An Introduction to Microchip Technology (MCHP)
Vice President, Director of Equity Research
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Barton B. Hooper, CFA®
Vice President, Director of Equity Research
Investment industry experience since 1997
Barton joined Weitz Investment Management in 2007. Prior to joining
the firm, he was a research analyst at Oak Value Capital Management and
Trilogy Capital Management. Prior to his investment management experience, Barton worked at
George K. Baum & Company and was a certified public accountant at Deloitte
& Touche LLC. Barton has a bachelor's in accounting from the
University of Missouri and an MBA from Washington University in St. Louis.
Jr. Equity Research Analyst
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Andrew McClure
Jr. Equity Research Analyst
Andrew joined Weitz Investment Management in 2023. Prior to joining the firm, he was an equity research associate at Craig-Hallum Capital Group. Andrew has a Bachelor of Business Administration degree in finance from the University of Minnesota Duluth.
Microchip Technology, Inc., (MCHP) is a leading provider of mixed-signal
microcontrollers (MCU), analog integrated circuits and other semiconductors. The
company offers approximately 100,000 products to over 125,000 customers in the industrial,
automotive, data center, appliance and communications end markets. The
company's MCU and analog businesses combined generate over 85% of its revenue.
The history of Microchip Technology dates to 1987 when it
was spun off from its former parent company, General Instruments. In 1989, Microchip
Technology became a fully independent company, and over the next 30-plus years,
now executive chairman Stephen Sanghi led the company through two phases of
business development which have enabled the company to become a top competitor
in most of its primary markets. The first phase, Microchip 1.0 (1990-2017),
focused on creating sustainable revenue streams, taking share in
microcontrollers, and building scale through internal efforts and acquisitions.
Microchip 2.0 (2018-2021) channeled efforts to integrate multiple acquisitions,
technology tools, and manufacturing into what the company calls Total System
Solutions — a strategic approach to win more business per customer order.
After three decades as CEO, Mr. Sanghi turned that role over
to 20-year executive Ganesh Moorthy. Moorthy is now leading the company through
its “Microchip 3.0” phase which is focused on leveraging the Total Systems Solution
(TSS) strategy, driving sustained above-market organic growth, and expanding margins.
Understanding Microchip Technology's Offerings
As mentioned, Microchip Technology's products include mixed-signal
microcontrollers (MCUs) and analog integrated circuits — both of
which are important components to many of the electronics, smartphones,
vehicles, appliances, and more devices that we use every day. An MCU is a
simple miniature computer comprised of many components and used either to
control several small features of a larger system or be the complete “brains”
of a smaller one. Analog integrated circuits provide power management, signal
conversion, security, timing, and other functionality needed to run electronics
and digital devices. These products are typically used in applications where
the accuracy of captured data is critical.
A helpful example of how Microchip Technology's products and
its TSS strategy works is something that is in everybody's home — a refrigerator.
The fridge has an analog chip which measures the temperature inside to ensure
the air stays at a constant temperature, say 37 degrees. Presume your child opens the door and spends a
few minutes contemplating life while deciding whether to have juice or milk, and
when done, the temperature has risen to 39 degrees. This information is sent
from the analog temperature sensor to the microcontroller which then sends a
signal to the compressor to turn on (powered by an analog power management
chip) and cool the fridge back to the desired 37 degrees. Microchip Technology's TSS strategy would be
to earn the refrigerator company's business to provide MCUs or one of the
analog chips and then use its ability to package the combination into a single offering
or grouped offerings, thereby allowing it to leverage a single customer
relationship into the sale of multiple products.
