NetLogic Microsystems (NETL) is a profitable and growing mid-cap semiconductor company that sells a strong lineup of code-compatible multi-core processors to heavyweight semiconductor companies like Cisco Systems (CSCO - Free Cisco Stock Report) and Alcatel Lucent (ALU).  It has recently embarked on an ambitious diversification strategy designed to garner higher sales and greater exposure to the investment community. NETL’s components are integral to the Internet infrastructure, and network search engines. Products are sold to original equipment manufacturers, primarily in the United States, China, and Malaysia. An increasing sales volume has just started to generate heretofore elusive profitability, which points to a bright future. In addition, NetLogic has caught the eye of several large companies in the chip sector with cash-heavy balance sheets. These are Analog Devices Inc. (ADI), Intel Corp. (INTC - Free Intel Stock Report), SanDisk Corp. (SNDK), Broadcom (BRCM), and On Semiconductor (ONNN).

Trading on the NASDAQ, NetLogic stock has steadily risen from a low of $2.96 in 2004, to a March 2010 high of $35. Sales have risen from $35 million in 2003, (a year before it went public with 35.16 million shares), to what we expect will be over $380 million in 2010. And although the bottom line had dipped into the red for seven consecutive quarters, the company ended that streak recently and turned a profit of $0.08 a share in the most recent (September) quarter.  Meantime, finances are excellent. Cash on hand topped $225 million at the end of September, compared to $44 million at December 31, 2009. The company is virtually debt free (about $4 million in total), and has shareholder equity of $535 million. Furthermore, cash flow is starting to soar.

In our opinion, the semiconductor space has been underestimating forthcoming chip demand. Inventory had been cut back drastically over the past two years, and as economies around the world gradually recuperated, we feel there will be greater demand for semiconductor chips than previously expected. NetLogic’s own inventory has been declining. During the current (fourth) quarter, we look for inventories to further decline as major clients, such as Alcatel-Lucent, Cisco, and Huawei, work down their own inventories. Looking ahead, the company’s 4G-LTE processor should be a prominent wireless infrastructure growth driver. New design wins at Verizon (VZ – Free Verizon Stock Report), which is entering 38 more metropolitan cities, should advance NetLogic’s market share.

The company’s plan to enter emerging markets will probably be very beneficial, especially for sales of the XLR, XLS, and 10GE Phy. multi-core processors, and makes us more confident in its longer-term prospects. NetLogic hopes to make significant inroads into markets in China, India, and Africa over the next few years. The company is expected to profit from the need for speed. It s ultra-quick processors are used in the buildout of Internet networks, wireless infrastructure, and market datacenters.

Lastly, investors should note that increasing merger and acquisition activity is pervading the chip sector. Cash is piling up on the larger player’s balance sheets, and it is looking for something to spend it on. Share buybacks have failed to counteract the contraction of price-to-earnings ratios, and the low-interest-rate environment means that fixed-income investing is hardly worthwhile. Acquisitions, meanwhile, have on balance, been profitable. As a result, with the prospect of a better economy ahead, look for the larger aforementioned players to search for companies to spend their money on. NETL looks to be a prime candidate, which only adds to the speculative attractiveness of the stock.
We look for NetLogic to earn $0.04 a share in the fourth quarter, resulting in a full-year deficit of $0.95. For 2011, however, we expect fledgling quarterly profits to rally for an annual profit of $0.75 - $1.00 a share.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.