from 2,300 on the Intel 4004 in 1971 to 5 billion transistors on the 62-core Intel Xeon Phi processor that was released last year. Individual chips, which used to be of 10 microns in 1972, are now down to 22 nanometres (a nanometre being 1,000 times smaller than a micron). Silicon wafer, the building block of an IC chip is made from humble Sand wherein sand is heated at 2000*C and other high power processes to filter the impurities to make a high grade silicon wafer. Hence, at present india can’t count on export income from semiconductor chips. But local Indian demand is sufficient enough to provide a support to the sector if Indian govt impose import restrictions on the same. 

If i can recall our Reliance industries was also having plans to set up IC chip and solar PV cells units with an investment of around 30000 crores...i don’t know whether they are still serious about the same. BHEL is also making a solar PV and silicon wafer making facility with an investment of around 2000 crore.

However one thing where india is having an edge over the others with respect to chip is....chip designing. Indian engineers are designing high tech chips for major electronics companies of the world. India is designing 15% of chips globally. Broadly speaking, the industry comprises of VLSI design (transistors), embedded software development and hardware/ board design, all of which make up a $15 billion chip design industry.

From Qualcomm to Intel, the world’s leading chip design shops have established their captive design centres in India. A lot of this is high-value work. Semi-conductor design firm Freescale’s India Design Centre, for instance, has developed a world-class family of micro controllers for automation systems and complex medical applications. 

Electronic goods companies need to quickly launch new products that too at low costs. Outsourcing the designing work to the specialists mitigates major risks since design is the main building block. Indian engineering institutions are creating a huge supply of ever efficient engineers.
Hence so far i have filtered two companies who are best placed to benefit from this shift. These are Bharat Electronics Ltd and Tata Elxsi.

Bharat Electronics Ltd ( BEL) is a govt PSU under the ministry of defence. BEL is serving Indian defence sector with its innovative products since 1954. Its turnover has grown  from some 20 lacs in 1956 to 6000 crores in 2012-13. The best part in this is that around 75% of the turnover (as per annual report) is achieved with products developed at BEL through in house R&D, rest is from technological partnerships. It manufactures Missiles(currently Akash Missile), Battle tanks, Army communication system, Naval system, Night vision equipments, aviation systems, electronic warfare systems etc. These are all high tech system requiring significant technological strength. In civil sector, it is making civil radars(used at airports), telecom broadcast systems ( Like tablets/Set top boxes), homeland security systems, solar products etc. It is only one of the few PSU’s making semiconductor chips.

India is looking to develop its local defence sector in order to free itself from import dependence. Hence it is allowing for Private and FDI investment in defence sector. It has made compulsory for any Foreign company getting order from Indian Govt to get 30% of supplies/services of its order from Indian companies which is a great opportunity for BEL. It is increasingly looking after civil sector for huge growth in sector like homeland security, civil radar and telecom and communication products. Once it has produced a very low cost tablet for Indian govt for population counting. 

I don’t know its plan for telecom sector but i am sure sooner or later the company will leapfrog into the sector with great vigour due to its inherent strengths.

The best part of the investment is the cash holding of the company. Market value of the company at current price of rs. 1100 is 8800 crores. It is having a mammoth 5300 crores as cash which is 60% of the market value. So we are getting 60%, 660/- in cash and so we are paying only 340 Rs. for the stock for its earning capability. Hence chances are great that company my announce a big special dividend. However its gross block has grown from around 1431 crores in 2008 to 1902 crores in 2013 ( net block of 413 cr to 510 cr), which means company hasn’t invested much in setting up new capacities. So i feel the more chances are for further expansion than special dividend. I am yet to find out the reason of such a low growth in capacity addition over time...the reason may be that it is importing major components of its final product as mentioned in its annual report...2551 crores of foreign exchange outflow against an inflow of just 166 crore. Net outflow is almost 40% of total turnover which is huge by any standard...i can't find out how much is for capital items.

This can raise a doubt on its R&D capabilites because its operating margins are just around 8%. its operating income is 525 crores on a turnover of 6200 earns major part of its net profit from interest on fixed deposit which is 560 crores for 2012-13. it looks more like a trading or assembly company. for 2012-13 its operating cash flow turned negative to -1351 cr, mainly because huge pending debtors of 3300 crore (our Govt will not default however) which reduced its cash holding from 6800 cr to 5300 cr. Nothing significant is visible on technology front at present.

But perhaps this is the reason for its lower valuation and if there comes a good policy breakthrough or company plans some significant investment for capacity addition because it invests 8.5% of its turnover, around 500 crore in R&D, which is huge by indian standard and comparable to world's best.
Due to these, it may appear somewhat risky...but cash holding of 60% provides for safety margin and
 it is best placed to reap the benefits of defence sector localization.

I will further study its R&D break throughs to have a better understanding of its technological prowess. On a net basis..till then it is  a buy from me.

Tata Elxsi- another gem from the house of tatas. This company is a leader in chip design and product design providing services in the field of product engineering, industrial design, animation and VFX etc. It is serving leading consumer brands of the world. Its turnover is 630 crores for 2012-13 with Net profit before exceptional item is around 38 crore which is going to show better due to picking up of demand and closing of loss making unit in los Angeles.

Its visual computing lab has produced VFX shots for movie Bhaag Milkha Bhaag and many other Indian blockbusters apart from Hollywood movies. it plays a part in launches of cars like Tata Motors’ Manza, Tata Motors’ Aria, where the entire special effects were created purely from the engineering data. So there was no actual car used for creating those special effects. 

I am holding this from 2009 picked at 130/- and adding at every fall. Sh S Ramadorai, the current chairman sees Tata Elxsi as next TCS in the making. He was managing director at TCS for 13 years and now after retirement, he has been given the task of mentoring smaller gems like Tata elxsi and CMC to  giants like TCS.
Business for Tatas is always a serious thing. Tata elxsi is a leader in Broadband, wireless and 4G telecom technologies.
It is giving constant dividend of 7/- for many years inspite of ups and downs in its net profits, which is 4% yield at current market price of 172/-


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