Microchip Technology's Competitive Positioning
Through our long-term ownership of Texas Instruments, Inc.,
(TXN) and Analog Devices, Inc., (ADI) which are both primarily analog
integrated circuit manufacturers, we are well versed in the regular cyclicality
of the semiconductor industry. While cyclical, we believe the MCU and analog
integrated circuit category offers the favorable dynamics of businesses we like
to own. Some of these characteristics include high gross margins, engineered
intellectual property, and components which are critical to operation but with
relatively low prices that prevent easy substitution. Microchip, Analog Devices
and Texas Instruments also share the favorable attribute of having large
customer bases and a wide diversity of products so no one customer, product, or
category has outsized influence on results. The microcontroller and analog segments
of the industry have also consolidated over the past 20 years, and as such, we
believe are more rational from a pricing and capacity standpoint compared to
other times in history.
Microchip Technology identified, and is benefiting from, the
adoption and expansion of several tailwinds which are driving digitization and
the demand for the company's products. The Microchip 3.0 strategy is focused on
leveraging its TSS strategy to capitalize on six secular megatrends: 5G,
Internet of Things (IoT), data centers, autonomous vehicles, electrified transport,
and sustainability. Combined, revenue from the six megatrends represented 45% of
the company's fiscal year 2023 revenue. Microchip Technology believes these
tailwinds are durable, and the company estimates that megatrend-related revenue
will grow at twice the rate of the remaining business which, itself, should
grow at rates close to global gross domestic product (GDP). Over time, the
company believes it will take share in its relevant markets.
Navigating Obstacles
As has been the case for many businesses, the COVID pandemic
and its aftermath have been difficult for Microchip Technology to navigate. The
company first dealt with a significant fall off in orders early in the pandemic
and was then overwhelmed by demand for and shortages of its products as
consumers and businesses shifted from buying services to goods such as
automobiles, appliances, and computers. The company was faced with
unprecedented backlogs which are now unwinding, and investors are concerned it will
be faced with a significant inventory correction. We believe it is likely that
customers will need a period of digestion which may result in lackluster sales
and earnings growth, but we have yet to encounter evidence that the secular
growth tailwinds described above have been curtailed. We expect that the
company's results in any one period may be volatile, but we believe over our 3—5-year
horizon, the company's growth trajectory is relatively predictable.
Potential for a Bright Future
In addition to our experience with Texas Instruments and
Analog Devices, we were drawn to Microchip Technology as it appears to be early
in its journey of returning more capital to shareholders. The company rightly
(in our opinion) prioritized acquisitions to capitalize on the opportunity to
build out its product and technology lineup to solidify its competitive
position. Since the closing of the acquisition of MicroSemi Corporation (a
provider of semiconductor and systems solutions for aerospace/defense,
communications, data center, and industrial markets) in 2018 — which was the
company's last material transaction — Microchip Technology has focused on
paying down debt, increasing its dividend, and repurchasing shares. The company
is in the middle of executing a plan to return 100% of its free cash flow in
the form of dividends and share repurchases by the fourth quarter of fiscal
year 2024. We believe this return of capital, combined with the potential for
revenue and earnings appreciation, presents a compelling opportunity for shareholders.
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As of 09/30/2023, the following
portfolio company constituted a portion of the net assets of Conservative
Allocation Fund, Large Cap Equity Fund, Multi Cap Equity Fund, and Partners III
Opportunity Fund as follows:
- Analog Devices, Inc.: 0.0%, 4.5%,
0.0%, and 0.0%.
- Microchip Technology: 0.0%, 2.1%,
0.0%, and 0.0%.
- Texas Instruments, Inc.: 0.0%, 0.0%,
2.5%, and 2.7%.
Holdings
are subject to change and may not be representative of the Fund's current or
future investments.
The
opinions expressed are those of Weitz Investment Management and are not meant
as investment advice or to predict or project the future performance of any
investment product. The opinions are current through 10/20/2023, they are
subject to change at any time based on market and other current conditions, and
no forecasts can be guaranteed. This commentary is being provided as a general
source of information and is not intended as a recommendation to purchase,
sell, or hold any specific security or to engage in any investment strategy.
Investment decisions should always be made based on an investor's specific
objectives, financial needs, risk tolerance and time horizon.