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Thursday, November 19, 2020

Intact Financial Corp Update

Intact Financial Corp Update

After a decade of buying up rivals to become Canada’s largest property and casualty insurer, Intact Financial Corp. is looking across the Atlantic with its biggest deal yet.

Intact sealed an agreement Wednesday to buy the Canada, U.K. and international operations of London’s RSA Insurance Group Plc as part of a $12.3 billion (US$9.4 billion) transaction. Denmark’s Tryg A/S is taking RSA’s Swedish and Norwegian operations.

Intact’s portion of the deal is $5.1 billion and brings it into entirely new markets in Europe while bulking up its core Canadian business. It supercharges an acquisition spree that has turned the Toronto-based company into the dominant force in Canada’s non-life insurance industry, a little more than a decade after it was cast off by Dutch insurer ING Groep NV.

The RSA deal also will be a major test of whether Chief Executive Officer Charles Brindamour, 50, can replicate the firm’s success in digesting acquisitions on a larger scale and farther afield that it has ever attempted before.

“We have an established track record of integrating companies,” Brindamour, said during a press conference on Wednesday. “We’ve done that many times in the past. We feel that we are in a strong position to tackle that challenge.”

Spinoff Success

Intact traces its roots back to 1809, when a group of businessmen formed the Halifax Fire Insurance Association. That firm was acquired in the 1950s by a Dutch insurer that eventually became part of ING. In 2009, ING divested its 70 per cent stake in ING Canada Inc., which changed its name to Intact.

Brindamour, who had become CEO about a year earlier, wasted little time in bulking up the newly independent insurer. Intact bought French insurer Axa SA’s Canadian business in 2011, bolstering its domestic premiums by almost 50 per cent.

Intact went on to make 12 more deals with a total announced value of about US$3.1 billion before the RSA acquisition, according to data compiled by Bloomberg. The firm serves about one in five families and one in four small- and medium-sized businesses in Canada, Brindamour said.

So far, the strategy has been rewarded. The company’s shares have risen more than fourfold since since May 19, 2009, the day its listing as Intact became official. That compares with a 68 per cent gain for the S&P/TSX Composite Index. Intact’s market value of about C$21 billion is up about fivefold in that time.

Intact has benefited from being an independent, publicly traded company competing against policyholder-owned insurers that can’t make deals the same way, said Victor Adesanya, an analyst with DBRS Morningstar. The company also has a track record of making its acquisitions profitable by spotting trends in the market and exiting unprofitable business lines, he said.

“They’re able to deploy advanced data analytics when it comes to risk selection, segmentation and identifying risk,” Adesanya said in an interview. “They do this better than others in the industry.”

The RSA takeover -- the largest ever by a Canadian property and casualty insurer -- will put that system to the test. For one, it will add significant bulk to the company, increasing annual premiums in Canada from $10 billion to about $13 billion and boosting total premiums about 67 per cent to $20 billion.

Intact’s workforce will balloon 63 per cent to 26,000, its specialty-insurance business will grow by 30 per cent, and it will be navigating unfamiliar regulatory environments in the U.K., Ireland and Denmark.

Brindamour says he has admired RSA for a long time and has thought deeply about the complexity of an acquisition. He said he’s comfortable with the deal now because RSA’s businesses have leadership positions and Intact’s existing operations are in “very good shape.”

He noted that his company’s net operating income per share has grown at a 10 per cent compound annual rate over the past decade and revenue growth has exceeded the industry’s by about 4 per cent a year over that time.

“The reason why acquisitions make sense for us is because we’re an outperformer in the markets where we operate,” Brindamour said.

Sources

https://www.bnnbloomberg.ca/intact-caps-decade-long-buyout-spree-with-12-3b-rsa-deal-1.1524536

Friday, November 13, 2020

Reinsurance is set to grow

Reinsurance is set to grow

At various points over the past decade, we have considered expanding our asset management business to include reinsuring obligations related to long-term annuities, as the capital is of long duration and our investing skills can add value in the investing of the capital. We previously had two misgivings: the first was our strong belief that interest rates might decline, which made it unattractive to lock in long-dated liabilities at high interest rates. The second was the fact that much of the capital from reinsurance activities would need to be invested in credit instruments, and we were concerned that our credit platform was not sufficiently large to take on the scale of capital involved.

Fast forward to 2020: interest rates globally have dropped to near zero, and while rates could go negative, in our view the odds do not favor that for any significant length of time. As a result, we believe the risk involved in reinsuring long-tail liabilities is the lowest it has ever been. Furthermore, our recent partnership with Oaktree has significantly added to the scale of our credit capabilities. Together, these developments have meaningfully changed the nature of the opportunity for us.

