Taking Stock: Will LSI Stay In The Game?

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September 22, 1997

Taking Stock: Will LSI Stay In The Game?

LSI Logic is aggressive in networking and communications, but investors await movement on a Sony PlayStation contract
By William Schaff
any of the companies I've recently written about have risen in value to heights that make one afraid to look down. In today's market, that may not be so healthy. For a change of pace, here's a look at a listing on the New York Stock Exchange, LSI Logic Corp.
The leading provider of applications-specific integrated circuits (ASIC), the Milpitas, Calif., company lets customers build so-called "systems on a chip" based on its CoreWare design program. No, these systems are not as powerful as a n Intel microprocessor, but they are much more than a commodity memory chip. LSI Logic's ability to partner with major customers in quickly designing, manufacturing, and delivering products has been key to its success.
LSI's 1997 revenue is derived pretty much evenly from three areas: communications and networking, components for consumer products, and computing. LSI's real strength is in the first two categories.
The company is also aggressively pursuing sales in the switch, hub, and routing markets with all of the major networking companies, including Bay Networks, Cabletron, Fore Systems, and Xylan.
By year's end 1998, telecommunications and networking products should represent more than 40% of LSI's total revenue. This projected growth is driven by the company's ability to deliver products faster than most competitors.
LSI continues to enjoy growth in the supply of components for consumer products-the result of strong demand for digital cameras, digital versatile disks (DVDs), digital vid eo, satellite desktop boxes, and Sony's PlayStation. In fact, Sony-from which LSI derived 14% of its 1996 revenue-just recently announced a 33% increase in unit volume production starting in October for this year's holiday season.
Manufacturing capacity and per-unit costs should start declining in the latter part of 1998, after LSI opens a new fabrication plant in Gresham, Ore., in midyear. Though plant start-up problems (and the usual overhang of potential industry overcapacity at time of startup) pose some operational risk, the facility should eventually become one of the company's more efficient operating units.
Competition Fights Back
The biggest downside issue, near-term, is LSI's potential loss of some or all of the next-generation Sony PlayStation 64 business to Toshiba. Look for LSI to be competitive in its bid, but the uncertainty level remains high. Sony represents almost 18% of LSI's current revenue, with a majority of it related to the Sony PlayStation 32. The loss of that busi ness cannot be discounted easily, although its financial impact probably would not be felt until late 1998 or early 1999.
The unsettled Sony situation is the primary reason why LSI's stock remains depressed. However, revenue and earnings should become more predictable as the company expands into the networking and communications sector and diversifies its client base away from the consumer products arena.
In the most recent second quarter ended June 30, LSI's revenue was $332 million, up 2% over the same quarter last year. The company expects third-quarter sales to increase only about 4%, and I project 1997 revenue will be about $1.35 billion.
Gross margins reached 49.1% last quarter, the highest in company history. Gross margins are expected to remain flat, then decline about 2% once the Oregon plant is operational.
LSI recently announced plans to buy back 5 million shares-or roughly 3.5% of those outstanding. My 1998 earnings estimate for the company of $1.75 per share is obtainable, and my 12-month price target remains at $38.
William Schaff is chief investment officer at Bay Isle Financial Corp. in San Francisco, which manages the InformationWeek 100 list. Reach him at bschaff@bayisle.com .
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