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  • Marvell Technology $9 To $60 On Cash Flow And Share Buybacks

    Marvell Technology Corp

    MRVL

    Prepared On:

    Jan 26, 2013

    Prepared By:

    Marc Liu

    President Capitol Isle Partners LL

    393 Rowayton Avenue

    Norwalk, CT 06854

    Executive Summary

    Positive - MRVL is in the throes of a major product transition that when completed will put them in the center of all the hottest new world interactive smart chip technology - Smart Phones, Smart TVs, Hybrid Home Wireline Networks, and Wireless Storage Solutions i.e. products supporting the Cloud.. They are leaders in many of these categories. This transition started several years ago should begin having an impact on MRVL's sales and operations beginning towards the end of the second quarter 2013. The stock price is still in a wait and see mode regarding the success of the transition. While the big investors seem to be moving into the stock many others are waiting for the actual sales to begin appearing in the financials. MRVL is a major player in all the new and growing component areas. So it seems more like a matter of when the sales will reach lift off - as opposed to if.

    Positive - MRVL lost a patent suit against Carnegie Mellon University. The judgment totaled over $1 billion and was payable partially up front and partially through royalties on future product sales. There are multiple cogent reasons to be optimistic that this verdict could be either overturned or radically reduced. No one can second guess the minds of the law or the juries. However it can be said that the current stock price does not reflect any positive legal effects at all - so anything positive here could help move the stock price up.

    Positive - MRVL's operational structure is "Fabless" by design. They do not own the fabs they use and therefore have much greater flexibility in where and how they build their products. This structure also has a major impact on their cash flow as they do not have to tie up large amounts of cash in capital intensive plants. A look at their balance sheet will confirm this point. They generally carry very heavy cash balance and no debt. Not long ago they had almost $3 billion in cash and a market value of $6 billion - not many companies can boast that kind of situation.

    Positive - Given their high cash balances and what they believed was a stock price that didn't reflect the coming successes of their new products, management (starting around Feb 31, 2011) decided to begin buying their stock. And, this was no casual effort, So far they have spent $3 Billion (once the current authorization is filled) to buy about 250 million shares (or 38% of the initial 6770 million shares that were outstanding).

    Positive - Given its Fabless structure and aggressive new product development effort, MRVL is a cash flow machine. Even after the $3 Billion buyback (and some negative circumstances), they should still have over $1.7 Billion in the bank - possibly for more buybacks.

    Positive - With some fairly modest assumptions about sales (I forecast calendar 2015 sales of $4.2 Billion) only 16% higher than calendar 2010, it appears they might be able to do $900 Million in profits (the same as calendar 2010 - no growth here). The big difference (of course) is the fact that the number of shares outstanding has been reduced dramatically. I have forecast that they will buy another round of stock (40 million shares) after they fill the latest authorization - leaving them with 380 million shares.

    Positive - I have also forecast cash flow of $1.2 billion in addition to the $900 million in net profits. With the reduced share count at 380 million, we get the following per share figures for calendar year 2015.

    Net profits per share $2.37

    Net cash flow per share $3.15

    If we use the average industry price earnings ratio from this year of 22, this would yield a price target of $52. Given that the current stock price is $9, this seems like a more than reasonable 3 year investment time horizon. Please don't forget that MRVL will also have $$2.9 Billion on the balance sheet if my projection is correct. This could be worth an additional $7.60. Or all told almost $60 a share.

