The Day Ahead: Silicon Labs has the recipe for a hot IPO

The market prepares for a rare bird in the flock of mediocre IPOs
Written by Larry Dignan, Contributor

Silicon Laboratories, a communications chip manufacturer, has all the ingredients for a hot initial public offering (IPO) on Friday. The company has a short supply of shares available, eye-popping sales growth and a hot market niche. It is expected to price 3.2 million shares on Thursday night for trading on Friday. Silicon Labs is expected to price between $21 to $23 (£13 to £14), with Morgan Stanley as the lead underwriter.

Analysing IPOs is more of art than science, and fundamentals often get tossed out the window. However, Silicon Labs actually has some fundamentals worth noting. Here are the vital signs. The company reported earnings (yes, earnings) of $11m (£6.8m) on sales of $46.9m (£29m) in 1999. Sales jumped dramatically in every quarter last year. In 1998, Silicon Labs reported sales of $5.6m (£3.4m) and a loss of $3.4m (£2.1m).

Yes, folks, Silicon Labs is a real company. That fact makes it a rare bird in the flock of mediocre IPOs this quarter.

So what does Silicon Labs do? The company makes mixed-signal integrated circuits, or ICs, for the communications sector. Silicon Labs' digital signal processing chips are found in mobile phones, cable and satellite set-top boxes, modems and fax machines.

Silicon Labs currently relies heavily on its modem chip business, but is now expanding to focus on wireless applications. The company recently launched a series of integrated circuits used in credit card verification devices and telephone networks. Another key item worth noting about the company is that it is "fabless", meaning it relies on third parties to manufacture its chips.

Like other chip manufacturers in the communications sector, Silicon Labs is cashing in on strong demand and the need for cheap, smaller and low-powered semiconductors. The chip sector is in a cyclical upturn, and Silicon Labs is likely to run with other high-flying semiconductor stocks.

The company also has a blue-chip customer list. Silicon Labs' customers include Intel, Lucent, Motorola, PC-Tel, SmartLink and 3Com. However, there are risks with that client list, especially since four of those five customers accounted for 92 percent of sales. PC-Tel accounted for 62 percent of sales, followed by SmartLink at 12 percent, 3Com at 10 percent and Motorola at 8 percent. Silicon Labs doesn't have long-term arrangements with any of its customers.

In regulatory filings, Silicon Labs disclosed a few customer developments worth noting. Under the company's current agreement with PC-Tel, Silicon Labs is the sole supplier of chips. PC-Tel, however, is looking for a secondary source. "If PC-Tel qualifies a second source, we believe that this could have an adverse effect on the prices we are able to charge PC-Tel, and the volume of ICs that we sell to PC-Tel," the company said.

Aside from the PC-Tel risk, Silicon Labs is also suing 3Com and Analog Devices, a competitor. The lawsuit, filed in January, alleges that Analog Devices and 3Com "have misappropriated our confidential information, know-how and trade secrets". Depending on how the lawsuit shakes out, Silicon Labs could lose some business.

Litigation and a short customer list are both the norm with young companies going public these days. Simply put, Wall Street isn't likely to focus on the risks related to Silicon Labs. Instead, investors are likely to focus on the stock charts of its competition and see big gains ahead.

Across all of its product areas, Silicon Labs competes with Advanced Micro Devices (AMD), Analog Devices, Conexant, Delta Integration, Fujitsu, Infineon Technologies, National Semiconductor, Philips and Texas Instruments.

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