No. of Recommendations: 53
Hi KP's,

I thought I would pass along the study I did on IRF as part of the RB Seminar. There are still a couple of RB criteria yet to be address.
Comments, suggestions for improvement, or additional information re IRF as usual are welcomed.

Regards,
Ev
-----------------------------------------

The company under study as a Rule Breaker is International Rectifier (IRF). The purpose of this study is to determine if it meets the Rule Breaker criteria. If it does not meet the challenge of being a Rule Breaker will it satisfy my personal criteria as an excellent long-term investment.

BASIC COMPANY DATA:

International Rectifier designs, manufactures and markets power semiconductors that refine electricity from wall outlets or batteries into a more usable form.
A detailed business description can be found here:
http://yahoo.marketguide.com/mgi/busidesc.asp?nss=yahoo&rt=busidesc&rn=4776N

Company has been in business 52 years – led by the family of Dr. Alexandar Lidow
Located in El Segundo, California
A member of the S&P Mid-Cap Index 400
5,098 employees / 1,546 shareholders ( relatively undiscovered)

Fiscal Year Ends in June
Foreign Business creates 68% of sales
Research and Development is 6.3% of sales
Insider Ownership = 8.9% of stock ( a definite positive – you want the officers and directors putting their own money into the company – demonstrates belief in the company. 9-10% is a good range for a company of this size.
Institutional Ownership = 78%
Market Capitalization = 3,044.42 billion
Data from Value Line 1/19/2001 and Marketguide

What is a “rectifier?” A device that converts alternating current into direct current.

Important and Emerging Industry: How is it important? How is it emerging?

At first glance IR is seen as a semiconductor company – not exactly emerging. A 52 year old established, profitable, relatively unknown company a Rule Breaker? But let's look further. It seems that IR is an “unusual” kind of semiconductor company. Unlike the products of most semiconductor device makers, IR's perform a power management function by converting electricity into a form more usable for electrical equipment. So here we see the important and emerging industry – Power Management / Power Conversion.

The technology of power management is about an $8 billion a year industry that is growing rapidly. Power management technology can cut our dependency on petrochemicals and revolutionize the way we power our planet.

Now the power of power management is in large part being driven by the Internet, and the infrastructure needed to run it – routers, servers, computers, mainframes all must have efficient, reliable, dependable power 24 /7 – from individuals to hundreds of thousands of businesses across the world power is critical. Any Internet dependent company that loses power for as little as 30 minutes – has lost huge amounts of money which is why power outages are such headline making news.

Lets look at some other areas of Power Management – first as we know information technology continues to explode - masses of IT users now, and will continue in the future to need their information portable – cell phones, laptops, personal digital assistants, digital cameras, and Internet appliances. These devices continue to be smaller, lighter, faster, and run longer. You can't have these technological innovations without Power Management – they can't be made. We're not talking about just the battery life, but all these enhancements have to work together – Power Management reduces heat so the products can be compact, and increase productivity per watt – it enables these portable electronics to work. Beside every one of these products there has to be a Power Chip running. Power Management products create the power efficiency to make electronic innovations happen.

The technology of Power Management / Power Conversion is becoming and will continue to be an industry critical in addressing global energy usage. We have now become aware of just what a power crisis looms on the horizon as seen by recent events in California. I believe this is just the tiny tip of the iceberg – outdated infrastructure throughout the world will have to be addressed. According to the Gilder Group, “Power Report” - “Hundreds of billions of dollars per year are going to be invested in new technologies to move, condition, store, and distribute electrons.” Electricity accounted for 25% of our energy consumption 25 years ago, today it accounts for 37%. It will account for more than half of the U.S. energy by early in the next century. The Gilder Report says, “ We are entering the century of the electron. “ “Not the information century?” “Not the communications age?”

We can now see that the technology, and the industry of Power Management is emerging as a “reinvention” due to our increasing demand for power that is clean, reliable, and efficient.

How is it important?

Lasting Relevance & Deep Customer Reach -- Does the industry you're considering typically lead to deep relationships with thousands or millions of customers?
Think about how deeply into the customer base and into a customer's life an industry reaches.