Our first step in preparing for this opportunity was to establish our reinsurance business, and we have received a number of licenses over the past few years. The ownership of the business and its operational oversight will be conducted through our newly created Bermuda company for this purpose called Brookfield Asset Management Reinsurance Partners (BAM Reinsurance).

As a next step in building the business, we announced a strategic partnership with American Equity Investment Life (AEL) under which BAM Reinsurance will reinsure annuity policies. We have agreed to take on $5 billion of existing policies in our reinsurance company and take an additional $5 billion of future policies as they are written. The simple story is that we will receive up to $10 billion of cash, invest those funds in our alternatives and income-oriented investment strategies and, if we can out-earn the rates we pay on the liabilities, we will do very well.

In order to set up this business for the long term but continue to have this reinsurance entity benefit from everything that exists at overall Brookfield Asset Management Inc., we are planning to replicate the success we have had pairing corporations and partnerships for each of our businesses. Thus, we will split off to all shareholders of Brookfield Asset Management a fractional share of Brookfield Asset Management Reinsurance Partners. Each new whole share of BAM Reinsurance, once assembled from fractional shares on distribution to you, will be equivalent in value to a current BAM Class A share. For those of you who follow our listed partnerships, you will know that we have done comparable distributions of “paired” securities in the past. In all cases, the “paired” corporate shares have traded in tandem with the partnership units, thanks to their equivalent distributions and exchange features.

Subject to the receipt of regulatory approvals, we plan to complete the distribution of BAM Reinsurance shares in the first half of 2021. The distribution will amount to a dividend of approximately $500 million of capital, or approximately a $0.33 for each BAM share you own.

Bruce Flatt

Chief Executive Officer

Brookfield Asset Management Inc.

November 12, 2020

Postscript

Insurance companies sell contracts not "products". Products are manufactured goods. Insurance companies like the term product as a sales gimmick to make it seem as though it is a solid object. These contracts are agreements to assume risks. The insurance company gets regular payments for this risk. If there is a claim they have lawyers on staff to negotiate low pay, slow pay, or no pay on claims. The claim language is twisted in legal terms so avoidance of payment or redefining what the contract specifies as payment can be manipulated by the insurance company.

Brookfield is wise to get into this business. Buffet saw an insurance company as a basis for his empire too. It's free money to invest with inflation, actuaries, and lawyers on the side of the insurance company.


Thursday, November 12, 2020

Alternatives are the solution

Alternatives are the solution

Low interest rates have been a tailwind for Alternative assets over the last 20 years. Once considered a complementary investment to a traditional fixed income and equities portfolio—and concentrated amongst the largest institutional investors, Alternatives today are an essential and growing part of most investment portfolios. The trend is also accelerating as a result of the recent moves to even lower rates and by the broad range of investments and products across Alternatives now available to investors.

As demand for Alternatives has grown, so too have the breadth and variety of investment offerings. Twenty years ago, investments in Alternatives represented roughly 5% of institutions’ investment portfolios and were largely concentrated in hedge funds and private equity. Today, that number is closer to 25%. Over the same period, the number of investible strategies has grown significantly with the emergence of private credit and real asset investing (real estate, infrastructure, and renewable energy, as examples). Going forward, our clients tell us that these allocations are increasing towards 60%.

The benefits of real assets in a normal economic environment are clear: they offer stable yield underpinned by high-quality contracts. The investments are often private in nature—and are therefore not subject to mark-to-market volatility—and returns are inflation-protected. A low-interest rate environment amplifies these benefits, and is now forcing more investors to either consider Alternatives for the first time or increase their existing allocations.

The reason for this is simple; pension plans, sovereign wealth funds, insurance companies, and many other investors have medium to long-term risk adjusted return targets that can’t be satisfied in the public equity and bond markets. A decade ago, an investor could hold a 10-Year German Treasury bond and earn a 4% yield; today the return stands at negative 1%. And while a select few large institutional investors have built out direct real asset investing capabilities, all have seen the benefits of partnering with asset managers like us who are able to leverage investment expertise and operating scale to drive investment performance and provide access to quality assets.

Across Alternatives, there are many categories of investment across the risk-return spectrum, and these numbers continue to grow to meet the demand of clients. Today we offer private investors over 15 different strategies across five different asset classes, which enables them to build a balanced real asset portfolio that can be tailored to meet their investment objectives. Our listed affiliates are an amalgam of these for public market investors. Beyond the traditional flagship funds, we offer our clients perpetual core private funds, private debt funds, listed credit products and region-specific funds. As we have grown, we have attracted new clients, and their commitments to our funds have grown, as has the average number of funds our clients invest in. From our own experience, it is clear that the allocation to Alternatives is growing faster now than it ever has, and we don’t see any reason for it to slow down.