    Positive - Now let us not forget about the dividends. MRVL pays out $.24 a year in dividends. But even if the annual dollar amount of the dividends paid are held flat, that same $.24 should grow to $ .29 by yearend 2015 just through the impact of share buybacks alone. But that's small potatoes when one considers the cash flow situation. Not only will MRVL be sitting on loads of cash but once the buybacks stop as ultimately they must, a large proportion of the excess cash flow (and perhaps even cash on hand) could be used for dramatically higher dividends. It would not be impossible to envision a $2.50 annual dividend per year by 2015. While this is only about 4% on a stock trading at $60, it's quite a different story if hat stock had been purchased for $9. This would provide a yield of 28%. (Think this is a stretch? Warren Buffet is the largest holder of Wells Fargo which he bought in 2009 around $13 a share at the time the dividend was $.20 a year. Today just 4 years later, WFC's dividend is $1.00 and their stock price is $33. Buffet is earning 7.7% on his original cost basis. It should be noted, however, that WFC is nowhere near done raising their dividends. They are just beginning to hit their stride under their new structure and are now very substantially the largest originator of mortgages in the country. They have about a 35% share of the US mortgage market. If you want to build a cash yielding portfolio for the future, this is the way to do it.

    Conclusion:

    > Buy common at $10 or under.

    > Buy LEAPs - as far out as possible

    > Buy vertical LEAP spreads - as far out as possible

    Marvell Technology Group Ltd. (MRVL)

    9.16 0.05(0.55%) Jan 25, 4:00PM EST |After Hours: 9.15 0.01 (0.11%)

    Marvell Technology Group Ltd. (MRVL)

    -Nasdaq

    Prev Close:

    9.11

    Open:

    9.17

    Bid:

    N/A

    Ask:

    9.40 x 300

    1y Target Est:

    9.09

    Beta:

    0.63

    Next Earnings Date:

    21-Feb-13

    Day's Range:

    9.12 - 9.36

    52wk Range:

    6.98 - 16.86

    Volume:

    8,464,276

    Avg Vol (3m):

    12,484,600

    Market Cap:

    4.90B

    P/E (ttm):

    15.68

    EPS (ttm):

    0.58

    Div & Yield:

    0.24 (2.60%)

    Pertinent Events and Activities:

    1 - Greenlight Capital ownership:

    1 - A1 - Today Greenlight Capital (David Einhorn) owns 32 million shares one of their biggest new positions.

    1 - A2 - They bought their first half of their position around $14and the rest around $9. Their blended cost is around $11.50. The current price is $9.

    1 - A3 - MRVL was David Einhorn's biggest loser in 2012, but instead of selling the stock and moving on he doubled down.

    "For Greenlight Capital, Marvell was a straight miss throughout the entire year of 2012. Over the quarters, shares fell from $13.85 to $7.26, although it did not seem to faze Einhorn, who continued to add to his stake with high conviction, not reducing once.

    Einhorn purchased about 16.64 million shares of Marvell in the third quarter of 2011 for $14 per share on average, and increased the position by almost 1 million shares in the next two quarters. In the second quarter of 2012, he made his second largest purchase of the company to date of more than 7 million shares, bringing his total holding to over 25 million shares.

    2 - Legal Situation:

    "Commenting on the negative Carnegie Mellon verdict, Einhorn said "this is a case of a novel interpretation of the law by a local judge, combined with a hometown runaway jury." He said while the legal system is hard to predict, there are many reasons to believe the award will be substantially reduced or eliminated."

    3 -Technology/Customer Situation:

    "Einhorn said the company's large product transition is not in the valuation. He compared the position to his past Sprint (NYSE: S) bet. "A year ago we were feeling pretty discouraged by our Sprint position, but we re-evaluated and determined that while the stock was down for good reason, our overall thesis was intact. It turned out to be a good decision." He expects Marvell Technology to turn out similarly and "sprint higher" in 2013."

    4 - Institutional Ownership and Capitalization Shrink:

    4 - A1 - The insiders own 140 million shares

    4 - A2 - The big institutional holders own 150 million shares (including Greenlight)

    Solid pedigree:

    T. Rowe Price 26 million

    FMR 17 million

    JP Morgan 13 million

    Black Rock 13 million

    Platinum Ptnrs 12 million*

    Vanguard 10 million

    Ameriprise 10 million

    Legg Mason 9 million*

    State Street 9 million

    *These are very aggressive investors

    Their stakes could move up very quickly reducing the float even further.

