ON Semiconductor - Nice Addition Of Aptina, Yet Overall Appeal Is Limited

| About: ON Semiconductor (ON)


ON Semiconductor acquires privately-held Aptina in a $400 million deal.

The deal seems very fair based on revenue multiples, while operating margins are slim.

The poor through-the-cycle profit margins and poor historical performance prevents me from jumping the bandwagon, despite current momentum.

ON Semiconductor (ONNN) announced on Monday that it will acquire privately-held Aptina to boost its presence in the image-sensor business.

The deal seems more than fair even as Aptina posts very slim operating margins. Yet the overall valuation, cyclicality and poor historical performance limits my appeal for ON Semiconductor's shares.

The Deal Highlights

ON Semiconductor announced that it has entered into an agreement to acquire Aptina Imaging in a $400 million cash deal.

Aptina Imaging provides high-performance CMOS image sensors for automotive and industrial markets, a key focus area for ON Semiconductor. Other markets served by Aptina include cameras, mobile devices as well as computing and gaming platforms.

Aptina's results will initially be published on a stand-alone basis. The deal has already been approved by the board of directors of both companies and is expected to close in the third quarter of 2014.

Implications For ON Semiconductor

According to market research firm TSR, the worldwide demand for image sensors for automotive and industrial applications will grow at an impressive compounded annual growth rate of 16% over the three-year period between 2013 and 2016.

ON Semiconductor aims to use its own sales force and operational capabilities to benefit from this expected growth for which Aptina is well-positioned. The deal is expected to be immediately accretive to earnings, excluding one-time acquisition related charges.

Aptina reported unaudited revenues of $532 million over the past twelve months. Its gross margins were 29%, while operating margins came in at just 3%. This implies that ON Semiconductor is paying a 0.75 times revenue multiple while paying roughly 25 times operating earnings.

Valuing The Company

ON Semiconductor ended its latest quarter with $617 million in cash and equivalents while total debt stands at $920 million. This results in a net debt position of around $300 million which is set to increase towards $700 million following the completion of the deal. The announced deal will be financed through cash and equivalents as well as access to a credit facility.

Over the past calendar year, ON Semiconductor reported revenues of $2.78 billion after reporting declining revenues for two years in a row. Earnings came in at $151 million over the past year, a significant improvement versus the $90 million loss reported in the year before.

Trading around $9 per share, ON Semiconductor's equity is valued at nearly $4.0 billion. This values the company at 1.4 times annual revenues and 26-27 times annual earnings.

The company does not pay a dividend at the moment.

Investors Takeaway

Shareholders react very cautiously optimistic to the deal. Obviously, the discount in terms of revenue multiples is attractive. This is especially true given the expected growth for Aptina and the anticipated accretion to earnings per share.

On the other hand, the net debt position is set to more than double following the deal, which might explain some of the caution which investors are displaying in Monday's trading.

Despite the cautiousness as shown by the market to the deal, I believe the headlines of the deal look very good. I must admit that due to technical difficulties I have not been able to replay the conference call about the deal yet.

So far the good news. Shares of ON Semiconductor trade at premium levels. For the coming year, analysts expect earnings to improve to $0.80 per share on a non-GAAP basis. Based on a similar discrepancy between GAAP and non-GAAP earnings as seen over the past year, ON Semiconductor could post GAAP earnings just north of $200 million this year.

While the valuation seems fair, the company has shown a lot of volatility in its results over the past decade, as it has posted significant losses as well during the downturns in the industry. The significant dilution over the same time has hurt the share price as well, which has hovered in a $3-$12 trading range over the past decade.

While I applaud the deal, the overall valuation is more than fair given the historical performance of the company which limits my appeal to jump the bandwagon at current levels.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.