With interest rates likely to be anchored at close to zero for the next several years, we expect this will also translate into strong support for asset valuations. Our partner, Howard Marks, recently published a letter titled “Coming into Focus” that discusses in depth how lower risk-free interest rates increase asset valuations, which we encourage you to read. We are at the very early stages of this playing out in the private markets, but as transaction activity returns, we fully expect to see higher valuations for the best assets. The recent sale of one of our office buildings in London at 10% higher than the price we paid for the property 12 months ago is a perfect illustration of this point, where lower interest rates increased the discounted cash flow value of the asset. While it could take time for transaction activity to fully ramp up, and contrary to the sentiment that has existed in the market, this sale provides us with clear evidence that the high-quality real asset portfolio we own is today worth even more than it was just nine months ago. 

Bruce Flatt

Chief Executive Officer

Brookfield Asset Management Inc.

November 12, 2020

Monday, November 9, 2020

TRUMP'S 5 RULES FOR RULING THE WORLD

TRUMP'S 5 RULES FOR RULING THE WORLD

Politics has a way of turning everything upside down.

Flit over to Twitter and the same government media echo chamber that was loudly defending the Iran deal is concern trolling about strong inspections of North Korea’s nuclear program and worrying that President Trump’s suspension of military exercises is far too great of a concession to the tiny tyrant. 

The clever ones ask, “What’s the difference between the Iran deal and the North Korean negotiations”? Isn’t Trump’s stated willingness to meet with dictators a lot like Obama’s no preconditions pledge? 

And then there are the trade wars. What is he thinking by upsetting the Chinese and the Europeans?

It’s 2018. And after spilling several small rivers of black ink (digital and virtual) analyzing, smearing, belaboring, insulting and fact checking President Trump, the media still doesn’t understand him.

That’s not surprising. The media has been writing about America for much longer than that and has even less of a clue about how people live outside its preciously hip urban and suburban bubbles. 

But there are 5 simple rules for understanding President Trump. They define how he’s lived his life until now. And what still drives him at 1600 Pennsylvania Avenue. If you understand them, you will get what he’s doing. If you don’t, there’s always a job waiting at the New York Times.

1. Act, Don’t React

Trump hates reacting, he loves taking the initiative and forcing others, rivals, competitors, media syndicates or foreign dictators, to react to him. That’s the essence of strategy and he nails it the way few have. 

When UK Foreign Secretary Boris Johnson muttered that there was a “method to his madness”, that was it.

The method is becoming the driving force in an escalating conflict. Instead of reacting to attacks, Trump forces his attackers to react to him. He takes the initiative and leaves his opponents sputtering. 

That’s how he became the President of the United States. It’s what he’s doing internationally. 

By acting, Trump takes control of each encounter. What happens next may not be ideal, but Trump cares more about maintaining the initiative than about forcing a specific outcome. He doesn’t see politics as a chess match, but as a boxing match. He doesn’t get locked into predetermined goals. Instead he lets the kinetic confrontation create opportunities by exploiting his opponent’s reactions.

Picking a fight with the North Korean dictator, led to a peace summit. A trade war with China has already led to some serious concessions. A trade shoving match with Europe and Canada offers potential wins.

Unlike previous administrations, Trump isn’t satisfied with the status quo. And that means that he tries a lot of things. 

That takes us to Rule 2.

2. Try Everything

Critics have poked fun at Trump’s failed business ventures. But you don’t succeed without trying and failing.

Trump is comfortable with failure. He knows that if you’re willing to knock on 100 doors, you might get 1 sale. His approach to politics is trying a lot of different approaches and policies to get to a win.

When Obama expressed a willingness to meet with dictators and terrorists, it’s because he was already sympathetic to them. The seeds of the Iran deal were always in him. The negotiations just took him where he already wanted to be. Trump however isn’t meeting with Kim Jong-un because he likes him. He’s doing it because it might pay off. Or it won’t and then he’ll try something else.

Obama needed Iran. Trump doesn’t need North Korea. He can take it or leave it. He’s hungry for wins, but he also sees the potential for them everywhere so he doesn’t overcommit to any individual deal.

Political professionals scoff at that scrappy attitude. They insist on the importance of posture and position. Trump knows all about posture and position, but he refuses to be its prisoner. He can insult Kim one day and flatter him the next. Politics is just business with countries instead of companies.

Trump’s approach is the same to both politics and business. Do whatever it takes to get the deal. And then decide if the deal is worth taking.

3. Chaos is Power

Most people want to minimize chaos. Countries and companies spend fortunes, fight wars and dedicate decades to reducing chaos. Trump however thrives on chaos. Instead of trying to control chaos, he generates it, causing uncertainty and then offering a sense of security in exchange for a good deal.