    "For Greenlight Capital, Marvell was a straight miss throughout the entire year of 2012. Over the quarters, shares fell from $13.85 to $7.26, although it did not seem to faze Einhorn, who continued to add to his stake with high conviction, not reducing once.

    Einhorn purchased about 16.64 million shares of Marvell in the third quarter of 2011 for $14 per share on average, and increased the position by almost 1 million shares in the next two quarters. In the second quarter of 2012, he made his second largest purchase of the company to date of more than 7 million shares, bringing his total holding to over 25 million shares.

    Currently, he sits with over 32 million shares, after he increased again in the third quarter." As of Jan 2013, he holds 34 million and is still buying.

    4 - A3 - The second tier institutional holders own around 50 million shares

    4 - A4 - These two categories own 340 million shares

    4 - A5 - There are 10 million shares short

    4 - A6 - There are 330 million net share held by large holders

    4 - A7 - MRVL spent $2 billion buying back around 150 million shares at $13.50

    4 - A8 - Adjusting for the above, there are now 540 million net shares before the latest buy back

    4 - A9 - There is a current authorization to buy back another $1 billion. At $10 per share this is another 100 million shares.

    4 - A10 - After this current buy back (if it's done at $10), the capitalization will be 440 million shares.

    5 - Small Float after Current Buyback Authorizations:

    If the large holders (along with management) hang onto their stock, there would be an open float of 110 million shares at yearend 2014 or 80 million shares at yearend 2015 if management buys in another 30 million shares.

    At $10 a share, this would value the whole company at $3.8 billion.

    And, at $10 a share, this would value the open float at $ .8 billion

    There are many hedge funds that could easily take down the entire open float by themselves-

    Greenlight Capital is one example.

    Dan Loeb of Third Point LLC

    Bill Ackman of Pershing Square Capital Management LLC

    Carl Ichan - Icahn & Company

    Steve Cohen - SAC Capital Advisors

    And on and on

    And, of course, David Einhorn at Greenlight Capital is on record that they are not finished buying yet

    Potential Upside Surprises:

    > The patent lawsuit could be reversed or nullified. This change could yield $1 billion in relief from upfront payments
    and the $.20 per chip royalty that they now have to pay to Carnegie Mellon.

    Any major stock reaction in this area would be a substantial because the worst is already priced in to MRVL.

    > The transition phase to the new product lines and the new customer structure (less dependent on several large accounts).

    This would be a very big deal because the majority of the decline in their business was losing their several largest customers and having to replace them.

    > The massive shrinkage of the capital base would dramatically leverage the growth in per share income given the fewer number of shares.

    With a resolved legal settlement and a fully implemented new product line, MRVL's
    sales, profits and cash flow should be set for dramatic growth. The per share leveraging of these two changes (given vastly reduced shares count and the relatively small open float) could set up MRVL for a potentially explosive upside

    > Once operational problems (legal and sales) are back on track, it can be expected that MRVL's cash flow would jump substantially. This would allow further expansion of share buy backs - even at somewhat higher prices.

    The overall leverage in this situation is very large given the current level of the price and the potential for recovery.

    > MRVL is a very high margin business and their problems are clearly defined. They should not be viewed as an orphaned investment.

    > Negative/Positive: Institutions could be forced to sell MRVL if their other "growth" investments fall (margin calls, fund holder liquidations, etc.). Note: This could also be a substantial plus for MRVL - if it happened after the restructuring is complete - as it would allow them to expand their buyback program at very attractive prices

    Potential downside surprises:

    > The lawsuit cannot be adjudicated successfully.

    Such a loss would substantially slow the recovery program.

    > The loss of one of the major executives. The managers at the top are few and they are all family.
    It would be hard to find replacements with the same ability and (family) connection.

    Such a loss would substantially slow the recovery program.

