Did Sigma Buy Coppergate as Neither Could Make It Alone?

Includes: AVGO, SIGM, T
by: Shlomi Cohen

Mellanox Technologies Ltd. (Nasdaq:MLNX), which I hold in my portfolio tracked by "Globes", will be at a Credit Suisse conference this week in Arizona, where it is expected to reiterate its optimistic outlook for the fourth quarter.

Other companies at the conference will be some of Mellanox's major customers - such as HP (NYSE:HPQ) and IBM which implement Mellanox's solutions for large data centers.

Mellanox calls to mind Sigma Designs (Nasdaq: SIGM), which is also in my portfolio tracked by "Globes", and will publish its results on Wednesday for its fiscal quarter which finished at the end of October.

Mellanox founder and CEO Eyal Waldman will carefully check Sigma's results, and primarily its guidance, because for the first time Sigma executives are set to issue guidance for a full quarter which includes the operations of Israel's Coppergate, which Waldman apparently intended to buy, and then retreated, and Sigma bought on November 10th.

Sigma last week registered for trade the new shares which it gave to Coppergate's owners, and the document shows that among Coppergate's investors was Waldman himself, who received 21,000 shares of Sigma.

In another document, Sigma revealed last week Coppergate's results for the first nine months of the year, and it seems that its growth stopped with sales of around $49 million, exactly the level recorded in the corresponding period of 2008. Additionally, net profit fell significantly to $7.6 million, from $11.2 million in the corresponding period, due to a significant rise in R&D as well as in marketing and administrative expenses.

Apparently it was the economic crisis which led to the halt in Coppergate's growth this year, and maybe contributed to its sale, because between 2007-2008 it grew at quite a quick pace, almost 65%, from sales of $37 million to $61 million. If we extrapolate to the near future based on the first nine months of the year, it appears that for the meantime Coppergate will not be adding to Sigma's growth, but it will raise Sigma's gross and operating profit, because at least based on the beginning of 2009, Coppergate had gross profit of 56% compared with only 46% for Sigma, and operating profit of 15% compared with only 9%.

Road map required

When the merger was announced in October, for $160 million, Sigma said that in the coming year Coppergate will contribute to its earnings per share. If it does not retreat from that view this week, it will have to explain in conversations with analysts how it intends to pull it off, considering the results of 2009. Coppergate's processors and Sigma's are found today side by side with the digital converters of Cisco (NASDAQ:CSCO), Motorola (MOT), and others, which for example power the home network for the IPTV services of telecommunications giant AT&T (NYSE:T). Market estimates are that 90% of Coppergate's sales are from the AT&T project, which also contributes significantly to Sigma's sales.

Coppergate's processors are responsible for fast communication in the home, using the existing wiring of all types - electric, telephone, or cable - and Sigma is responsible for processing the video content. It seems logical to assume that the two companies are already working on a new consolidated processor, which in the future will do even more than what each one currently does separately.

If development efforts are successful, Sigma in the future will be able to more easily compete with the sector's gorilla, Broadcom (Nasdaq: BRCM).

Analysts and investors are currently very skeptical of Sigma's ability to compete with Broadcom, and many see in the Coppergate merger a type of partnership of the weak, as neither company alone neither Coppergate nor Sigma had a real chance to compete against Broadcom, and with no choice they merged in the hope to succeed jointly.

Among analysts who have already expressed negative opinion of the merger is Lazard's Daniel Amir, who has a "Sell" recommendation on Sigma, and a target price of $10, a price it nearly reached in the days after the announcement.

Amir is concerned that Sigma is "burning" most of its cash in the deal, and is mostly getting in return an overconcentration on one customer, AT&T. He also does not believe in its ability to compete against Broadcom. Sigma founder and CEO Thinh Q. Tran will have to convince analysts that he has a road map to return to growth , as happened three years ago, when the IPTV market was the hottest thing and Sigma's share was around $70.

Disclosure: The author holds both MLNX and SIGM in his portfolio

Published by Globes [online], Israel business news - www.globes-online.com - on November 17, 2009; Reprinted on Seeking Alpha with permission

© Copyright of Globes Publisher Itonut (1983) Ltd. 2009