That’s what Trump is doing with trade. It’s what he did to China and North Korea.

Trump tries everything (Rule 2) and escalates confrontations (Rule 1) so that his opponents have no way to counter him except by escalating the confrontation and creating more chaos. And then Trump forces them to negotiate by proving he can function in a chaotic and uncertain situation better than they can.

That’s how he got North Korea to the table. After decades of the Norks intimidating previous administrations by creating chaos with their threats, Trump topped those threats. The media warned that a nuclear war would break out. Instead China and North Korea chose a peace summit.

The summit may come to nothing, but Trump had already broken the Nork ability to intimidate us.

China, Europe and Canada don’t want a trade war. They have nothing to gain and plenty to lose. By creating economic chaos, Trump also became the only man who can end the chaos and restore security.

Chaos is power. 

When the United States became a world power, its administrations emphasized stability over everything. Trump welcomes chaos because it’s a much more effective negotiating strategy. Entities that seek order can be intimidated with chaos. But politicians who seek chaos can’t be intimidated.

Trump doesn’t seek order. He wants victory.

4. Never Show Your Hand

Conventional politicians have a narrow window of agenda items. They’re very clear on what they want, what they don’t want, what they’re willing to do and what they’re willing to give up to get it.

Trump has always been ambiguous. Parse his sentences and you can read them three different ways. Each assertion eventually uncovers a contradiction. That’s confusion. Tactical confusion.

As Trump has mentioned plenty of times, he loves being unpredictable. 

Trump is the only president in a century who is able to go into negotiations with a completely unpredictable outcome. And the roster of competing figures around him only creates more chaos.

To truly create chaos (Rule 3), you have to be unpredictable. That creates insecurity. It forces your opponents to read things into every move you make. And then to be stymied by the futility of it.

Ambiguity leaves the other side unable to assess what the United States would actually settle for. Instead it ends up offering far more than we would settle for just to restore that sense of security.

Trump is the most famous man in the world. And yet his decision-making remains mysterious.

5. Don’t Be Afraid to be the Bad Guy

If Americans have a fatal flaw, a weakness that undermines our domestic and international politics, it’s a need to be liked. Most other countries don’t wonder whether the rest of the world likes them. 

Blame Hollywood, dime novels or comic books, but as Americans we see ourselves as the heroes. And our enemies, foreign and domestic, know that they can break us by making us question our goodness.

It’s how they did it in Vietnam, in Iraq and too many foreign policy debates to count.

One of Trump’s great strengths is that he’s not afraid to be the bully, the heavy and the jerk. He can flatter Kim Jong-un, Trudeau and any other leader. Or call them names.

He can say shocking things and take unacceptable positions if it gets him what he wants.

That’s the attribute that upsets and infuriates Never Trumpers. But it also gives the United States far more negotiating leverage and freedom than it ever had before. And that’s why the people chose him.

Trump embodied all the things that had been going unsaid and all the truths that needed telling.

Past presidents valued their personal relationships with foreign leaders. But Trump is willing to throw a punch at the boy band leader of Canada if it gets a farmer in Wisconsin a better deal for his dairy. 

On the global stage, President Trump has forced North Korea, China, Europe and Canada to react to him. He’s trying everything. He’s creating chaos. He’s hiding his hand and he’s winning. 

The media shouts that Trump is isolated. If he were isolated, the world wouldn’t be revolving around him. The world doesn’t stop when Putin or China’s Jinping issue a statement. But a single Trump tweet can upend the priorities of international diplomacy for days, weeks and even months.

Trump isn’t reacting to the world. The world is reacting to him.

And as long as he can keep the world reacting to him, he’s the one setting the agenda for the world.

Daniel Greenfield, a Shillman Journalism Fellow at the Freedom Center, is an investigative journalist and writer focusing on the radical left and Islamic terrorism, Fri Jun 15, 2018

Wednesday, October 28, 2020

Tourmaline Announces Formation of Topaz Energy, Unlocking Value in Tourmaline's Significant Asset Base

Tourmaline Announces Formation of Topaz Energy, Unlocking Value in Tourmaline's Significant Asset Base

CALGARY, Oct. 10, 2019 /CNW/ - Tourmaline Oil Corp. (TSX:TOU) ("Tourmaline") is pleased to announce the formation of Topaz Energy Corp. ("Topaz"), a new private royalty and infrastructure energy company. Tourmaline will sell to Topaz: a royalty interest on Tourmaline lands, a non-operated interest in two of Tourmaline's existing 19 natural gas processing plants, and a contracted interest in a portion of Tourmaline's current third-party revenue for total cash and share consideration of $775 million.

