What will make Qualcomm worth 103B$?

With an offer of 70$ per share totalling 103B$, Broadcom has initiated a discussion of the current value of Qualcomm. The share price of Qualcomm prior to the bid was floating around 53$ suggesting a market value of 79B$. The Broadcom bid has increased the value of Qualcomm’s share price in the vicinity of 64$ (95B$) suggesting the investor view is mixed about the probability of a merger.

The immediate response from Qualcomm to the offer of 70$ was that it was undervaluing the corporation. So who is right? How do you calculate the value of a corporation?

Calculating what a company is worth requires a view of the current financial state of the company and assumptions about the company’s future.

 

Shareholder Value Analysis (SVA)

An effective way of calculating corporate value without being a CFO is to create an SVA analysis. An SVA calculates the value based on a company’s ability to generate future cash flows. Because of the time value of money, the cash flows are discounted with the Weighted Average Cost of Capital (WACC). Don’t worry – you don’t need to understand WACC or discounting to read the rest of the article. All you need to know is that WACC for the semiconductor industry is approx 9.2% at the moment and that it can change over time. It can be seen as the minimum acceptable rate of return investors in semiconductor companies will accept.

There are 7 value drivers that impact the future cash flows of a company in which Revenue growth and operating margins are most important for valuation of a fabless semiconductor company.

An assumption that satisfies the Broadcom bid can be seen below:

You don’t need to understand all of the technicalities of the calculation other than the Yellow box represent the value in m$ and in share price, based on the assumptions above. The sensitivity analysis lower left shows that the value of Qualcomm is impacted most by Operating Margin and Sales Growth Rate.

Operating Margin: In this example,  25% is chosen. Since the beginning of 2016, Qualcomm’s OPM has varied between 5.6% and 41%. The most recent was 5.6% showing Qualcomm’s dependence on license payments from their customers.

Sales Growth Rate: The latest quarter Qualcomm experienced -4% growth compared to the same quarter last year. This was again impacted by low license payments from customers based on legal disputes. In the example, 7.3% is chosen to satisfy the 70$ bid.

In other words – Qualcomm is worth 70$ if it can maintain an OPM of 25% and a Sales growth rate of 7.3%.

Value at 25% OPM

Real business nerds (yes we are) would immediately try and find out what different Sales Growth Rates would do to the valuation of the Qualcomm:

The chart shows (Assuming 25% OPM) that the market estimated that Qualcomm was able to grow sales 2.5% per year. The Broadcom offer would balance if Qualcomm was able to achieve 7.3% sales growth per year.

It is also possible to investigate Operating Margins impact on Qualcomm valuation. If the assumption is made that Qualcomm will be able to achieve an average sales growth rate of 7.3% the impact of various Operating Profit Margins can be evaluated.

The prebid valuation shows it could be achieved at 18.5% OPM and that the current Broadcom offer balances at 25% operating margin.

It is important to understand that for Semiconductor companies with most of the value tied up in intangible assets, a discussion about value is a discussion about expectations about the future. When Qualcomm states that the Broadcom undervalues the company it is really a discussion about two different views about the future.

 

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Divisional Semiconductor Growth, Q3-17

Most of the Q3-17 results of semiconductor companies have been published and it is time to take a look at the divisional growth of the top Semiconductor companies. The results already show that semiconductor revenue growth is dominated by price increases in the memory market favouring companies like Hynix, Micron and Samsung.

 

 

The Hynix DRAM and Micron Computing divisions have experienced extraordinary growth and reveal both the product and the market hotspot. The data centre market is on fire and has an insatiable hunger for memory. In particular, the DRAM market is heated – Hynix experienced twice the DRAM growth than NAND. The skew between DRAM and NAND is a result of the last few years investment strategies of prioritising NAND over DRAM. The memory companies have all been surprised by the increase in DRAM demand – they expected the world to convert to flash.

 

 

 

A shift in the Semiconductor Market

Nvidia’s Tegra division has the highest growth of non-memory divisions together with AMD’s computing and graphics division. Also, Nvidia’s GPU division is not far behind. This is by far the largest division of the three and growth is driven by GPU sales to the Datacenter. The Datacenter revenue is up by 114%. This result is revealing that the DRAM hunger is created by the growing need for Artificial Intelligence in the Cloud Data Centre.