This quote from IR's CEO, Dr. Alexander Lidow captures this criteria, “ The world's standard of living is inversely proportional to the cost of energy. If the cost of the energy goes down, everything becomes more affordable.” You can think of this lasting relevance, and deep customer reach in terms of a Value Chain that extends all the way down to our food production. Example, electricity is a huge cost for our dairy farmers – the more it costs them to milk those cows, the more its going to cost us for our milk. As we find new ways to stretch and make each kilowatt of electric energy more efficient and reliable, we will raise the standard of living across the globe.

What if the Industry Disappeared? -- A pivotal final question to always ask yourself is, "What if this industry disappeared today? How many people would notice and care?"

Even with the current technology the industry offers in the form of Power Chips if it disappeared millions would be affected, and notice as most electronic products on the market today simply would not work. Actually they couldn't be built.

Expanding possibilities and a huge growth curve moving toward total potential "How large can the industry become?"
I'll cite one example from today's Business Wire (01/29/2001)
http://biz.yahoo.com/bw/010129/ca_intl_re_2.html
“…today announced a new power semiconductor chip that could cut the production costs of compact fluorescent lighting by as much as 25 percent, significantly reducing consumer price resistance to CFLs, which are priced substantially higher than conventional incandescent bulbs.

``These next-generation power chips could play a major role in putting an end to the energy crisis we are facing today,' said Alex Lidow, International Rectifier's chief executive officer. ``Lighting accounts for 35 percent of the electricity used by consumers in this country. If consumers replaced conventional bulbs with energy-saving compact fluorescent lighting using this new power management technology, that would go a long way towards ending the threat of rolling blackouts.'

Compact fluorescent lamps, known as CFLs, produce the same light output as an incandescent bulb, while consuming only one-fifth of the power and lasting as much as 10 times longer. The lower operating costs of CFLs have so far failed to overcome consumer resistance to higher purchase prices. By integrating the electronics, International Rectifier's new chip eliminates 10 components and lowers the manufacturing cost of CFLs by as much as 25 percent. “

Another example of the growth curve can be seen in the area of electrical motors – 50% of the electricity in the U.S. is consumed by motors. 90% of them are uncontrolled motors with no semiconductors making them painfully inefficient. Power Management devices over the next ten years will convert one billion motors to speed control – thus saving incredible amounts of power making motors not only more energy efficient, but also improving their performance.

In summary, the industry and technology of Power Management/ Power Conversion has far reaching implications for the planet. I have only scratched the surface. As my study continues I will present additional examples, and applications of IR's expanding possibilities as I explain their specific products.
Interested readers will find some informative papers written by Dr. Alex Lidow, CEO International Recitifer http://www.irf.com/aboutir-info/psworld97.html
Dr. Lidow's vision for the company and an explanation of the Power Conversion process is presented. It is written in an understandable style.

IRF – “Moving from the Information Age into the Age of Power Conversion.”



Top Dog and First Mover, with gusto

How to recognize gusto - There are two essential elements to being a first-mover with gusto.
1. Sales and marketing of the product have to be aggressive.
2. An essential element of Rule Breaking gusto is that the company has control of its own destiny. If a company can't make its own product, pricing, and service decisions, it can't execute its business optimally.

Top Dog

How do you recognize the top dog?
1. Look at the company's market capitalization
2. Look at the company's sales and earnings.

Semi-Conductor company's are not often considered to be top dogs when one thinks of high growth because they are cyclical. Cyclical stocks tend to rise quickly when the economy turns up and fall quickly when the economy turns down. We can see this over the past several months, and in 1999 for the semi-conductor industry. IRF through the years has demonstrated this cyclical performance. However, I noted in my previous post IRF is a “unique” semi-conductor company – its sales and earnings seem to be on the fast track over the past three years due to its newer proprietary analog power integrated circuits, and Advanced Circuit Devices, and its automotive applications that will enable the future 42Volt electrical systems – these systems will improve gas mileage by about 20%, with just two new systems, electric steering and integrated starter-alternators. IR's products in this area are being shipped to a leading mini-van maker now according to the 10Q. This is the basis of Top Dog status – propriety, high-demand products.

