I wrote up Marvell Technology Group (MRVL) as an Alpha-Rich idea, calling for about 28% upside back on June 3, 2013, when the shares traded at the $10.89 level. Since then, the shares have run up 24% to a recent high of $13.51, largely satisfying my initial price target. While the shares have dropped about 7% following the most recent earnings report (largely on wireless margin fears and a disappointing showing in the networking business), I believe that this represents an excellent buying opportunity. I see 40% upside from current levels as the business as a whole continues to gain momentum.
Significant Operational Strength Across The Board With More Yet To Come
Marvell's three operational segments are divided into storage, networking, and mobile and wireless, each consisting of roughly 52%, 21% and 22% of the firm's net revenue. CY2012/FY2013 proved to be difficult for the company as hard-disk drive sales - largely dependent on PC sales - showed unanticipated weakness as the PC industry first began to show signs of collapse. Further, while the firm's networking semiconductor segment continued to perform well, Marvell faced additional headwinds (margin and market share decline) in its mobile and wireless unit as the firm's cellular solutions faced intense competition from the likes of Spreadtrum (SPRD) and MediaTek in China.
Marvell's Storage Business Is Solid, But Networking Needs Another Quarter
Fast-forwarding to today we see a completely different picture. While hard disk drive ("HDD") sales continue to decline, Marvell has not only taken HDD share from its chief competitor, LSI (LSI), but it has established itself as a leading supplier (and has been rapidly gaining share) in the high-growth solid state drive ("SSD") controller market, both in mainstream SATA interface devices as well as higher end PCIe drives. All told, this was worth 10% Y/Y growth in the firm's largest operating segment, and I wouldn't be surprised if this growth were to continue unabated over the next several years. I don't think the share gain story is quite done, particularly in PCIe, and believe that despite HDD declines, the business can continue to grow meaningfully over the next several years, albeit modestly.
Networking has probably been the least interesting segment overall for the company, although it is a high gross margin, a stable one. That said, it looks as though sales were down about 5.5% Y/Y - which raises some eyebrows. While management explained this weakness as due to uneven order patterns, weakness from certain PON customers, and weakness in switching products, I can't help but notice that Broadcom (BRCM) actually saw a 6.7% Y/Y increase in its networking and infrastructure group. Turning to the most recent quarterly reports from Freescale (FSL) and LSI - the two non-Broadcom competitors - I note that networking was actually up 4% Y/Y in its July quarter. LSI, too, saw its networking segment up 5.6%. While the noted share gains may be based on current design win momentum (which trails actual product launches and revenue recognition), I'd like to watch this segment a little more closely before assuming that all is well as far as market share goes, particularly as the firm's new 28nm NPUs begin to ramp in earnest.
Mobile And Wireless: The Real Growth Story
However, the real gem is the mobile and wireless business. If there has been a secular growth story in technology over the last several years, it has been the broad move toward highly connected, highly capable mobile devices. Marvell was an early beneficiary of this trend as it was selected as the cellular platform supplier for the original BlackBerry (BBRY) smartphones. However, as Apple's (AAPL) iPhone came into vogue, Marvell's cellular chip shipments came under pressure. Further, Spreadtrum and MediaTek proved to be very fierce competition in the China market where Marvell currently plays, particularly as Marvell's products had actually fallen behind for a brief stint.
However, Marvell's new product offerings look competitive. The firm ships a Category 4 LTE (150Mbps downlink, 50Mbps uplink) modem today, and is working feverishly to release its first integrated single chip solution that comes with the LTE baseband and a quad ARM (ARMH) Cortex A7 processor. Further, Marvell pairs its platform with its connectivity combo solution (and for designs using Marvell's platforms, Marvell noted on the call that its combo solution enjoys a 100% attach rate). All told, Marvell's R&D seems to be paying off, and it has a pretty competent (although fairly standard) solution to compete in the mass-market smartphone arena, which drives a share gain story in conjunction with a TAM growth story, which could mean significant upside for the firm's mobile and wireless business.
Marvell also claims to be gaining share in the non-mobile wireless connectivity business as well, citing a strong design pipeline for its 1x1 and 2x2 combo solutions. That being said, there is a fly in the ointment here, so to speak.
As I noted above, Marvell's integrated LTE + apps processor solution seems largely "standard" - and it is. These aren't the glorious, high ASP chips that largely dominate the Western view of a modern "smartphone". These chips are almost commodity, particularly as all of the key apps processor IP is usually licensed from ARM (in the high end, there is a business case for custom IP). So, while I expect gross margins for mobile and wireless to be lower than the average of the other two divisions, the secular growth story cannot be ignored and I believe that there is a pretty solid operating leverage story here given the substantial R&D spend increases over the last few years here.
Shares Have 30% Upside
With Marvell having solidly proven itself back on track, I believe that shares are - at a minimum - 40% undervalued here. Given that the various growth initiatives originally promised several years ago have finally begun to pan out, I feel comfortable that current FY2015 EPS consensus remains too low at $0.94/share in light of the recent $0.04 beat and guidance for the coming quarter well above consensus ($845M consensus v.s. $850M - $890M guide). I expect FY2014 EPS consensus of $0.86 to prove too low and am looking for $0.90 for the year. Assuming 15% EPS growth (which is conservative in light of the significant operating leverage that is present in M&W) this suggests that Marvell will do $1.03/share next year. At the current 11.2x multiple ex-cash, Marvell would be worth about $15/share. However, given the multi-year M&W story, continued strength in storage, and potential strength in networking (I would like confirmation of share gains), I believe that a 13x FY2015 multiple ex-cash is more than reasonable (and likely conservative), which suggests a target price of $17/share, 31% upside from current levels.
What About The CMU Lawsuit?
Quite possibly the biggest overhang to this whole thesis is the recent CMU patent trial against the company initially led to a ruling that was a very clear negative for Marvell - calling for $1.17B in damages (with the potential for these damages to be tripled) - for the alleged infringement of a single patent. While the initial shock from this ruling sent shares tumbling (and I'll admit that I was spooked for awhile), it is my view that Marvell will end up settling with CMU for a small fraction of what the initial judgment is worth, particularly as in light of recent technical evidence, the infringement claims do not appear to be as substantial as I had initially thought (and I noted this realization in my last article).
On the off-chance that Marvell ends up having to dole out this full payment, then this is worth ~$2.03/share, which Marvell could afford to pay. While my upside target from here factors in the ~$3.52/share that the company has on its books, such a loss does not affect the firm's continuing operations, and as a result would likely result in a $2/share drop - not pleasant, but with a $17 upside target, and with shares trading at just south of $13 as of writing, this doesn't seem all that devastating to the thesis. That being said, I do believe the chances are low, particularly as Marvell was recently let off the hook on a similar-but-unrelated patent infringement allegation, in which Lake Cherokee Hard Drive Technologies asserted that Marvell had infringed on two of its patents.
Wrapping It Up
The core thesis is quite simple: Marvell dominates the storage controller business through sheer technological force of might, it is making meaningful inroads in the mobile and wireless markets, while defending and extending its turf in storage and holding its own in the networking space with a new product launch that could help to meaningfully drive share. At current valuations, hot off of a quarter and guide that just smashed sell-side estimates (meaning that we will likely see significant upward estimate revisions in the 8/23 trading session), it is my view that shares will trade at least 40% higher over the next 12 months.
Additional disclosure: I may go long MRVL at any time.