Prudential's Misguided Semiconductor LBO Targets

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Includes: ADI, INTC, LLTC, MXIM, TXN
by: William Trent, CFA

Ever since the Freescale buyout (NYSE:FSL), firms have been coming out left and right with their lists of the next buyout candidates. Prudential is the latest to join the fray, reports Eric Savitz of Tech Trader Daily:

“[S]emiconductor companies and their balance sheets are being managed too conservatively relative to the lower risks they now face,” he writes. “[I]f semiconductor boards don’t rationalize balance sheets to reflect their lower risk profiles, then LBO firms may step in and do it for them.”Lipacis lists five stocks with “the most opportunity for upside through more efficient use of their balance sheets:

* Analog Devices (NASDAQ:ADI)
* Linear Technology (NASDAQ:LLTC)
* Altera (NASDAQ:ALTR)
* Texas Instruments (NYSE:TXN)
* Maxim Integrated Products (NASDAQ:MXIM)

He thinks those companies could substantially raise their valuations via a combination of share repurcases and the issuance of debt; he says potential upside to the shares could be as high as 20%-40%.

We agree that the semicondustor industry could use some financial discipline. However, when the excitement first started cranking up, we said if you figure the average buyout will be at 9x EBITDA and you expect a 25% buyout premium to make speculating worth your while, you should only buy stocks trading below 7.2x EBITDA. Let’s see how Prudential’s list compares:

ADI - 10.6x

LLTC - 11.2x

ALTR - 15.9x

TXN - 7.7x

MXIM - 9.3x

Granted, all of these represent trailing EBITDA figures, and a buyout would likely be based on a forward multiple. However, the essentially done deal of Freescale still trades at just 8.6x trailing EBITDA, lower than all of the stocks Prudential is touting with the exception of Texas Instruments. Furthermore, since we think semiconductor EBITDA will likely decline next year, basing the target on a trailing multiple is probably generous.

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