SPECIAL REPORT

A Brownstone Research Publication

How to Invest in Tesla’s Secret Supplier

By Jeff Brown

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How to Invest in Tesla’s Secret SupplierBy Jeff Brown, Editor, The Near Future Report

It’s a letter every management team hates to get…

It was October 2013. And the board of directors of TriQuint Semiconductors had just received a letter from Starboard Value – a renowned activist investor.

Activist investors are individuals or groups that buy a significant stake in a public company to influence how that company is run. They typically demand large changes that are uncomfortable for both management and the employees. And I know from personal experience what this feels like from when I was working at Juniper Networks and NXP Semiconductors.

At the time, TriQuint’s share price had been massively underperforming much of the semiconductor industry, making it a prime target for Starboard Value. And when Starboard takes a position in your company, it demands change. TriQuint was no exception.

In 2013, Starboard acquired 7.9% of TriQuint Semiconductors. And once the position was made public, it came with a list of “demands” to improve business and boost the share price.

Half of TriQuint’s business was not doing well, and this was covering up its crown jewel – the Bulk Acoustic Wave (BAW) filter business.

These BAWs can filter radio frequencies to enable better signal strength, fewer dropped calls, lower

power consumption, and less heat in phones.

BAW filters were very important in the ongoing 4G cellular rollout at the time. And they’re even more important now in the 5G rollout. Starboard pushed TriQuint to sell off or restructure unprofitable business segments and focus more attention on BAWs.

These are the kinds of difficult, uncomfortable decisions that result in large restructuring and employee layoffs.

Starboard also thought the company should focus more attention on its new high-end semiconductor technologies involving gallium nitride (GaN). At the time, these were only used in military applications, but Starboard saw the future and knew this tech would be used increasingly in automobiles, servers, and wireless base stations.

This wasn’t a revelation by Starboard. Industry insiders knew this as well, but the revenues were further out and TriQuint was too focused on its existing business rather than investing heavily in the future.

At the time of the letter, TriQuint Semiconductors’ shares were trading at $7.09. But Starboard had started accumulating shares back in February of that year and had an average cost basis of $4.82. Shares began trading higher almost instantly. And just 22 months later,

Special Report 2021

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TriQuint merged with another company, RF Microdevices. By then, TriQuint shares were worth $27.55. All told, investors made 471% in just under two years with this stock.

Careful readers may recognize the names of these two companies. After they merged, they became Qorvo (QRVO) – which is a Near Future portfolio company.

But TriQuint wasn’t the only success story for Starboard Value. This activist investor has a track record of turning around troubled semiconductor companies for a great return.

In early 2016, Starboard invested in Marvell. At the time, Marvell was scattered with no clear direction of product lines. But then Starboard came in, got rid of the husband and wife team that founded the company, and helped focus operations.

Three and a half years later, Starboard exited its Marvell position for about a 200% gain.

In late 2017, Starboard started purchasing shares of Mellanox – another beleaguered semiconductor company at the time. Mellanox focused on interconnection technologies but struggled to gain traction in the market. It just didn’t have enough scale in its business.

It was only a year and a half later when Starboard exited its position because NVIDIA purchased the company. Starboard made 138% on its investment. And now, Near Future Report subscribers also have exposure to Mellanox through shares in NVIDIA.

Starboard knows how to create change in a company and unleash shareholder value… What it advocates may be uncomfortable and difficult for the companies that it invests in, but in general, its analysis is strong.

And Starboard has just taken a position in a semiconductor company that I know very well. In fact, I used to compete against this company

in some segments when I was an executive at NXP Semiconductors. That company is the recommendation we’re sharing in this report.

Welcome to The Near Future Report

Welcome to The Near Future Report. I’m your editor, Jeff Brown. I have nearly 30 years of experience working at high-tech companies like Qualcomm, NXP Semiconductors, and Juniper Networks. With this research service, we look for stable, mid- to large-cap companies with products enabling the newest technological trends. We can think of these as “sleep well at night” stocks with great growth potential.

These technology trends include 5G wireless networks, artificial intelligence (AI), precision medicine, cloud-based software, and more.

We profit by staying rational and investing in great technology companies whose products and services are perfectly positioned for the highest-growth trends coming around the corner.

And that brings us to one of the biggest trends we’ll see in the coming months: the future of transportation.

More specifically, the rise of electric vehicles (EVs).

Electric Vehicles Have a Surprising History

Before I share the company in this report – and show you how we’ll profit from EVs in 2021 and beyond – let’s take a step back. Understanding the “bigger picture” is an important part of any investment thesis here at The Near Future Report.