 

 

Removing the large memory companies from the list gives a deeper look at the divisional growth:

  • The good divisional results from On Semi and Renesas are driven by acquisitions.
  • The results of the Broadcom storage division also indicates growth in the data centre.
  • Wireless, Industrial, Analog, IOT and sensors are high on the list.
  • Embedded micro has done reasonable but below market growth.
  • The automotive business has been disappointing despite much talk.

 

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Nvidia’s Earnings report and call

Nvidia reported another great quarter. Revenue was up and growth rates continued to be strong although slightly lower than earlier.

Operating income followed.

And for the first time Nvidia was able to generate over 1B$ in operating cashflow and in free cashflow.

The earnings release and conference call revealed the following:

  • The cryptocurrency mining impact on the business is hard to quantify but is reported as OEM revenue. Although significant in size, it is not going to distract Nvidia from the strategic business areas. It remains an opportunistic opportunity for the company. The revenue was 70m$ in Q3 vs 150m$ last quarter. Whenever a currency becomes too large or too difficult to mine it become viable to optimise it in an ASIC. 
  • The newly introduced Volta processor is delivering 10x performance in deep learning applications, far outpacing Moore’s law. Volta is already ramping significantly in all major cloud data centres.
  • The TensorRT platform suggests a Nvidia move into a more software-based approach in the hyper-scale data centre.
  • Three major Chinese customers have adopted the Volta V100. Alibaba, Baidu and Tencent will join Amazon, Facebook, Google and Microsoft in using the GPU for AI in their datacenters.
  • Volta has also penetrated the main server customers enabling server-based AI.
  • The attendance and downloads of AI-related conferences and software has increased by 5 to 10x over the last couple of years
  • Within the data centre, the main areas for GPU’s are
    • Supercomputing or high-performance computing. This is a 11B$ market in which Nvidia has a 15% (733m$) market share.
    • Deep Learning Training
    • Inference – the queries made by billions of internet users to the data centre. Today this is supported by CPU’s but GPU’s can increase the network speed by 100x
    • AI as a Service or Public Cloud AI Services – multi-billion dollar opportunity for Nvidia.
    • Vertical Industries: Automotive ADAS, Healthcare Diagnostics, Manufacturing, Robotics, Logistical industries
  • Nvidia sees the vertical industries as the largest opportunity and they are now ready to address them with the GPU capabilities in the cloud.
  • Volta is only in its infancy and the expectation is that it will continue to grow while the graphics part of the business is seasonal.
  • Cloud customers either have Volta capability or has announced it and the customer need is expected to be high.
  • GPU for graphics is sold one at the time, heavily influenced by seasonality and game launches. E-sports is becoming increasingly attractive and having the best gear drives down latency and impacts a players ability to win. The other element is high graphically attractive content. The last element is social – people want to share their brightest moments and that requires performance.
  • Volta is the single biggest processor that humanity has ever made. 20B transistors, 3D packing, the fastest memories available,  a couple of hundred watts replacing hundreds of CPU’s.
  • Nvidia is a one architecture company. This is not a limiting factor as there is so much software, numerical libraries, inference software, compilers and other. Jen-Hsun believes this is a massive advantage for Nvidia and makes the company perform at a level that requires much more people if you use multiple architectures.
  • Customers have many choices on what architecture to select. Jen-Hsun believes that the strong commitment that Nvidia has to a single architecture is convincing customers that Nvidia is a safe bet.
  • The world is experiencing computing problems on a scale we have not seen before and High-Performance Computing and AI have never been more attractive.
  • On the cooperation and announcements of AMD and Intel, Jen-Hsun believes Rodger leaving AMD is a great loss for the company. The Modern GPU is not a (G)PU’s anymore. They are not limited to graphical.