Topaz will be a low-risk, high-distribution, hybrid royalty and infrastructure energy company with long-term growth plans. Topaz will be capitalized initially with a $150 to $200 million third-party equity private placement, with Tourmaline retaining a 75% to 81% equity ownership interest. Tourmaline intends to reduce a portion of its ownership as Topaz participates in future acquisition activities and an anticipated Topaz public liquidity event in 2020. The initial acquisition from Tourmaline is expected to generate approximately $90 million in revenue(1) in 2020, of which it is anticipated approximately 75% will be paid out in quarterly dividends ($0.80 per share annually, 8% yield).

The assets to be acquired from Tourmaline will consist of three components:

A gross overriding royalty ("GORR") on natural gas, oil, and condensate production on 100% of Tourmaline's existing lands (approximately 2.2 million net acres).

A non-operated 45% working interest in two natural gas processing plants underpinned by long-term take-or-pay commitments from Tourmaline.

A contracted interest in a portion of certain third-party revenues generated by natural gas processing and handling agreements.

Upon completion of the transaction and private placement, Topaz will have a majority-independent Board of Directors and will be managed initially via a management contract with Tourmaline. The Topaz GORR will provide for an interest in Tourmaline lands and access to multiple, well-defined, future drilling and growth opportunities, including exposure to future Tourmaline production growth. Topaz will begin operations with zero debt and will have a scalable business model with the potential for additional transactions with Tourmaline and other industry participants.

The transaction with Topaz is expected to close in mid-November 2019 and is subject to customary closing conditions and regulatory approvals. Peters & Co. Limited is acting as exclusive financial advisor to Topaz.

Transaction Rationale

The transaction with Topaz will monetize a portion of the currently-unrealized, substantial-intrinsic value in Tourmaline's significant infrastructure complex and Tourmaline's industry-leading low-cost profitable EP business.

This transaction has minimal impact on Tourmaline's forecast 2020 cash flow and no impact on current EP plans.

- Tourmaline will utilize the gross cash proceeds of approximately $135 to $185 million for potential consolidation activities within the existing three operated core complexes, for debt reduction, and for share buybacks under its existing normal course issuer bid. The transaction will make a top-tier balance sheet even stronger.

- The transaction improves forecast 2020 cash flow per share (debt adjusted)(2) from $6.98 to $7.33, an increase of 5%, assuming the mid-range of the initial proceeds.

- Tourmaline retains an average working interest of approximately 95% in all of its processing infrastructure and will maintain its low operating and corporate cost structure.

- Tourmaline continues to maintain the strong capital discipline required for the free cash flow generation business plan; EP capital spending in Q3 2019 was fully funded by cash flow generated in the quarter. Much stronger anticipated Q4 2019/Q1 2020 AECO prices, coupled with oil/condensate production growth, is expected to continue to improve Tourmaline's free cash flow.

- At Gundy Ck in the NEBC Montney gas condensate complex, Tourmaline was able to ramp up the new c-60A deep-cut gas plant to the full 200 mmcfpd capability in late August, prior to the start-up of the North Montney pipeline. The ramp up increased overall corporate liquids production (oil, condensate, NGL) to an average of 61,000 - 62,000 bbls/d in September.

Sunday, September 20, 2020

Analog Devices Inc..Q4 2019, Letter to the Shareholders

Analog Devices Inc..Q4 2019, Letter to the Shareholders

Dear Fellow Shareholders

We are living in a time of astonishing innovation in the Third Wave of Information and Communications Technology (ICT), as we refer to it at ADI. This wave is characterized by ubiquitous sensing, hyper-scale and edge computing, and pervasive connectivity. These technology modalities enable the generation of vast amounts of data that allow us to glean actionable intelligence about the world. As one of the very broadest high-performance analog solutions providers, we play a critical role at the nuanced intersection of the physical and digital domains, by providing the building blocks to sense, measure, interpret, connect, and power the edge. Essentially, ADI is where the data is born.

This era of extraordinary technological change will continue to improve quality of life globally through continuous advancements in areas such as seamless and efficient automation, more sophisticated communications networks, universal and affordable healthcare, environmental integrity, and much more.

Through our research and development (R&D) investments and strategic acquisitions, ADI is better equipped than ever to solve our customers’ toughest engineering challenges from sensor to cloud, from DC to 100 gigahertz, and from nanowatts to kilowatts. And as analog engineering challenges become more complex, our customers are telling us that they want us to provide more complete solutions. This provides ADI with new, attractive opportunities to deliver profitable growth in the years ahead.