We may be surprised to learn that electric vehicles are nothing new. They’ve been around since the 1830s… nearly 50 years before an internal combustion engine (ICE) car was invented.

It’s uncertain who invented the first electric car, but by the middle of the decade, inventors from

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Hungary, Scotland, Holland, and the state of Vermont had already built small electric cars.

During the 1890s, EVs outnumbered other vehicles 10-to-1. New York City even had a fleet of EV taxis… And some EVs had ranges between 100 and 180 miles on a single battery charge.

Pictures of the early EVs are tough to find, but there are few designs from around 1900.

Here is a picture of English inventor Thomas Parker (seated in the middle), who was one of the first to make a “practical” electric car.

One of Thomas Parker’s Early Cars

Source: Electric Vehicle News

And below are a few “electric pleasure cars” from the 1907 MoToR Car Directory.

MoToR’s 1907 Motor Car Directory

Source: Archive.org

But eventually, gas-powered ICE vehicles replaced EVs due to the convenience. Energy storage has always been an issue with EVs. And much like today, battery technology has been a limiting factor.

Another issue was the infrastructure. It was much easier to build out a nationwide system of gas stations than to create electric charging stations across the country.

That’s why gas-powered cars won out over EVs for the past century. But now, that trend is reversing.

The Man Who Made Electric Cars Desirable

Over the past century, EVs have been a hobbyist pursuit more than anything… that is, until a small company called Tesla, led by chairman Elon Musk, released its Roadster in 2008.

In tests, the Roadster got about 245 miles on a single charge. This range was unheard of for an electric car in mass production. No longer would you have significant range limitations with an EV.

The Roadster was no slouch either. It could accelerate from 0 to 60 miles per hour in under four seconds and had a top speed of 125 mph.

Tesla estimated the Roadster’s efficiency ratings were equivalent to gasoline mileage of 135 miles per gallon.

Seeing these results forced other car manufacturers to take EVs seriously… And it started a massive worldwide competition to create the best EV.

But while most car companies were merely researching or creating hybrid vehicles, Tesla continued releasing more models. The company now has four models for consumers to buy… the Model S, 3, X, and Y.

This pursuit of future technologies has pushed Tesla’s valuation to over half a trillion dollars.

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And while I’m a huge fan of Elon Musk and Tesla, this valuation is way too expensive for the “sleep well at night stocks” we look for here at The Near Future Report.

There’s no doubt Elon Musk pushed forward the world on electric vehicle technology. And largely due to the progress made by Tesla, the total cost of owning an EV is now less than a traditional ICE car in many parts of the world… Now the free market can propel this industry forward.

EVs Will Become Cheaper Than Gas Cars

According to the Kelley Blue Book, the average price of a new car in November 2020 was $39,259. That marks a 1.3% increase from November 2019.

But the average selling price of an electric vehicle was $43,703… Which is down 8.0% from November 2019.

My Tesla “Argument” With a Yale Professor

Many readers know that I’m an alumnus of Yale University’s School of Management. In April 2019, I got into something of an “argument” with one of the professors at Yale.

He was applying the business models of the legacy car manufacturing industry to Tesla. His sophomoric argument was that Tesla was still a car manufacturer that was losing money on every car and would eventually go bankrupt. I told him he was wrong.

I explained to him where the real value was in Tesla. It had the best EV battery technology on the market… it was one of the most advanced artificial intelligence companies in the world, which put its self-driving software technology years ahead of its competitors… and the company was gearing up to launch a shared autonomous vehicle network that would be worth a fortune.

He had no retort…

I suggested that he short the stock if he was convinced the company was overvalued. He said he wouldn’t. Later, a few of my classmates came up and told me they were investing in Tesla.

Since then, Tesla’s stock is up more than 1,526%. Ouch… It has to hurt to have been that wrong.

I’m not sharing this to gloat but rather to make a point. Just because someone is standing in front of a class doesn’t make them right – or even knowledgeable, for that matter. The same is true for many so-called experts. In this case, the professor’s position was myopic and demonstrated that he did not understand the subject matter at all. It was the kind of generic, emotional, sweeping arguments that mean nothing.

I treat myself in the same way. If I can’t demonstrate that I have critically analyzed a situation and clearly and logically presented an investment thesis, then you shouldn’t listen to me either.