You can get the Q4-17 Strategic Factbook on Nvidia here

 

Semiconductor threesome

With the recent news that Broadcom is considering making a bid for Qualcomm at a 27% premium over the opening stock price today, the merger mania is back on again. The two largest mergers in the semiconductor industry Broadcom/Avago and Qualcomm/NXP might be merging. The super merger will be valued at 104B$ total prior to Qualcomm buying NXP. Already in trouble with the EU, this merger could include or exclude NXP. Although the announcement of Broadcom moving its legal headquarter address from Singapore to Delaware, USA is likely to appease the US authorities, the merger is likely to face opposition in Europe, China, Taiwan and Korea.

Market dominance issues (Q2 Figures)

If a merger included all three companies the market situation in the semiconductor market would face the largest impact in the communication category. This does not include smartphones and similar products that we categorise as consumer products. The combined company would own close to 50% of the communication market, which will face scrutiny from the authorities. 

 

The issue becomes even bigger when viewed from a product perspective. The combined company would dominate the communication products category with over 70% market-share. Broadcom is already half the market while Qualcomm is the second largest player.

 

 

The product/market combinations produce create 3 large combos: Processing LSI to mobile, Communication products to mobile and communication products to the communication market. Those three combos can account for more than 60% of the revenue

Combined Financials: 

The combined company would be a very clear number 3 in the industry behind Samsung and Intel

Although a merger does not create a sum of all the numbers of the merging companies it can still be meaningful to look at the combined company. As can be seen from the combined revenue the new company would be growth challenged. 

 

 

None of the three companies has had stellar growth in a hot market.

 

 

 

The capital investments will be significantly lower than depreciations indicating contraction of manufacturing activity. The combined company will own fabs but it will be a fab light model.

The net Income will also be challenged, right now dominated by the difficulties of Qualcomm.

 

You can get the entire visual data report here: Broadcom, Qualcomm, NXP Merger

Do you leave money on the table? We help strategic purchasers in the semiconductor market find right partners and negotiate better deals. Our research and insights are sharp ammo for your negotiation. Understanding the business and business model of your semiconductor suppliers is key to achieve a win-win situation.

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Insights from Intel’s earning release.

Intel reported a very strong Q3 result, especially from an income perspective. Net income grew 33.6% from the same quarter last year and an impressive 60.8% from last quarter. We will get more detail when Intel files its quarterly report but a major part of the result will be based on the client computing segment. While the PC segment is in decline, Intel can still generate results by optimising manufacturing faster than customers are given price decreases.

 

 

However, this is only a temporary strategy as there are limits to how much juice you can squeeze out of a declining business. Intel will need to get some more meaningful growth out of the smaller divisions. The problem is that the smaller divisions are a lot smaller. 

 

 

The datacenter Group is the only current division that can add to meaningful growth. Getting close to 5B$/qtr the group is serving two major markets. The enterprise data centre market that is in moderate decline and the cloud data centre market that is in exponential growth.

 

 

The overall growth of 7,4 % is not stellar in a market that has grown 60% in the same period. Although most of the growth in the data centre is driven by increases in memory pricing, Intel's direct competitor Nvidia has grown more than 190% in the same period. Even AMD is starting to get revenue out of the cloud data centre. Intel is still a formidable company but it will need to transform its business faster than it is currently to maintain its ability to be a value creation company.

 

 

On the balance sheet,  inventory kept increasing suggesting that the revenue numbers achieved were lower than the planned expectations. This could also represent a product mix mismatch

Over the last few quarters, Intel has made some deep cuts into the SG&A expenses. It has reduced the cost with over 550m$ since the beginning of 2016. This is most likely representing deep cuts in marketing and sales as the administration costs typically are a function of size. Since the beginning of 2016, Intel has reduced headcount by 10.000 employees. Although there has been acquisitions and divestitures impacting this number, Intel is clearly in consolidation mode as a response to the modest growth rates. 

The MobileEye acquisition was closed in the quarter draining Intel for 14.5B$ of cash. Not surprisingly most of the value of the acquisition (10B$+) does not come from tangible or measurable intangible assets but has hit the goodwill balance. This is not unusual for an IP based acquisition but at the same time, it is a significant investment that impacts Intel's numbers and is certainly not without its risk. 

You can download the free Q3 Intel Factbook here

Do you leave money on the table? We help strategic purchasers in the semiconductor market find right partners and negotiate better deals. Our research and insights are sharp ammo for your negotiation. Understanding the business and business model of your semiconductor suppliers is key to achieve a win-win situation.

