Things just keep getting worse for Marvell Technology Group (MRVL). The company just pre-announced another weak quarter after last quarter's downside surprise. After guiding fairly conservatively at $800M - $850M on the back of last quarter's miss, the company now expects revenues to be in the range of $765M - $785M. The firm attributes the miss entirely to "lower demand from [their] storage HDD customers" and that the "SSD, networking, and mobile product revenues are tracking to be in line with prior expectations".
Revising Earnings Estimates For Q3
With the revised revenue value, the estimates for earnings per share will need to be adjusted. Assuming the company did not buy back any shares during the quarter (a very loose assumption), and assuming the following parameters from the previous guidance:
Gross Margin = 53.5% +/- 50bps
Non-GAAP Operating Expense = $300M +/- $5M
Other Income / (Expense) = $2M
Non-GAAP Tax Expense = $2M
We arrive at a range of $96M - $124M in Non-GAAP net income, or roughly $0.17 - $0.22 per share in earnings on a Non-GAAP basis, well below the previously guided $0.22 - $0.26 EPS range given.
Where Is The Downside?
In light of several quarters of negative revenue growth year-over-year, as well as negative sentiment coupled with two quarters of missing even the low end of revenue guidance, it is unlikely that the company will undergo price/earnings multiple expansion. While this lack of growth does not appear to be company specific, the reality is that the demand environment for PC related products will be lean until the launch of Microsoft's (MSFT) Windows 8. If demand for PCs booms, then the rising tide will lift all PC-levered boats. However, should Windows 8 machines be poorly received by the general public, then the pain will likely continue.
Valuing Marvell is tricky. The company is sitting on $2.1B in cash and no debt, which means that as of the most recent after-hours price of $8.02/share, the street values the business at $4.19 per share. Now assume a conservative multiple ex-cash in line with its largest hard-disk drive customer, Western Digital (WDC), ex-cash at 3.5x earnings. Now assume the low end of the Non-GAAP estimate for FQ3 and then assume FQ4 is flat (conservative in light of the potential success of Windows 8 machines). This values the business at $2.59/share so adding back in the cash position of $3.83 per share, we arrive at a worst-case scenario of $6.42.
How Reasonable Is That Downside Estimate?
The real question now is how reasonable that $6.42 estimate is on the downside. While I do not have a crystal ball, it seems to me that the company participates in a number of growth areas that would likely allow it to earn a stronger multiple than that of a hard disk drive maker:
- TD-SCDMA Smartphones - while the competition in this space is starting to heat up with Qualcomm (QCOM), Spreadtrum (SPRD), and MediaTek entering the space, the TAM is expected to grow from 60M units in 2012 to 100M units in 2013. While it is too soon to know how the competitive landscape will play out, the TAM growth alone should be a rising tide that lifts all boats. In the updated guidance, this area was going as expected.
- Networking - While this isn't a particularly strong growth driver, this has performed reasonably well for the company. In the updated guidance, this segment was also unaffected.
- Hybrid/Solid State Drive Controllers - as solid state drives and hybrid drives start to replace hard disk drives in the consumer space, Marvell is actually still set to do well, as it provides both SSD and hybrid controllers. The downside risk here is that LSI (LSI), via its acquisition of SandForce, is a very competitive player here. Also, the NAND flash builders such as Hynix, Micron (MU), and Samsung have or plan to move to internally designed controllers on the SSD side of things.
Conclusion - Is The Worst Over?
So, after the warning and the big after-hours whack on the share price, is the worst over yet? Well, sadly, this is unlikely. Marvell still needs to issue its Q4 guidance at its earnings report scheduled for November 15th. While the large cash position will provide some valuation support, the negative pre-announcement has a strong chance of weighing heavily on the shares ahead of the report.
To add salt to the wound, the company's CFO announced his resignation in tandem with the pre-announcement to "pursue other opportunities". This is likely not indicative of any fraud/disagreement over accounting, but it may cast a lingering shadow of doubt over the company's strategic direction and future viability.
On a long term basis, shares of the company seem substantially undervalued, but in the near term short sellers are now equipped with some serious ammunition. It is unclear if the valuation will act as a strong support in light of a number of fundamental changes without a near-term positive catalyst .