But I never recommend anything that I wouldn’t be willing to invest in myself. Even though I am not allowed to invest in my recommendations, I treat each investment recommendation as if I were investing my own money. This allows me to maintain complete objectivity with no conflicts of interest – my work is only for my subscribers – and also set the same bar that I use to allocate my own capital.

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So while ICE cars are going up in price, EVs are declining. While the 2021 chip shortage has temporarily increased the cost of EVs, we can expect to see this trend continue once supply chains return to normal. But the purchase price isn’t the only factor in determining the total cost of ownership.

We also must account for the difference in fuel costs, insurance, and potential maintenance. A study done by fintech firm Self Financial found that on average an EV was around $600 cheaper a year to run.

If you plan to own a car for seven years or longer, an EV is already a better option. That’s because there are fewer moving parts in an EV, so maintenance costs are lower. And because fuel is cheaper, we can save a couple of hundred dollars a year in fuel expenses… And we can save even more if we can charge the car away from our house – for example, at Tesla’s charging stations.

And some EVs are already cheaper than or equivalent to traditional ICE vehicles. A Tesla Model 3 starts at $45,000 right now. That’s not that different from the price of a gas-powered car… Cost parity between ICE vehicles and EVs is already here.

Then, when we factor in tax credits, things get even more interesting…

The U.S. federal government still has a $7,500 tax incentive available for consumers who purchase an EV from a company that has sold fewer than 200,000 EVs. Tesla and GM are no longer eligible for that, but other companies are. And many states have their own credits as well. California has among the largest, with up to $6,000 in rebates.

I raise these points not to try to convince readers to buy an electric vehicle – although perhaps you’ll choose to. I want to illustrate a simple point: The EV market is about to explode. The real inflection point is when the cost of an EV

is on par with the cost of a typical gas-powered counterpart. And that is happening right now.

Research firm Markets and Markets estimates 3.3 million electric vehicles were sold in 2019… And by 2030, 27 million EVs will be sold every year. That’s massive growth over this decade.

But it may be undershooting the target. Remember, analysts and industry experts often underestimate the impact of new technologies on the market. And if EVs become a lot cheaper to own than ICE vehicles, consumers are going to demand EVs.

As impressive as 27 million vehicles sold in a year is, that’s a small percentage of the market.

In 2019, the International Organization of Motor Vehicle Manufacturers reported that about 91 million vehicles – gas and electric – were sold.

Assuming that number stays steady for the next decade, it means that EVs will only make up 29.6% of the market by 2030. That’s way too small of a market share for the cheaper, more environmentally friendly electric vehicles. I wouldn’t be surprised to see the number of EVs sold in 2030 to be well over 40 million and perhaps as high as 50 million.

EV Competition Is Strong

This is why we’re seeing so many entrants into the electric vehicle market. Companies see the success of Tesla. They’ve seen the projected growth of this market. And that’s why every established automaker is working on building out its EV lineup.

We have Ford making electric Mustangs and Broncos.

GM is making an electric Hummer… And it plans to make the Cadillac brand all electric by 2030.

The BMW i4 looks sharp… as well as the Audi e-tron.

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Clockwise from top left: Ford Mustang Mach-E, Hummer EV, BMW i4, Audi e-tron

Source: Ford, General Motors, BMW, Audi

And then we have a proliferation of new entrants to the car market, hoping to catch some of the EV market. Raising capital for these new upstarts hasn’t been difficult at all.

Here is a list of just a few.

• Nikola• Fisker• Faraday• Bollinger• Lordstown Motors• Lucid Motors• Rivian• Workhorse• Nio• Hyliion• Canoo

Clockwise from top left: Rivian R1T, Fisker Ocean, Lordstown Endurance, The Lucid Air,

Nikola TRE, Bolinger B1, Nio EC6 Source: Rivian, Fisker, Lordstown Motors, Lucid Motors, Nikola, Bolinger Motors, Nio

The best new EV companies will rise to the top quickly, and I do not doubt that Tesla will continue to lead the race. Tesla sold over 300,000

Model 3s in 2019, tripling the sales of the second best-selling EV – the Chinese-made BJEV EU-series. But as I mentioned above, Tesla’s valuation is just too high for me to recommend it right now.

Established automotive companies aren’t great investments because they have too many legacy costs. Many have dated factories, union contracts, and burdensome pension benefits they must pay out.

And as for the new entrants I listed above? They’re all unproven. Most of these newcomers are still in the prototype stage – they have no product for sale. It’s difficult to build out manufacturing capabilities for something as complex as an automobile.