Is your Semiconductor Strategy based on anecdotes? Do you want opinions or data-driven insights? Semiconductor Business Intelligence follows the industry in detail. We update our customers with general or customised quarterly reports on companies, products and end-markets. All of our research is based on our proprietary data and analysis of top semiconductor companies and related markets. We create a quarterly Factbook for each product group, end markets and of each of the top 50 semiconductor companies at a fraction of the time and price your business intelligence team can compile it.

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Gold nuggets from TSMC’s earning release.

 

The semiconductor industry is heavily impacted by results of TSMC that accounts for approximately half of the foundry industry. The company reported 3rd quarter results yesterday and as usual gave some insight into the industry.

 

Although revenues were up to approximately the same level as the same quarter last year, inventories went up once more indicating a potential slowdown. Although TSMC was reasonably upbeat indicating a 6% /year growth rate they did reveal that their customers’ inventories also were increasing. Some of this effect can be down to Apple’s launch of new iPhones although this was not mentioned specifically.

 

There has been a major shift in technology over the last quarter towards 10nm technology that is likely to have a negative impact on revenue. 10nm technology allows TSMC to deliver more to the customers for the same price and it looks like the entire productivity gain has been given to the customer.

 

 

 

TMSC was upbeat about future capital investments and expected to open several lower geometry fabs over the next couple of years, down to 3nm. This could be true although the numbers for the quarter show a drop in CapEx below the depreciation level indicating a contraction in manufacturing capacity. The CapEx is lower than the replacement investments needed to maintain the current level. This might not be a signal as CapEx requirements can shift significantly over time but it could hint at TSMC delaying investments as a result of a change in the market conditions.

 

From a market perspective, communication and consumer keep losing share. This is in line with the general market trends of Smartphone consumption is under pressure from high memory pricing and from lower cost Chinese phones gaining market share on high feature flagship phones.

Interestingly TSMC is growing its industrial business indicating that the IoT revolution is finally hitting the money and not just a paper tiger anymore.

The computing segment also saw a jump in revenue coincides with the jump in 10nm revenue. It would be surprising if there is not a connection. Nvidia reported an increase in their Cost of Sales of approximately 200M$ in their last reported quarter which would move the needle 2,5% for TSMC. These data could be hinting at a good next quarter for Nvidia.

TSMC themselves report solid growth in cryptocurrency mining to 350-400M$ in Q3. This is mainly High-performance computing Asics and not revenue from GPU that is used for cryptocurrency mining. The implications could be negative for Nvidia as GPU graphics cards have been used for crypto currency mining but could be in the process of being replaced with very specialised ASIC processors.

The company is estimating the (Foundry) High-Performance Computing TAM to be 11.5B$ in 2017. The two major players AMD and Nvidia have a cost of sales of approximately 3,5B$ and 3B$ and is accounting for more than half of the market. TSMC’s HPC market share is in the ballpark of 30% or 3.5B in 2017.

 

Do you leave money on the table? We help strategic purchasers in the semiconductor market find right partners and negotiate better deals. Our research and insights are sharp ammo for your negotiation. Understanding the business and business model of your semiconductor suppliers is key to achieve a win-win situation.

Is your Semiconductor Strategy based on anecdotes? Do you want opinions or data-driven insights? Semiconductor Business Intelligence follows the industry in detail. We update our customers with general or customised quarterly reports on companies, products and end-markets. All of our research is based on our proprietary data and analysis of top semiconductor companies and related markets. We create a quarterly Factbook for each product group, end markets and of each of the top 50 semiconductor companies at a fraction of the time and price your business intelligence team can compile it.

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Operating Costs for Memory companies are now below 12%

Last night Micron decided to dilute their stocks with an additional 1B$ offering of new stocks. The company intend to use the proceeds to buy back debt. This comes at a time with record profits and cash flow for Micron and the other memory companies. This is indeed a time to harvest and sow, to prepare for the next (if history is a good indicator for the future..) memory cycle.

