In the recent week, spreads on many ongoing mergers have been shrinking. Part of the reason is probably money flows: arb funds that were heavily invested in Berkshire Hathaway's (BRK.A, BRK.B) acquisition of Precision Castparts (BATS:PCP) may have been allocating funds into other mergers.
However, there is one promising merger that seems to have completely fallen off the radar, with the spread actually widening from an already attractive level. It is not just the small size: so far seven separate pieces of analysis have been published on Seeking Alpha about TDK's takeover of Hutchinson (NASDAQ:HTCH), while there have been none about my subject today, even though it is twice the size of HTCH.
Mattson Technology (NASDAQ:MTSN) manufactures equipment used in building integrated circuits. The company operates in three niches: dry strip products (No. 1 market position), rapid thermal processing (world No. 2), and etching. In plain English, they make technology used by semiconductor fabs. It is a small company in its field, with revenues of around $200m and a market cap of around $260m.
MTSN's major competitors include Applied Materials (NASDAQ:AMAT) and Lam Research (NASDAQ:LRCX). Incidentally, the latter bought MTSN founder Brad Mattson's previous company Novellus for $3.3b in 2012. Not only are these competitors more than 30 times larger than MTSN, they too see the need for consolidation, as evidenced by Lam's ongoing merger with KLA-Tencor (NASDAQ:KLAC). There are smaller competitors, such as Ultratech (NASDAQ:UTEK), which has struggled with profitability for years. Still, it is five times the size of MSTN.
Consequently, MTSN faces an uncertain future as a small independent company in a race with behemoths. On the other hand, it also means that for anyone interested in entering the fab equipment sector, MTSN is pretty much the only attractive acquisition target at its size.
Another risk for MTSN is its extremely concentrated customer base. Three customers make up almost 90% of MTSN's revenues: Samsung (OTC:SSNLF), TSMC (NYSE:TSM) and Intel (NASDAQ:INTC). Each of these fab giants has plenty of resources it could use to expand into MTSN's niche, which could deal a mortal blow to the company. Therefore it makes sense that MTSN would be in a stronger position as part of a larger entity.
Mattson signed a merger agreement in the beginning of December. MTSN shareholders will get $3.80 per share in cash, with completion expected within the first quarter of 2016. Based on the recent closing price of $3.49, the spread is 8.9%.
If the deal can close as quickly as the company anticipates (i.e. assuming completion on 3/31/2016), closing is a mere 61 days away. Annualizing such short-term returns can result in shocking figures, especially when one accounts for compounding. So take these numbers with caution: the annualized return is 66%, while even a three-month delay would still leave an annualized return of 23%.
All in all, the buyer's offer is not that generous: while there is a premium (the offer price is 23% above MTSN's last close price before the announcement), the offer price is below MTSN's 52-week high. Amusingly, one of the analysts following MTSN still has a $8.50 price target on it.
Somehow, the market seems to take a dim view about the prospects of the merger. A spread this large normally suggests there is significant risk the deal won't be consummated. However, the implied risk seems to be overblown. Let's look at the buyer's rationale to understand the situation better.
The buyer's name is quite a mouthful: Beijing E-town Dragon Semiconductor Industry Investment Center. It is a subsidiary of E-town Capital, a state-owned enterprise which is officially a financial division of Beijing's Economic-Technological Development Area initiative. Entities connected to the Chinese government have recently been on a buying spree in semiconductor technology, and the takeover of MTSN is a small piece in the overall puzzle. Beijing's vision is apparently one of China as a giant of semiconductor technology, not merely a cheap manufacturing location. Seeing as SMIC (NYSE:SMI) has a large fab inside the Economic-Technological Development Area, it's not a stretch to assume E-town has been watching long enough to know the value of technologies like MTSN's.
The business of MTSN will likely benefit from a tie-up with a deep-pocketed parent, and E-town's connections should ensure growth for MTSN's sales to Chinese customers, which are currently relatively small.
The buyer's determination is evident in the termination fees. Should MTSN break the agreement, it would need to cough up $8.58m, not a small hit for a company its size. Initiating a break-up would be more costly for E-town, which would have to pay twice as much: $17.16m, about 6% of the deal value. The reverse breakup fee is relatively large for a deal like this and reflects the buyer's confidence that the deal will be completed.
Naturally, various approvals and consents must be secured before the deal can be completed. MTSN shareholders may grumble, but I expect they will ultimately vote for the deal in light of the potential decline in the industry this year.
Regulatory approvals are needed from CFIUS as well as various other approvals, including from China, Germany and Taiwan. Since the buyer is essentially the Chinese government, the Chinese approvals are a foregone conclusion. What about the others, particularly CFIUS?
Fear of regulatory scrutiny is understandable in the wake of Tsinghua Unigroup's overture to Micron (NASDAQ:MU), which was rebuffed on the belief that CFIUS would block such a deal. The deals have similarities, in that a Chinese state entity is bidding for an American semiconductor technology company.
However, MTSN is an order of magnitude smaller than MU. Competing solutions exist for all of its products, all of them manufactured by much larger companies. There seem to be no national security implications. There is no reason to expect problems with the approvals, but of course there is a political dimension to the process, so this is not a "sure thing." Then again, nothing ever is.
If the deal were to fail, what would happen to shares of MTSN? The share has been volatile: in the last 52 weeks, it has fallen as low as $2.13 and risen as high as $5.10. The volatility should be expected to continue. Due to MTSN's small size, slowdown in the semiconductor industry affects it quickly, but the company nevertheless seems to be taking market share: in the latest earnings call, the company's CEO estimated the industry to be flat to down 5% in 2016, yet forecast MTSN to grow revenues year-over-year.
A cursory look at a site like Yahoo Finance will tell you MTSN's trailing P/E is around 17. However, the semiconductor cycle has a strong impact on MTSN's prospects, and earnings are set to dip this year. In the short term, MTSN will suffer if the slowdown is larger than predicted, but that is to be expected in a cyclical business.
MTSN also could be a takeover target for other industry players. An independent MTSN may be too small for the long haul. If this deal falls through, MTSN's fate is likely to end up the target of another merger somewhere down the line.
The above is a roundabout way of saying that in the absence of an offer, I believe MTSN presents reasonably good value in a long-term perspective. I deliberately don't suggest a price target in the event of deal failure due to the large short-term volatility I expect.
The acquisition of MTSN is very likely to close and hence the merger presents an attractive arbitrage opportunity at this time. At the current level, it's a bargain.
Disclosure: I am/we are long MTSN, HTCH.
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.