But investors shouldn’t worry. Instead of trying to pick which manufacturer will be the biggest winner, we’re going to take a different approach…

The One Thing All EVs Need

With the explosion in investment and innovative new designs, the whole industry has begun, and we are in for a decade-long period of growth. And every single EV will need hundreds of dollars’ worth of semiconductors. And the largest area of semiconductor spend in electric vehicles is on power semiconductors.

In 2020, I sent one of my research analysts – Nick Rokke – to the Consumer Electronics Show (CES) in Las Vegas. Longtime readers know I’m a big believer in “boots on the ground research.” And when I can’t attend a conference or event, I’ll often send one of my handpicked analysts to attend and report their findings.

And at CES 2020, ON Semiconductors (ON) reported that it sells about $100 of semiconductor content into internal combustion engine (ICE) cars. But it sells about $500 of content into EVs. That’s five times more revenue that it can make per car.

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We already own one of the best automotive semiconductor companies in the world. That’s Infineon – which has more than doubled since we bought it in May 2020.

Now we’re adding a smaller competitor, ON Semiconductors (ON), to our portfolio.

Technological Transformation

Even though ON may not have the market share that Infineon has in the automotive industry, ON is one of the leaders in a new kind of semiconductor.

ON is cheap because the company is going through a transformation right now… It’s is working hard to get out of its lower-margin businesses and increase its investment in higher gross margin semiconductors.

ON has historically focused on power semiconductors and what the industry refers to as “standard products.” These are highly commoditized, very low-cost semiconductors. They are vital to the industry, but they also come with much lower margins.

For the better part of 60 years, the building blocks of power semiconductors like MOSFETs (metal–oxide–semiconductor field-effect transistors) and IGBTs (insulated-gate bipolar transistors) remained relatively unchanged. These chips were built on a pure silicon foundation. And this worked well for decades… especially for low power applications.

MOSFETs are typically used in lower voltage applications like adapters, power supplies, and low-voltage consumer products. It is normally used in 10- to 500-volt applications.

Super-junction MOSFETs are used in 500- to 900-volt systems. And IGBTs are used in high-voltage situations, like EVs and solar panels. They are typically used for 1.2- to 6.6-kilovolt applications.

As the industry has moved toward higher-power

applications, silicon-based MOSFETs and IGBTs are not the optimal solutions for high-power applications like electric vehicles… and other new technologies like 5G wireless networks.

As a result, the industry has shifted toward new material solutions that perform much better in high-power applications.

One solution is a semiconductor material called gallium nitride (GaN). GaN field-effect transistors (FETs), using practically the same design, provide anywhere from 5–50 times performance improvement over today’s silicon MOSFETs.

As a semiconductor material, GaN is 10 times faster than silicon. It is capable of operating at much higher voltages and is a more efficient material to manage power conversion. As if that weren’t enough, GaN provides better thermal performance – basically, it puts out less heat even at higher power levels. And heat is one of the most critical things to manage in electronic equipment.

GaN also allows electronic equipment to be designed with fewer components, which results in a smaller overall design. Fewer components and smaller design ultimately result in less expensive products.

Another semiconductor material that is replacing the IGBT modules is silicon carbide (SiC), which is typically used for higher voltage situations – like controlling power in an EV or a solar panel. It has similar improvements over pure silicon as GaN does.

The market size of SiC and GaN is still small… It’s less than 10% of the total power semiconductor market according to research firm Yole Développement. But it is the fasting growing segment, which is where we want to be as investors.

And here’s the best part, On Semiconductor is a leader in GaN and SiC semiconductor technology.

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EVs Aren’t the Only Megatrend ON Is Powering

While we’ll be investing in ON primarily for its exposure to electric vehicles, it’s not the only reason to like the company.

ON Semiconductors is also enabling the following three tech trends:

1. Solar power – ON is a leader in photovoltaic (PV) inverters, the component that converts sunlight into electric energy. This is the most important part of the solar panel.

I happen to know that Tesla uses ON’s PV inverters in its solar roof installations because I’ve been designing a new house, and I’m going to install Tesla’s solar roof on it. I already have a detailed technical quote from Tesla about using an inverter from a company called Delta – which gets its power semis from ON. This is as much a validation of On Semiconductor as it is of Delta’s finished product.

2. Machine vision – ON has amazing complementary metal–oxide–semiconductor (CMOS) sensors. These sensors are mainly used to help cars “see.” ON dominates the auto camera market with a 50% market share in auto cameras and an 80% market share in ADAS (advanced driver assistance) cameras. ON will be a major player in the autonomous driving revolution.