Solid Financial Results for Fiscal 2019

In fiscal 2019, we delivered revenue of approximately $6 billion amidst challenging macroeconomic conditions and trade uncertainty. Our business-to-business (B2B) markets, comprised of industrial, automotive, and communications, achieved modest year-over-year growth and outperformed the semiconductor industry again. We delivered industry-leading adjusted gross margins of approximately 70%, adjusted operating margins of more than 40%, and adjusted diluted earnings per share of $5.15.1 Notably, we generated strong cash flow as evidenced by our 33% free cash flow margin, which places us in the top 10% of the S&P 500.

The strength of our innovations and customer engagements, the diversity of our franchise, and our operational discipline have enabled us to consistently deliver strong returns. Over the last five years, ADI has generated a total shareholder return of 148%, or more than double the S&P 500 return.

Our Fiscal 2020 Priorities

As we enter fiscal 2020, I would like to describe the three primary priorities on which we are focused to continue driving ADI’s long-term success.

1. Deepening Customer-Centricity

ADI possesses among the broadest product portfolios, applications expertise, and manufacturing capabilities in high-performance power management and precision and high-speed signal processing technologies, which helps our customers bridge the intersection between the physical and digital worlds.

Throughout the year, we saw robust customer engagement driven by a couple of factors. First, our customers are facing a scarcity of available analog engineering talent and they are increasingly turning to us for that expertise. Second, our customers are encountering more complex challenges in the Third Wave of ICT with digital systems increasingly relying on real-world data to create actionable intelligence.

As a result, we see our customers partnering with us more deeply to gain the full benefit of our technology capabilities and product innovations with relationships starting earlier and lasting longer. As a testament to that, our opportunity pipeline value achieved record levels in fiscal 2019.

2. Efficient Use of Capital

At ADI, we have an intense focus on creating and delivering best-in-class value for our customers and doing so is our first call on capital.

Our success is underpinned by our philosophy that superior innovation drives superior results and we understand that R&D enables our virtuous cycle of innovation-driven success. This is why we invested more than $1 billion in R&D during fiscal 2019. We choose our investment areas judiciously—focusing on what we believe are the most attractive opportunities across our business, particularly in our B2B markets.

Also, given the growing demand for analog technology and the evolving needs of our customers, we have acquired two companies to increase the scale and the scope of our offerings over the past five years.

With the acquisition of Hittite in 2014, ADI became the market leader in high-performance RF and our portfolio now spans the entire frequency spectrum from DC to 100 gigahertz. Since this acquisition, ADI has more than doubled the revenue from this portfolio, and in fiscal 2019, our RF revenue increased more than 30% year-over-year led by growth in industrial and wireless communications.

The acquisition of Linear Technology (LTC) in 2017 added highperformance power management and additional precision signal processing to our portfolio, expanding our offerings to deliver more complete solutions. Our new power management design wins across 5G infrastructure, data center, and automotive are moving to production this year, and we expect a more meaningful revenue ramp in fiscal 2021. This puts us on a path to double LTC’s historical revenue growth rate in the years ahead.

Through our development of cutting-edge innovations and our ability to solve the most difficult problems across a broad array of applications, we generate significant cash flow and are deeply committed to delivering strong shareholder returns. In fiscal 2019, we generated nearly $2 billion of free cash flow and delivered on our target of returning 100% of our free cash flow after debt repayments in the form of dividends and buybacks.

3. Capitalizing on Secular Trends

As the data age rapidly evolves and the demand for edge computing rises, analog technology becomes even more relevant. Currently, a modest 10% of data is generated outside the cloud, and by 2025, this amount is expected to grow to 75%.4 We believe this trend uniquely positions ADI to capitalize in two ways. First, we will be a critical partner in the collection, curation, and communication of our customers’ edge data. Second, with more than 85% of our annual revenue coming from B2B markets, we are well-aligned with the markets driving this increase in data—let me provide you a few examples.

In Wireless Communications, we are pushing the limits of 5G innovation with our market-leading microwave and integrated transceiver portfolio, adding algorithms and optimized power solutions to differentiate our portfolio. These enhancements enable customers to dramatically increase data density, while reducing their radio footprint and power. Importantly, 5G is more than just radio innovation—it requires a complete re-architecting of the core and wireline network to meet the 5G vision of gigabit speeds, low latency, and high reliability. This network expansion is expected to require a significant upgrade to the backhaul system, unlocking another new revenue opportunity.

In Automotive, the center of value creation is pivoting from the internal combustion engine to the electric powertrain and passenger comfort and safety. Again, ADI plays an important role in enabling these advancements. In electric vehicles, our battery management solutions provide customers up to 20% more miles per charge vs. our competition and we are revolutionizing how monitoring and controlling batteries will be solved—and doing so wirelessly. In Level 3+ autonomous vehicles, our high-speed signal processing technology is necessary to deliver the ever-increasing levels of resolution and range required in active safety systems.