Some may look at IR's older commodity type components that were sold out of catalogs as holding the company back, or preventing RB type growth. These products still account for about 70% of sales. I view this as something that adds to IR being a Top Dog – that is they can count on these “boring” products (even though cyclical in nature) continuing to generate profits, and cash as the company continues to transition to this exploding power management arena. The new power management products have double-digit higher gross margins, and much more profitable than the component products.

It can be clearly seen below that over the past one year, and three years IRF is demonstrating exceptional Earnings and Sales growth.
Number	% Sales	% Earnings
Years Growth Growth
9 12.7 13.6
7 12.6 60.9
5 8.2 12.9
3 13.9 770.4
1 38.1 225.6

IR according to the company in the overall power management market they hold the largest market share at 20%. They also report having over 80% of the $4 billion power MOSFET (meal oxide semiconductor field effect transistors) subsector of the power management market. MOSFET's are the main power chips in portable Pentium III systems.

A WORD ABOUT GUSTO

IR in my estimation exhibits gusto in that it is the only company in the world that produces components to address the entire power conversion process of refining raw electricity into clean, usable power.

Qtr. 2 – 01, reported 1/24/2001 results clearly demonstrate gusto:
Revenue grew by 57 percent year-to-year and posted record earnings in its second fiscal quarter. Net income increased sharply year-to-year, to reach $46.5 million ($0.71 per share) on revenue of $268.1 million, compared to net income of $12.4 million ($0.23 per share) on revenue of $171.1 million in the prior-year quarter.

Revenue for analog power ICs, advanced-circuit devices, and power systems surged 123 percent year-to-year, and these proprietary products accounted for 31 percent of revenue in the period, compared to 21 percent in the prior-year period. Following the recent completion of several strategic acquisitions, proprietary products are expected to account for approximately 35 percent of the company's business in the current quarter and to approach 40 percent by fiscal year-end.

December-quarter orders grew 58 percent year-to-year and 3 percent sequentially, to reach another record high. Quarter-end backlog set record levels, and distributors' stock of IR components remained lean.
Alex Lidow, Chief Executive Officer, commented, "Our richer product mix and higher IR content per application were fundamental to the company's record sales and profits in the quarter. In the midst of difficult and uncertain market conditions, our focus on the industry's fastest-growing market segments continues to yield significant benefits, with orders for our proprietary products growing 157 percent year-to-year. Demand for greater performance, speed, and portability, as well as growing concerns about electrical power only serve to increase the value of our leadership in power management."

Gross margin was 40.7 percent for the quarter, compared to 34.0 percent in the prior-year quarter and 39.6 percent in the immediately-preceding quarter. The increase reflected a greater proportion of proprietary products, cost reductions, and higher royalties. Gross margins of 53 percent on incremental sales exceeded the company's goal of 45 to 50 percent and reflected its continued execution of a more focused and profitable business model.

Royalties contributed $12.6 million in the quarter, compared to $11.4 million in the preceding and $7.7 million in the year-ago quarters. The year-over-year increase reflected new license agreements and higher shipments of products covered under existing license agreements.

The company generated a number of significant sole-source design wins during the December quarter, including:
· A world leader in flat-panel displays selected IR analog power ICs and advanced-circuit devices to power 32- and 37-inch flat-panel television screens in a new sole-source, multi-year program.
· IR's advanced-circuit devices were designed into the first three Pentium® 4 server platforms.
· A world leader in compressor motors for home appliances selected IR's new, energy-saving compressor control systems.
· Two leading auto suppliers selected advanced-circuit devices from IR exclusively for their new electronically-assisted power steering programs.
· International Rectifier proprietary technology won sole-source position on four new satellite programs and on the new Mars Exploratory Rovers.