All of the memory companies have enjoyed increasing revenues and gross profit margins to the level where the operating costs now are below 12%. Surprisingly Hynix have the highest gross profit margin indicating very competitive products or a strong presence in high-profit markets like the data center.

 

The chart also reveals the high operating costs of processing companies like Intel and Nvidia. Their business is highly reliant on keeping a high gross margin to keep the business healthy. A few companies are obvious negative outliers of which AMD and Cypress is a more permanent kind than NXP.

 

Is your Strategy based on anecdotes? Do you want opinions or data-driven insights? Semiconductor Business Intelligence follows the industry in detail. We update our customers with general or customised quarterly reports on companies, products and end-markets. All of our research is based on our proprietary data and analysis of top semiconductor companies and related markets. We create a quarterly Factbook for each product group, end markets and of each of the top 50 semiconductor companies at a fraction of the time and price your business intelligence team can compile it.

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TSMC’s new fab cost more than the yearly foundry Capex.

Morris Chang of TSMC recently gave his view of the capital investments needed for the company’s next 3nm fab in southern Taiwan. Chang believes the fab will require an investment of 20B$ before it is fully operational. This is more than the total yearly capital investments for the entire semiconductor foundry industry.

The total CapEx of Semiconductor companies, Semiconductor conglomerates and Semiconductor foundries will not pay for many fabs moving forwards. Manufacturing will be a game only played by the largest of companies.

 

 

Although semiconductor foundries are controlling more of the total semiconductor manufacturing they are not able to capture the value creation from their customers in the current growth market. While most of their customers have grown both revenue and operating profit the foundry industry has not been able to follow. Read the Bloomberg article here

 

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Semiconductor Fabless Revenue is not growing.

Many Semiconductor companies have embarked on a strategy without semiconductor manufacturing. The immediate advantages of a fabless model is a positive impact on the investment cash flow as capital expenditures for new factories now is the problem of the foundry. The long-term ramifications are difficult to predict but short-term gains are hard to resist, even if there is a price to pay.

 

 

We have started to track the performance of the different manufacturing categories, ranging from fabless to fully fab’ed semiconductor companies, with two categories in between.

A good performance metric to evaluate the different model is the operating income and it does not look favourable for the fabless category in the latest upturn. Every other category has done better the last 6 quarters. Not surprisingly the FullFab category has benefitted from the memory boom as memory companies owns their own fabs. The fab heavy category is impacted by a positive gain by NXP in Q1-17 but has generally grown healthy. The best model over the last 6 quarters has been the FabLight model.

Investigating if there is a shift in the profit of the semiconductor value chain requires an investigation of the operating profit of the foundry companies.

 

 

With an initial gain in both revenue and operating income, both are now pointing south indicating that the bargaining power is back in the hands of the foundry customers. This could indicate a market shift.

It might still be too early to conclude which model is optimum for Semiconductor companies, but we are committed to drilling for data and insights needed to make the right strategic decisions.

 

Is your Strategy based on anecdotes? Do you want opinions or data-driven insights? Semiconductor Business Intelligence follows the industry in detail. We update our customers with general or customised quarterly reports on companies, products and end-markets. All of our research is based on our proprietary data and analysis of top semiconductor companies and related markets. We create a quarterly Factbook for each product group, end markets and of each of the top 50 semiconductor companies at a fraction of the time and price your business intelligence team can compile it.

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Toshiba can eat its cake and keep it

It looks like a Toshiba’s memory division finally will be sold, and the cash-strapped conglomerate can get a much-needed cash infusion. A consortium constructed by Bain capital has been selected by Toshiba as the winning bid (not necessarily the highest bid), that also can satisfy the Japanese authorities. The deal can still be derailed by Western Digital that has several joint ventures with Toshiba and has sued the corporation to stop the transaction.

 

It has been incredibly complicated for Bain to navigate the many stakeholders and get to a deal. Not only has there been the national interests of Japan to protect but also many different stakeholders have been trying to get a share of TMC. Several customers like Apple, Dell and Kingston, are working to hedge themselves against further increases in Flash pricing by getting a share of the profits joined by suppliers, competitors and joint venture partners.

