Microchip: Value Beyond The Numbers

| About: Microchip Technology (MCHP)

Financial statements and analysis can deliver vital information such as P/E ratios, profitability and revenue growth. However, some companies have very valuable intangible assets (even beyond brand and internally developed patents) that can set them apart as investments. Apple (NASDAQ:AAPL) was one of these companies, as any amount of financial analysis 5-10 years ago would not have captured the investment potential in Steve Jobs' "out-of-the-box" mindset. In the semiconductor arena, Microchip (NASDAQ:MCHP) is one of those companies with significant intangible assets that are not captured in any financial statements.

There are 3 key intangible assets for MCHP that I will highlight which I believe sets MCHP apart from other companies in the semiconductor universe.

1) A management team that is more focused on long-term shareholder value creation versus many peers who have often been lured into short-term actions to boost earnings.

2) A loyal employee base that has been developed through years of smart decision making by management.

3) A steady track record of growing market share, sales and earnings that is best in class in the industry.

Currently, MCHP appears to trade roughly at an in-line valuation to its peers. MCHP trades at 15x CY2013 estimates versus peers ranging from 11x-17x using analyst estimates from Yahoo Finance. Additionally, taking out MCHP's net cash per share of $7.55, its valuation drives down to 11.3x (peers at 10x-15x range). (However, be cautious when using valuations ex-cash, as I have written here.)

MCHP and Peers Valuation

While many of its peers also run very lean and efficient businesses, especially Linear Technology (NASDAQ:LLTC), it seems that Microchip's "best-in-class" track record should afford it a more premium valuation (and historically this actually had been the case for MCHP). Below, I go through each of the three key reasons I noted above in more depth.

Long-term shareholder value versus short-term returns

Steve Sanghi, Microchip's CEO, has long espoused long-term vision and focus at MCHP, as have many other CEOs of public companies. One key difference, though, is he has taken actions to support this view. For instance, MCHP refrained from making major acquisitions at inflated prices during the first dot com bubble. (Just one bad acquisition example was INTC acquiring communications-focused Level One in 1999 for an 80% premium and over 8x revenues.)

While MCHP as of late has been more acquisition focused, Sanghi's commentary clearly suggests an uber focus on delivering shareholder value, which is key. One piece of advice I have for any CEO who wants the fastest method to achieve a modest market capitalization is to simply start with a large market capitalization and then make a disastrous acquisition (best historical examples of this are here).

Additionally, Microchip has been known as a dividend payer over the last 10 years, and today leads the semiconductor industry with a dividend yield of nearly 4.5% (versus peers such as LLTC and Maxim (NASDAQ:MXIM) in the 3-3.5% range, and even INTC at 4.0%). Beyond that, MCHP's hefty net cash balance of $1.46b, or $7.55 per share, gives the company ample room to protect and grow the dividend for many years to come (currently the annual dividend is $1.40 per share). Many other semiconductor and technology companies have jumped on this dividend bandwagon the past few years, but during the 2000s, most of these companies focused on share buybacks (many of which were often ill-timed). In my view, a focus on dividends suggests a management team more focused on creating core-business value, rather than trying to time their own stock or use buybacks to help increase management stock option values. (just a note that MCHP has done some stock buybacks in the past, but the primary focus has tended to be on the dividend)

The M&A and dividend strategy for MCHP are just two items that indicate focus on long-term shareholders.

Loyal employee base

During the severe financial crisis of late 2008 and early 2009, many semiconductor companies laid off employees in droves (for example, National Semiconductor actually let go of 25% of its workforce or 1,725 people, Texas Instruments (NYSE:TXN) nearly 10% of its workforce or 3,400 people, and Taiwan Semi let go of hundreds of people in January 2009 only to re-hire many of them again in May of 2009. While it is important to contain costs, mass layoffs can severely hurt employee morale, and makes it difficult to build loyalty. The strongest companies tend to think very carefully on how many people to hire, go after the best folks, and then work hard to retain them. From my research, MCHP is one of the only semiconductor companies to not lay off employees en masse during the financial crisis, and this must be a major positive for the employee base (and likely results in return loyalty and increased productivity). MCHP has 6,300 global employees, and anecdotal evidence from Steve Sanghi all indicates a relatively happier employee base. In fact, early on at MCHP (early-90s), Steve Sanghi's main focus was to work with the VP of Human Resources to create a superior business "culture" and restore employee morale (as detailed in his book). Using Southwest (NYSE:LUV) as a gold standard example that we all are familiar with, we know that a happier and more productive employee base can be an ongoing competitive advantage.

Steady track record of growing sales, earnings and market share

MCHP has grown sales over 90% since fiscal year 2001 (conservative metric as this was a peak bubble year for MCHP, but this is both organic growth and through acquisition). More impressively, the company has driven EPS from 70c in fiscal 2001 to $1.65 in EPS in its last fiscal year, all roughly on the same base of shares outstanding of roughly 200 million (and this is not even mentioning the well over $5 in dividend payments since then). And the company has steadily grown market share in the micro-controller (MCU) market to rank #4 worldwide in the latest reports, and maintains a top position in the 8-bit market (a market which continues to be robust despite constant calls for its demise). Looking at almost any metric or prior track record, MCHP has clearly performed well.

But when looking at track record as an indicator for future performance, it is also important to note that MCHP has a stable management team. Steve Sanghi, CEO, has been with MCHP for 20+ years, and many of his top lieutenants have been with the company for 10+ years (Mitch Little, VP of WW Sales, Dave Lambert, VP of Fabs, long-time CFOs, etc.). This is the same management team that has driven MCHP from market share rankings in the MCU space of 10+ to a top 8-bit MCU ranking today and a top 4 ranking overall in worldwide MCUs (which is likely to improve soon with the recent SMSC acquisition, adding an immediate $400m+ to revenues). While past performance is never a guarantee of future performance, it does clearly show that this management team knows what it takes to succeed.

Overall, my goal was to highlight some very intangible reasons MCHP deserves a premium valuation to its peers. The factors above likely seem to be "no-brainers" for management teams, but in today's high management turnover environment, MCHP seems to be one of the few companies adhering to good long-term shareholder friendly principles.

MCHP is set to report earnings on Nov. 8th, and while investors should focus on the numbers (which may go bullish or bearish depending on a whole host of factors), they should also keep in mind many of the long-term positive intangibles.

Disclosure: I am long MCHP. 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.