ON has a major partnership with Tesla, which is the closest to releasing fully autonomous vehicles. The Tesla Model 3 has a triple forward-looking camera using three ON CMOS image sensors. And the Model 3 has five more cameras that look out the back and sides of the vehicle using ON CMOS image sensors.

ON also works with NVIDIA and is the image sensor provider for its NVIDIA DRIVE Constellation simulation platform. NVIDIA’s

graphics processing units (GPUs) process the complex data to enable autonomous driving in many leading car manufacturers. And according to Navigant Research, NVIDIA is the leader in the space. That leader uses ON chips in its systems.

These chips are also used in factories to help enable robot vision and automation. This will become a bigger market as the manufacturing renaissance I’ve predicted comes to the U.S.

3. 5G and wireless communication – ON’s power semis are used in 5G base stations across the world. It’s estimated ON places about $150 of content in each 5G base station. And we’re still in the early stages of the Phase 1 infrastructure build-out for the world’s 5G wireless networks.

Also worth noting is that ON acquired one of my favorite wireless semiconductor companies, Quantenna Communications, in 2019. Quantenna was a former Exponential Tech Investor recommendation known for its bleeding-edge Wi-Fi chipsets. It had the best in the business. And just as the world is upgrading its cellular networks from 4G to 5G, the process has already begun to upgrade Wi-Fi networks to the latest and greatest Wi-Fi standard, Wi-Fi 6 and Wi-Fi 6E.

And there’s another reason we should position ourselves in this company…

Starboard Gets Involved With ON

In October 2020, Starboard Value announced that it had taken a stake in ON Semiconductors. As I showed above, Starboard does not invest in a company unless it has ideas about how to improve its overall financial position and put the company in a stronger competitive position.

Starboard wants to see more consolidation of ON’s manufacturing footprint. And it wants to increase margins by exploring a fab-lite model…

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which means outsourcing most semiconductor production to a company like Taiwan Semiconductors, another one of our portfolio companies. This is a more profitable model for a semiconductor company like ON. Factories are expensive to operate and maintain, especially when a company doesn’t have massive scale like Intel, for example.

I believe ON can close a few more factories to increase operational efficiencies. And I’m sure Starboard will push it to do so. And it will also maintain some manufacturing capabilities, especially for strategic, high-value products where ON is better served by controlling its manufacturing in-house. This can be a critical requirement for some end customers, so there is still value in ON maintaining some of its manufacturing footprint.

The other dynamic at play is that Starboard’s recommended changes at ON will ultimately make it a more attractive acquisition target in the semiconductor industry. This is exactly what happened with Mellanox, which was acquired by NVIDIA. Assuming that ON is successful in jettisoning undesirable manufacturing facilities and lower margin product lines, its higher gross margins and rapidly increasing free cash flow will make it attractive to both larger semiconductor companies and private equity firms alike.

In short, we want to build a position in ON before the transformation is completed. This is how we will maximize our returns on this investment.

What a great setup. Rather than trying to predict which automotive manufacturer will be the biggest winner in the booming EV field or overpaying for a company like Tesla, we’ll invest in a key supplier with exposure to the entire market. Let’s not pass up this opportunity.

Action to Take: Please refer to our model portfolio for the most current recommended buy-up-to price for ON Semiconductors (ON). Be sure to use a limit order when placing trades. For the time being, we will hold this stock with no stop loss. Always remember to use rational position sizing.

Risk Management: Because we will be holding this stock without a stop loss, I encourage all readers to use rational position sizing. We should remember to never go “all-in” on any one investment. Our mission is to build a portfolio of our companies. That’s how we’ll optimize our success.

Note: My mission is to find the best technology companies trading at an attractive valuation. If this stock is trading above our recommended buy-up-to price, it means it is slightly higher than what I consider an excellent entry point. Technology stocks have natural volatility, and we almost always have an opportunity to establish a position at a great valuation.

That said, ON Semiconductors has great long-term prospects. If it is trading above and subscribers would like to begin building a position today, we could consider establishing a 25% position now and wait to complete our position at a later date.

As an example, if a reader would like to deploy $10,000 to this investment, we could invest $2,500 today and fill the rest of our position in the event of a pullback or a raise in the buy-up-to price.

If this stock is trading at or below our recommended buy-up-to price, then it means I consider it a good entry for a full position.

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And remember, I’m constantly monitoring our portfolio. If I feel it’s appropriate to raise our recommended buy-up-to price, I’ll always notify readers.

Regards,

Jeff Brown Editor, The Near Future Report