Better Buy: NXP Semiconductors NV vs. Cypress Semiconductor Corp.

By Markets Fool.com

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Automotive computing is a long-term goldmine on wheels.

Today, the global market for automotive semiconductors stands at $29 billion, but that's just the beginning of a much larger trend. In-car entertainment and information systems, formerly the domain of high-end luxury vehicles, are becoming impressive in mid-range and downright cheap vehicles. Modern cars are riddled with computer-controlled systems, and we are only at the very start of the self-driving vehicle revolution. Grabbing market share in this exciting sector today should pay big dividends in coming years.

NXP Semiconductors (NASDAQ: NXPI) and Cypress Semiconductor (NASDAQ: CY) are among the leaders in today's automotive computing market. Let's compare and contrast the two car-chip giants and see which one's the better fit for your portfolio.

Car chips are already a big deal here

In the automotive sector, NXP plays across every sub-market. The company is among the three largest global suppliers of in-car power controllers, sensor chips, and microcontrollers. Thanks to the recent merger between NXP and Freescale Semiconductor, the company is now the undisputed overall leader with a 14.2% total market share in 2015. No other chip vendor crossed the 11% threshold.

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Cypress is a much smaller player, with a tighter focus on specific end markets. As the third-largest vendor of microcontrollers and memory chips for in-car purposes, the company is not butting heads with NXP in security systems, power controllers, or sensors.

Just because NXP boasts annual revenues four times the size of Cypress' sales doesn't mean that you can forget about the smaller competitor. Automotive semiconductors are of utmost importance to both companies. This segment accounted for 36% of NXP's total revenue in the recently reported second quarter. For Cypress, that industry supports 33% of the company's incoming sales.

Operating efficiency

That being said, the two companies stand miles apart in many ways.

NXP is solidly profitable today, sporting a 12% net margin and $537 million in trailing free cash flows. By contrast, the bottom line at Cypress is deep in the red and even its operating margins are negative. The company does produce positive cash flows, but only to the tune of $57 million over the last four quarters.

In all fairness, Cypress is working through two recent big-ticket acquisitions. The company merged with memory specialist Spansion in 2015, in a deal that doubled the company's market cap and tripled its annual revenues. More recently, Cypress agreed to pay Broadcom (NASDAQ: AVGO) $550 million for its Internet of Things operations. Game-changing buyouts of this scale are never easy, and can cause financial headaches long after the closing documents were signed.

On the other hand, NXP is doing the same thing. I already mentioned the Freescale merger, which stands to nearly double the company's sales. But where the Cypress saw the Spansion merger choking its bottom line, NXP's margins have been trucking along just fine. Cypress merged with a barely profitable business, where cost savings targets were pushed three years into the future. NXP picked up a solid competitor with strong profits of its own, and is already reaping cost savings from that deal.

Valuation

So NXP is both the larger player and the more efficiently managed business here. The two stocks are priced accordingly, too.

Since Cypress isn't currently profitable, it's difficult to compare the stocks in terms of vanilla price-to-earnings valuations. But there are other metrics available.

For example, EBITDA figures are often used to compare core business profits between companies, without distortion from tax accounting strategies and financial costs. NXP shares currently trade at 14.8 times trailing EBITDA profits. For Cypress, this ratio stands at 160.

Price-to-book ratios can gauge the value a company has created from its shareholders' equity. Here, Cypress shows a P/B ratio of just 1.8 while NXP stops at 2.8.

The book value ratio shows NXP in line with other major chip vendors. From this perspective, Cypres is either undervalued or deeply troubled -- a potential turnaround story with much left to prove. The sky-high EBITDA ratio underscores the risks a Cypress investor must be willing to take.

The bottom line

I would only consider owning Cypress as a speculative turnaround play, hoping that the company can deliver real value from its massive deals before it's too late. It's much too early to call this stock a long-term investment, with or without the automotive market opportunity.

I'd sleep much easier with NXP under my pillow. This company is betting the farm on automotive chips and the Internet of Things, from a position of solid financial strength. No investment is ever completely risk-free, and NXP is no exception, but this stock doesn't make me nervous at all -- especially at current prices.

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Anders Bylund has no position in any stocks mentioned. The Motley Fool owns shares of and recommends NXP Semiconductors. The Motley Fool also recommends Broadcom and Cypress Semiconductor. Try any of our Foolish newsletter services free for 30 days.

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