    > Large losses in other institutional holdings (AAPL, WMT, GE, IBM, etc.) during a stock market down turn could cause them to cut back on their positions in MRVL.

    This would be a substantial negative - if it happened before MRVL's restructuring program is complete.

    Note: This could also be a substantial plus - if it happened after the restructuring is complete as it would them to expand their buyback program at attractive prices.

    Technical Analysis:

    Ø The Chart Pattern

    The chart has formed a well-defined "double bottom." This is a powerful bottoming pattern only succeeded by a potential triple bottom which seems unlikely in this case...

    My guess is that MRVL will form a reverse head and shoulder pattern with the current shoulder being formed in the next several months between $9.25 and $7.50.

    Ø The Stochastic

    The stochastics are at the top of their range. This would indicate the price is ready for a pullback (thus forming the other shoulder) or at the very least a sideways motion.

    Ø Cup and Handle Formation

    For those of you who are really into this technical stuff, MRVL is forming what is referred to a "Cup and Handle" formation. This formation is thought to be the chart set up before an upside breakout. The stock bottoms in the form of a "Cup" trades sideways awaiting confirmation of the bottom and then moves higher once that confirmation arrives.

    Ø The Relative Strength

    Relative strength looks solid and rising. This would argue that the bottom has been put in for MRVL and that the double bottom formation will hold.

    Ø The Technical Recommendation

    Accumulate between $7.50 and $9.00.

    Buying around $8 is probably best as MRVL may not get down to the $7.50 area for very long. Don't forget MRVL is still in there with a $1 Billion buyback program and will be buying with both hands at anything under $9.

    Additional Structural Investor Benefits

    Ø MRVL is a heavily traded stock - executions (in size) are virtually instantaneous.

    Ø MVRL pays a $.24 dividend - so we are being paid 2.60% while waiting for the positive events to unfold. Additionally, it is likely that - once the turnaround is firmly in place and buybacks cease (or diminish) - the excess cash flow will be partially used to increase dividends.

    Ø MVRL has a large and active options presence. Virtually all of the various option strategies can easily be established. I find their LEAPs (long term options) particularly intriguing. The Jan 2015 Call Options with the right to buy MRVL at $10 trade at around $1.75. The total cost upon exercise of this option at $10 would be $11.75 for two years. This is a" total" premium of 30% (15% annualized) and a "cash on cash" premium of 19% (9.5% annualized). These are very nice returns should one wish to write these LEAPs for income purposes against the MRVL stock position. But, since I believe MRVL has the potential to trade somewhere between $15 and $30 over the next 2 years (with $25 as a more specific target), the more interesting way to play this is the outright purchase of these LEAPs. If the $10 Call LEAPs were purchased at $1.75 today and should MRVL trade at $25 before Jan 21, 2015, these LEAPs could see prices between $13 and $18 depending on the timing of the MRVL price move (the sooner the move the higher the near term premium). This would result in a 750% to 930% profit. And, the downside is limited to $1.75 per share. There is, of course, the potential to loss 100% of this investment, but an even great potential loss could apply to the common stock.

    Marvell Technology Forecast

    Tag Words:

    David Einhorn

    Greelight Capital

    Carnegie Mellon University

    Dan Loeb

    Third Point LLC

    Bill Ackman

    Pershing Point Capital

    Carl Ichan

    Icahn & Company

    Steve Cohen

    SAC Capital Advisors

    AAPL

    WMT

    GE

    IBM

    T. Rowe Price

    FMR

    P Morgan

    Black Rock

    Platinum Partners

    Vanguard

    Ameriprise

    State Street Bank

    Fabless

    Smart Chip Technology

    Hybid Home Networks

    Cloud Networks

    Wireless Storage Solutions

    Disclosure: I am long MRVL.

    Additional disclosure: This article was prepared with information openly available to anyone. I was not paid by MRVL or any affiliated financial institutions for the preparation of this article.

    Tags: MRVL
    Jan 28 3:58 PM | Link | Comment!
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