Alex Lidow noted, "Sole-source design wins for our proprietary products provide outstanding business opportunities and greater visibility than the multi-market components that constitute about a third of our business. Overall demand for our products remains strong: In the March quarter, we expect to add $5 million to $15 million of revenue sequentially and generate gross margins of 45 to 50 percent on the incremental sales. Notwithstanding widespread concern over near-term industry conditions, our market focus and proprietary business puts IR on track to reach our target of 40 to 45 percent growth this fiscal year. We believe that IR is well-positioned to continue outperforming our industry."

Listening to the Conference Call – CEO Lidow spoke with clarity, and directness. I felt like he was clearly a man with a vision who was on a mission. He was in control, fielded all questions without a hint of hesitation.

Read industry rags.
IR Named to Individual Investor Magic 25 – 12/2000
http://www.individualinvestor.com/tbd/article.asp?ID=24383

IRF Who Needs Nasdaq? 05/01/2000
http://www.individualinvestor.com/tbd/article.asp?ID=2613

“But make no mistake. This ain't your daddy's average New York Stock Exchange selection. It has juice.
The company's shares have already gained more than 400% over the past 12 months, fueled by the semiconductor industry's spectacular revival and the ever-greater need for integrated solutions that maximize power in electronic devices. Power management has moved from obscurity to center stage, as makers of cars, computers, cell phones and servers race to create smaller, lighter, faster products.
International Rectifier had been a supplier of low-margin power supply products, but in the past few years the company has reinvented itself by creating proprietary technology used in semiconductors for power conversion.

The company's products provide an even, usable flow of electrical power for electronic equipment and increasingly, communications devices. The information technology market now accounts for 54% of the company's sales.
For example, the company is a market leader in power MOSFETS, or metal oxide semiconductor field effect transistors. The devices are used to improve the performance and energy efficiency of electronic circuits, and they show up in automobile anti-lock brakes, industrial test equipment, telephone networks, modems and satellites. “

Sustainable, Competitive Advantage - Sustainable advantage gained through business momentum, patents, visionary leadership, and/or inept competition. Does the company offer uniquely innovative products, a moat.

The thought I have given to sustainable competitive advantage is akin to “Analysis Paralysis.” At every turn there is a different financial scholar, consultant, or even Fool Writer who has a theory, or methodology on what constitutes competitive advantage. We could turn to any of the following, and I'm sure there are more that examine competitive advantage:

Geoffrey Moore - “The Gorilla Game”
Dr. Michael Porter, - Harvard Business School - “Competitive Strategy,”
Michael Mauboussin - “Real Options” (TMF Centaur introduces us to Mauboussin in this article: http://www.fool.com/research/2001/foolsden010130.htm

Clayton Christensen – “Innovator's Dilemma”
TMF Oak – “A Sustainable, Defensible Business,” http://www.fool.com/portfolios/rulemaker/2000/rulemaker001130.htm

TMF Tom9 – “Is Rambus' Advantage Sustainable,”
http://www.fool.com/portfolios/rulebreaker/2001/rulebreaker010108.htm

It's enough to make your head swim!

Our lesson confirmed that in fact it is not an easy task, and to “…feel free to look creatively beyond the lack of usual moats – brand, software standards, and operational efficiency.”

With that said, I've decided to tackle this criteria in regard to IRF the characteristics that I see as creating lasting advantages: (some may disagree with some of my characteristics/qualities)

The most important attribute to creating a lasting advantage is CASH – the more the better. You can compete for a long time if you have cash – you can grow your company by investing in R&D, acquire other company's, handle a major company crisis, without living in terror that the company is over, and you are in a powerful bargaining position with suppliers, and customers. CASH will always give anyone a big advantage

IRF has plenty of cash – as of 9/30/2000 it had cash and equivalents of over $800 million, and now current assets exceed current liabilities by more than $1.0 Billion. IR obtained this cash through the sale of stock FY 00 – QTR. 3 – they sold the stock @$43 share, way above the highest IR price in several years – they took that money and retired debt that was costing them 10 –11%.

It seems they are using that cash wisely, as they are looking at purchasing one or more companies in the $1billion sales range – these are companies that had come to IRF wanting to be aligned with a larger stronger company.