In Industrial, the rise of Industry 4.0 and digital factories is increasing the need for more sophisticated sensing, measuring, and actuating solutions. This creates additional demand for our precision signal chain and power management franchises and expands our addressable market for our suite of connectivity and sensor solutions.

Finally, in Healthcare, demographic and economic pressures, coupled with the availability of new sensing and diagnostic capabilities, are opening up a myriad of new opportunities for ADI. This includes mission-critical X-ray systems, where we are pushing performance to new levels with our photonic conversion solutions by reducing dosage intensity, while increasing image fidelity. And, wearable devices with our clinical-grade vital signs monitoring solutions are poised to enable hospital-grade patient monitoring at the home.

 Our Sustainable Future

ADI has long been focused on responsible sustainability efforts, but I believe the time has arrived where we not only prioritize sustainability, but also environmental regeneration. To this end, ADI employees will increasingly bring their ingenuity and energy to trailblazing new solutions that restore and replenish natural resources and ecosystems, reduce our carbon footprint and the environmental impact of our operations, as well as partner with our customers and suppliers to reduce the impact on our planet.

To provide just one example, our innovative battery management solutions are at the heart of building more efficient electric vehicles, which helps to curtail tens of millions of tons of CO2 entering the atmosphere. Putting this into perspective, every million ton reduction of CO2 emissions is equivalent to the annual CO2 absorption by over one million acres of mature forest. As we look ahead, we believe we have a bigger role to play in engineering a sustainable future. We will be providing more on our strategy and commitments, which are aligned with the United Nations’ Sustainable Development Goals, in our Sustainability Report this year.

Looking Ahead

Over our company’s 55-year history, ADI has navigated several important transitions because of our ability to successfully sense and adapt to technological, demographic, and economic changes. Our leading technology portfolio and customer relationships, business diversity, and focus on continuous improvement has created a strong business model with both a broad array of optionality and opportunity as well as long-term resilience.

 As the world becomes more digital, more autonomous, and more intelligent, I am confident in our ability to deliver stronger performance. This is due to the many thousands of talented people across our company who are passionate about creating industry-leading innovation and dedicated to the success of our customers each and every day.

I have been with ADI for more than 30 years, and I can say unequivocally that I have never been more excited about the prospects and opportunities that lie ahead.

Sincerely,

Vincent Roche

President and Chief Executive Officer

Analog Devices, Inc.

Stock Idea…Analog Devices Inc…ADI on the NYSE

Stock Idea…Analog Devices Inc…ADI on the NYSE

Analog Devices, Inc. (Analog Devices) designs, manufactures and markets a portfolio of solutions that leverage high-performance analog, mixed-signal and digital signal processing technology, including integrated circuits (ICs), algorithms, software and subsystems. Its products include Analog Products, Converters, Amplifiers/Radio Frequency, Other Analog, Power Management and Reference, and Digital Signal Processing Products. The Company is a supplier of data converter products. The Company is a supplier of high-performance amplifiers. Its analog product line also includes products of high performance radio frequency (RF) ICs. The Company's DSPs are used for high-speed numeric calculations. The Company offers its products for applications in various end markets, such as industrial, automotive, consumer and communications. The Company operates in the United States, Rest of North/South America, Europe, Japan and China.

Business Model Themes

Analog Devices is one of the world's largest analog chipmakers, with an especially strong position in analog signal processing chips. We think it is well-positioned to profit from more advanced and higher-priced semiconductor content in automobiles, 5G wireless networking equipment, and industrial applications like medical devices and factory automation equipment in the years ahead.

Analog chips are used to convert real-world signals, such as sound, temperature, and pressure, into digital signals that can be processed. We believe Analog Devices has a wide economic moat because of its proprietary analog designs and high customer switching costs; since analog chips are neither particularly expensive nor do they require cutting-edge manufacturing techniques, high-quality analog chipmakers tend to retain design wins as long as the end product is being built, all while maintaining healthy pricing and strong profitability over time.

Most of Analog Devices’ organic sales come from data converters and amplifiers used in various end markets, such as wireless base stations, and the company expanded into power management chips via its acquisition of Linear Tech. An especially promising end market for the firm continues to be the automotive sector. Not only are traditional cars adding electronic content in their vehicles such as sensors, active safety systems, and advanced infotainment systems, but also hybrid and electric autos are doubling and tripling the amount of chip content inside of each vehicle. 

