Owning Cypress Over SunPower Makes Sense; EMC Over VMware Doesn't

Cypress Semiconductor Corporation (CY) and EMC Corporation (EMC) have control over the majority of the outstanding shares of their spin offs as of EOY 2007. Cypress controls 51% of SunPower Corporation’s (SPWR) and EMC holds 86% of VMware,’s Inc. (VMW) outstanding shares. SunPower, which Cypress had purchased when it was a very small PV manufacturer, was spun out November 2005. VMware Inc., which EMC purchased for $625M in 2004, was spun out on April 2007.

The shares of SunPower have appreciated well over 150% since the spin-off in spite of the recent sell off. VMware shares more than doubled by the end of October and has since come down to the price at the time of the IPO. The current market capitalization of $6B and $22B for SunPower and VMware respectively exemplify how favorable these acquisitions have been for the parent companies.

The media has constantly speculated on the advantages of owning Cypress and EMC over their spin-offs SunPower and VMware respectively. The perceived benefits are lesser volatility and cheaper ownership. Below is an analysis that assumes a conservative valuation for the parent companies (at one times the revenue) and calculates the discounts realizable on the spin-offs by buying the parent companies instead of the spin-offs:

Cypress Semiconductor Corporation (CY):

Data Point	Formula	Value
Enterprise value of CY at one times 2007 revenue	A	$821.6M*
Enterprise value of CY	B	$3.07B
Enterprise value of CY attributable to its ownership of SPWR stock	C=B-A	$2.25B
Enterprise value of SPWR	D	$5.9B
Percentage of SPWR’s outstanding shares owned by CY	E	57
Enterprise value of CY’s ownership of SPWR stock	F=D*E	$3.36B
Percentage Premium/(Discount)	G=100*C/F-100	(33.06)

*Total 2007 revenue including SPWR was $1.6B.

EMC Corporation (EMC):

Data Point	Formula	Value
Enterprise value of EMC at one times 2007 revenue	A	11.9B*
Enterprise value of EMC	B	$30.96B
Enterprise value of EMC attributable to its ownership of VMW stock	C=B-A	$19.06B
Enterprise value of VMW	D	$21B
Percentage of VMW’s outstanding shares owned by EMC	E	86
Enterprise value of EMC’s ownership of VMW stock	F=D*E	$18.06B
Percentage Premium/(Discount)	G=100*C/F-100	5.54

*2007 total revenue including VMW was $13.23B

To recap, owning Cypress over SunPower makes good financial sense. One gets to own a mid-cap semiconductor company at one times the revenue and get exposure to the red-hot solar space at a significant discount. However, EMC in place of VMware is a risky option.

Disclosure: None

Comments

[Stephen Ros...:]

You assume the value of EMC and CY depend on their 2007 gross revenues. Alot more is at work. EMC has an operating margin of 12 while CY has less than 1.
EMC is a better company stand alone to CY.

2008 Feb 01 02:30 PM

[User 1839:]

have you thought about doing a sum-of-parts valuation to determine what the respective values are of CY and EMC?

2008 Feb 01 05:08 PM

[One Familys...:]

sssrosss: You are correct. One times revenue valuation may be conservative more so in the case of EMC as compared to CY. A better way to value these companies might be using DCF analysis after coming up with a CAGR value for the businesses after taking out the spin off figures from their financials. Please see our article on Google for an example: www.onefamilysblog.com...


User 1839: The sum-of-parts market valuation can be done as follows using the formula column values in the tables in the article:

Spin off + Parent enterprise value = B
Spin off enterprise value = D
Parent enterprise value = B-D

Regards,
One Family's Blog
www.onefamilysblog.com

2008 Feb 01 05:38 PM

[One Familys...:]

The article erroneously mentions "VMware Inc., which EMC purchased for $625M in 2004, was spun out on April 2007". The spin-off timeframe was August 2007, not April. Alan Feldman kindly pointed this out to us yesterday:

www.vmware.com/company/

Regards,
onefamilysblog.com

2008 Mar 19 08:45 AM