In FY 00 / March IR purchased Zing Technologies a supplier of power semiconductor modules and components, for about $28.5 million.

A Bit About Moats
The case could be made that having control of the entire power conversion process through its products, and only focusing on power management, having global reach with 24% of sales from Europe, and 40% from Asia in FY 2000, a variety of proprietary products with patent protection creates a moat.
An analyst from Gruntal noted, “Once IR designs its chip into a system, it extremely difficult for a competitor to knock it out.”

Patents, and Proprietary Products

CEO Lidow, and IR hold 192 patents on its products. IR receives royalties from all of its competitors.

Research & Development

Research and Development Expenses at International Rectifier in 2000 were $47.18 million, which is equivalent to 6.3% of sales. In 1999, International Rectifier spent $40.51 million on R&D, which was 7.4% of sales. Over the next year that amount is expected to increase to 7.5% aand then 8% of revenues. In order to sustain your advantage you have got to increase R&D in order to be able to bring products to the market - even before they know they need this.

Good Management Smart Backing

I believe IR has met the first three RB criteria, thus we can infer that IR management is smart. I believe we can also surmise that because their sole business and focus over the past 40 years has been on Power Conversion, and Management – you should certainly get smart about it over that time or if you didn't get smart you would have gone out of business, or sold the company to someone who was smarter.

Vision: IRF – “Moving from the Information Age into the Age of Power Conversion.” – straight forward and to the point.

Marketing Savvy: I was unable to find specific information on how their products are marketed, but the most recent several quarters of sales performance would indicate they are marketing their products well.

Management and Board of Directors – you can read the details here:
http://www.marketguide.com/mgi/biograph.asp?nss=www&rt=biograph&rn=4776N
Nothing stood out in my mind that would lead one to think that management wasn't up to snuff. I did like seeing there was a mix of age ranges – 35 to 75 excluding Eric Lidow a founder of the Company, has been a Director of the Company since its inception in 1947 and was Chief Executive Officer until March 6, 1995. Mr. Lidow continues as Chairman of the Board and also serves as Chairman of the Company's Executive Committee.

The CEO Alexander Lidow, Ph.D., has been employed by the Company since 1977. He served as the Vice President--Research and Development of the Company's Semiconductor Division beginning July 1979, was promoted to Semiconductor Division Executive Vice President--Manufacturing and Technology in March 1985, and became the President of the Company's Electronic Products Division in July 1989. In February 1992, Dr. Lidow was elected Executive Vice President of Operations. He was elected a director in September 1994 and Chief Executive Officer in March 1995. Dr. Lidow serves on the Board of Overseers of RAND Corporation and on the Board of Trustees of the California Institute of Technology. Dr. Lidow is a son of Eric Lidow and a brother of Derek B. Lidow, a director of the Company.

I would also note that the Officers and Directors control 9% of the company stock – about the right amount of Insider Ownership you like to see in a company this size. It demonstrates they “put their money where their mouth is” by investing their own money in the company. Thus, they believe in the company's future.

IR meets the criteria of excellent management.

STRONG CONSUMER APPEAL

Consumers do not know they are using IR's products - but consumers seem to be drawn to IR's customers in what I would consider mass numbers - cell phones, computers, energy efficient appliances, pda's, Sony Play Station, video consoles, internet, and cars that save gas an operate more efficiently. The list goes on - consumer's seem to have a huge apetite for electronic gadget, and my opinion is the appeal will only strengthen for anything that conserves energy.

IRF - passes this criteria.

RELATIVE STRENGTH >90

For the 52 weeks ending 1/31/01, the stock of this company was up 45.0% to $53.96. During the past 13 weeks, the stock has increased 11.6%.
Relative Strength
3-Mo Relative Strength 64
6-Mo Relative Strength 45
12-Mo Relative Strength 86

In the turbulent market conditions we are experiencing and compared to the majority of RB type stocks I'd judge that 86 is quite good, and would thus say IR meets the criteria.







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