We're also seeing a similar trend of increased chip content in industrial applications like robots, factory equipment, and medical devices. ADI has tens of thousands of customers in these end markets. Further, ADI's signal chain semiconductors will likely be prominently used in 5G wireless network equipment. Nonetheless, ADI still faces challenges in a fragmented analog market. The firm has many competitors with equally strong expertise in analog chip designs, and the semiconductor industry is highly cyclical. Regardless of new product releases, Analog Devices' sales probably will continue to ebb and flow with the rest of the sector.

Sustainable Competitive Advantage (Moat)

We believe that ADI has a sustainable competitive advantage, thanks to intangible assets around proprietary analog chip design and manufacturing expertise, as well as switching costs that make it difficult to swap out analog chips for competing offerings once they are designed into a given electronic device. We are confident the firm is more likely than not to generate excess returns on capital over the next 20 years.

We believe that leading analog chipmakers benefit from favorable characteristics that lend themselves to economic moats. Moats for chipmakers with analog expertise tend to come from intangible assets associated with the strength of proprietary chip designs, as well as switching costs that make it difficult to swap out analog chips for competing offerings once they are designed into a given electronic device.

We believe analog engineering talent is difficult to come by, as greater emphasis is placed on digital chip improvements, and it often takes years to train up-and-coming analog engineers in the intricacies of chip designs. Thus, it is extremely difficult for startups to replicate the many years of analog expertise held by incumbents. Leading analog chipmakers also face stringent quality requirements in some end markets, such as the automotive industry, for example, where defects can only be tolerated as low as one part per million.

Although the analog chip market is quite fragmented, it would be difficult for any startup to achieve this level of quality while still being to satisfy high-volume production. Furthermore, analog chips tend to make up only a small portion of a product's bill of materials, so purchasing decisions tend to be based on performance rather than price, helping ADI and its peers retain pricing power. Automotive, industrial, and communications infrastructure customers, in particular, are unlikely to choose an inferior analog chip in order to save pennies on the cost of a piece of equipment worth tens of thousands of dollars.

Similarly, engineers are loath to swap out an analog from an existing design (again, only to save a few pennies on cost) because of the onerous redesign and retesting costs associated with the switch. One can imagine the frustration and possible reputational damage to a product if a perfectly functioning electric toothbrush or thermostat were to fail because of an unforeseen change in how the analog chip interacts with the rest of the circuit board. Again, such damages would be amplified in far more expensive equipment like cars, planes, or satellites. 

ADI and its chipmaking peers tend to profit from these high switching costs by having lower ongoing R&D and capital expenditure investments than digital chipmakers, which helps to contribute to healthy returns on capital for shareholders. In particular, buyers of analog semis typically don't demand smaller chips packed with more transistors, but rather, reliable products that deliver the desired accuracy and precision in power management or signal processing. Shrinking the chip might not necessarily enhance accuracy (and might even serve to reduce it), so analog chips tend to be made with lagging edge manufacturing techniques.

ADI and some of its peers take this benefit one step further by concentrating on end markets where product lives are measured in decades, as opposed to the increasingly short life cycles associated with consumer devices like PCs or handsets. ADI likely earns less than 10% of revenue from personal electronics devices like smartphones, tablets, and PCs. All else equal, we are less confident in outsize economic profits from chipmakers that serve the handset and PC industries, given the shorter product life cycles, intense competition, and customer concentration as a handful of tech titans exert tremendous buying power.

The analog chip space is highly fragmented, but ADI is the only firm with a substantial market share lead in any subsegment of the business. The firm has nearly 50% share of the data converter analog chip market, and these chips are widely used in communications infrastructure equipment, in particular, as they convert analog voice signals to digital signals for processing, and vice versa. We believe that ADI will retain its relatively dominant position in converters over time.

Management

We view Analog Devices as a well-run organization and an Exemplary steward of shareholder capital. Vincent Roche, a longtime ADI veteran, became president in 2012 and took over the CEO role in May 2013. Ray Stata, one of ADI's cofounders, is chairman of the board. Analog Devices has done a good job of distributing cash to shareholders, raising its dividend to $0.62 per quarter and targeting a 15% annual dividend increase. ADI announced that it plans to distribute 100% of its free cash flow to shareholders through dividends and opportunistic stock buybacks.

We approve of ADI’s acquisition strategy. First, the firm made a smart move to acquire Hittite Microwave, as the firm paid what we consider a reasonable 30% premium for a highly profitable radio frequency chipmaker. We believe ADI will benefit from selling Hittite products into 5G wireless equipment in the years ahead. We also think ADI made another shrewd deal to acquire Linear Tech, the highest-margin analog chipmaker. ADI has taken on a relatively high degree of leverage to buy Linear, but strategically, the deal makes quite a bit of sense and we anticipate that ADI will generate healthy free cash flow in order to pay down the debt over time.

(The above information was edited from a Morningstar Equity Analyst Report)