Execution Remains ON Semiconductor's Biggest Opportunity ... And Its Biggest Risk

While I thought ON Semiconductor (NASDAQ:ON) was undervalued back in February, the company's history of iffy execution relative to past margin targets and the cyclical weakness in the analog chip space were offsetting concerns. The shares are up almost 50% since then, though, which is about 10% better than the performance of the SOX over that same time, not to mention Texas Instruments (NYSE:TXN) and NXP (NASDAQ:NXPI) (though STMicroelectronics (NYSE:STM) was quite a bit closer).

Investors are certainly feeling better about the health of the chip space, and metrics like lead times would seem to support that. With ON, there's also above-average potential to grow on the back of increasing content in autos, phones, and computers. Even more significant for ON, though, is the potential to drive better margins (where the historical record is admittedly mixed) and drive real synergy from the upcoming merger with Fairchild (NYSE:FCS).

I come up with a wide range of potential values for ON Semiconductor and that seems appropriate given the confounding mix here of the potential to do better and the historical realities of the company's performance. Better days are certainly possible… but then, so too is an "Atmel (NASDAQ:ATML)-like" outcome of years and years of frustrating performance. My core DCF fair value (including Fairchild) is around $10.50 now, but there is definitely potential into the mid-to-high teens if management truly can maximize its growth and margin opportunities.

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Execution Remains ON Semiconductor's Biggest Opportunity ... And Its Biggest Risk

Seeking Alpha: ON Semiconductor Still Floundering

Even in a rough tape for semiconductors as a group, ON Semiconductor's (NASDAQ:ON) performance has been noticeably worse. The shares basically tracked the PHLX Semiconductor Index for most of the past year, but weak results in the third quarter led to a deeper plunge that has the shares down more than a third over the last year, and the brief rally in the wake of the bid for Fairchild (NASDAQ:FCS) proved fleeting.

I'm of two minds on ON Semiconductor at this point. The shares look cheap by the metrics I use, but this is starting to remind me more than a little bit of Atmel (NASDAQ:ATML) - a company with good technology and potential, but where management has never really been able to deliver on any sort of consistent basis. While I see Fairchild as potentially a very positive acquisition, ON management's abject failure with the Sanyo deal cannot, and should not, be forgotten.

I know a lot of readers want those of us who write for Seeking Alpha to give them clear "buy/sell" calls, but I really can't do that with ON Semiconductor. I believe the company should and can produce better results than it has, but that does not mean that it will. Investors aren't being asked to pay a lot to find out if they can do better, but if I were to buy, I'd at least go in aware of the risk that this is a serial underperformer that could disappoint for a while.

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ON Semiconductor Still Floundering

Seeking Alpha: Microsemi Chugging Along

Microsemi (NASDAQ:MSCC) has always been a different sort of semiconductor company. In an industry where investors pay a lot of attention to leading-edge technologies, Microsemi has historically been better known for less advanced high-reliability products that are often sole-sourced. Where many semiconductor companies are tied heavily to end markets like communications, industrials and consumer products, Microsemi has long been more leveraged to defense and aerospace.

The end result of all of this is that Microsemi shares often seem to zig when others zag. But with the defense, aerospace, and space markets looking stronger into 2015 and the company still building up its underrated FPGA business, Microsemi seems to me to be getting stronger at a time when many investors are worried about the semi space. As I continue to see fair value in the low-to-mid $30's, I continue to believe this is a stock well worth investors' due diligence efforts.

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Microsemi Chugging Along

Investopedia: Analog Devices' Slow Walk To Better Days

The still-awaited semiconductor recovery is certainly taking its sweet time in getting here. In the meantime, Analog Devices (NYSE:ADI), one of the leaders in the analog space, remains in something of a holding pattern. Although the stock has done pretty well as investors look forward to better utilization driving higher margins and larger cash returns to shareholders, the business is still waiting to see sustained demand improvement in its end markets.

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Seeking Alpha: Challenges Abound, But Overlooked Microsemi Should Be Ready To Deliver

Small-cap chip company Microsemi (MSCC) gets a lot of flak for what it is (highly exposed to defense) and what it isn't (a fast-growing mobile device story), but the fact remains that this company has grown revenue at a 20% compounded average rate over the past decade. What's more, the company is offering a rare combo - a good legacy business where competition faces an uphill battle, coupled with organic growth opportunities in growth markets and positive margin leverage.

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Challenges Abound, But Overlooked Microsemi Should Be Ready To Deliver

Investopedia: How Many Cuts Does It Take To Reach TI's Center?

Watching Texas Instruments (Nasdaq:TXN) over the past two years reminds me of that candy commercial where a kid asks how many licks it takes to get to the center of the candy. Revisions continue to head lower and investors have to be asking themselves just how much worse things can get before the turnaround finally happens. While I do believe TI has solid margin leverage to a chip recovery, the stock isn't cheap enough to entice me to brave the risks that the recovery takes even longer to achieve.

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Seeking Alpha: Can Microsemi Deliver On Its Leverage Promises?

Small-cap value is a dicey proposition in technology, as investors are often more inclined to ignore valuation in the pursuit of disruptive technology and break-out growth stories. Unfortunately, while Microsemi's (MSCC) growth isn't bad by the depressed standards of today's semiconductor market, this is not a stock that's going to challenge names like Broadcom (BRCM) or Mellanox (MLNX) for growth leadership. What Microsemi does offer, though, is a business leveraged to operating improvements and built around markets where the company is often hard to dislodge.

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Can Microsemi Deliver On Its Leverage Promises?

Investopedia: ON Semiconductor Looking At Another Off Year

Short of locusts, just about everything that could have gone wrong for ON Semiconductor (Nasdaq:ONNN) did, in 2011. Not only did the company have to deal with a pair of natural disasters, but the company saw a widespread erosion in the chip market throughout the year. While the chip industry looks to have likely bottomed in the fourth quarter of 2011, ON Semiconductor is going to have a longer road back than most and investors need to understand that today's value-pricing comes at a cost.

Twin Disasters Delay Sanyo Benefits 

When ON Semiconductor bought the Sanyo chip business, it was a bold and somewhat risky move to expand the business and vault the company in the top echelon of analog chip companies. Although the promise and potential of the deal is intact, the timing has been blasted by events completely beyond management's control.

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Seeking Alpha: Microsemi Needs To Start Delivering On Its Potential

There's a quote out there, apocryphally quoted to former NFL player Randy White, that “potential is a fancy French word that means you haven't done anything yet”. Although that is arguably a harsh introduction to semiconductor company Microsemi (Nasdaq: MSCC), there is an element of truth to it – Microsemi could indeed be an attractive semiconductor stock to hold at these prices, but the company needs to begin delivering on the growth and margin potential that bulls have long seen in the name.

Come Hell Or High Water
There were multiples concerns that set these shares back in 2011, but it is worth noting that Microsemi's performance was not that bad in the context of a generally poor year for semiconductor stocks.

For starters, the near-constant wrangling over the federal budget and the concern over the government's debt and deficit situation has led investors to assume significant cutbacks in defense spending. With roughly one-third of Microsemi's business coming from selling to defense contractors like Lockheed (NYSE: LMT), Raytheon (NYSE: RTN), and L-3 (NYSE: LLL), that's no trivial concern. Fortunately for the company, the recent defense budget was not as bad as initially feared and the company stands to benefit from smart warefare retrofit projects (like GPS-equipped mortars).

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Microsemi Needs To Start Delivering On Its Potential