There have been several antitrust issues to be avoided. Seagate, Toshiba and Western Digital (part of the competing bid from KKR & Co) have full control of the hard disk market and Toshiba, Hynix and Western Digital combined would control more than 43% of the NAND flash markets. Both of these antitrust issues would prevent a normal acquisition of the Toshiba Memory Corporation.

 

 

The construction from Bain involves eight different investment partners. To make the deal palatable to authorities and Toshiba, Bain is creating an investment vehicle with several different share classes to isolate some of the joint venture partners from influence. Bain has created an acquisition company called Pangea to act as the buyer of Toshiba Memory Corporation.

 

 

The owners of Pangea are:

  • Bain Capital. Responsible for the construction and a future IPO.
  • Toshiba. Reinvesting a significant amount of the proceedings into the new company.
  • Hoya Corporation: A supplier to Toshiba and seen as important in the eyes of the Japanse authorities.
  • SK Hynix: A direct competitor to Toshiba that is prevented from buying TMC directly.
  • A US Consortium: Four of the largest customers of NAND flash in the world. Dell, Apple, Kingston and Seagate.

There is now sufficient information to get an overview of the ownership structure of Pangea. The construction is built around three share classes that isolate some of the companies from direct influence:

  • Common Shares – with full voting rights
  • Convertible Preferred Stock – Likely with guaranteed dividends, liquidation rights and conversion right to common shares under IPO and similar circumstances.
  • Unconvertible Preferred Stock – Without liquidation and conversion rights. But a significant hedging investment if your company is buying flash.
  • An ownership structure that would satisfy the available information can be seen below:

 

 

Effectively Bain has constructed a financial setup that will give Toshiba Corporation 1.65 Trillion Yen and let them, together with Hoya, keep control of the company on Japanese hands. Bain themselves get a massive influence for a relatively small investment, while Hynix, the largest single investor get very limitied influcence.

 

 

 

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Money for nothing

Yesterday, Micron gave us insights into their most recent quarter that showed the memory market is still on fire. With virtually no increase in the cost of products sold, Micron managed to grow the business solidly. In short, customers are paying more for the same. We are certainly not blaming Micron for making a buck. The memory market is not for the faint at heart, you need to make a buck when you can to pay for the next generation fabs.

 

Digging a bit deeper reveals a more nuanced picture. Micron is increasing the number of bits shipped both in DRAM and in NAND but keeping the gains in improved manufacturing efficiency for itself. The focus from a capacity perspective has been on NAND that has increased 78% in capacity over the last year while pricing has been relatively stable. Micon has in reality been able to pocket the entire efficiency gain from NAND over the last year. For DRAM it has been even better. The focus on NAND capacity is at the sacrifice of DRAM capacity. The increasing undersupply in the DRAM market means that Micron not only could keep the manufacturing gains but also increase pricing per bit. As a result – DRAM is now 66% of Microns business.

Overall Micron is managing this cycle brilliantly and is reinvesting in the business. It has also managed to get control of the manufacturing joint venture with Nanya and now has full ownership of Inotera. This is going to be important for future capacity.

 

 

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The dark matter of semiconductor revenue

Unknown to most in the west, the Chinese fabless semiconductor companies continue to outgrow the industry. Companies like Spreadtrum, Hisilicon, Galaxycore, Silan or Rockchip might not ring a bell, but these companies are increasingly supplying Chinese companies for products to Chinese consumers. Some are subsidiaries of the manufacturing company ensuring guaranteed access to revenue. A lot of these companies get their silicon from SMIC, the leading foundry in mainland China. The company reports of SMIC gives an insight into the size and growth rate of Chinese fabless semiconductor companies. SMIC estimates that Chinese fabless will account for more than half the fabless market in 2020 and more than 12% of the total market.

You can see more free charts here

 

Is your Strategy based on anecdotes? Do you want opinions or data-driven insights? Semiconductor Business Intelligence follows the industry in detail. We update our customers with general or customised quarterly reports on companies, products and end-markets. All of our research is based on our proprietary data and analysis of top semiconductor companies and related markets. We create a quarterly Factbook for each product group, end markets and of each of the top 50 semiconductor companies at a fraction of the time and price your business intelligence team can compile it.

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