Thoughts On A Potential Broadcom Offer For InvenSense

| About: InvenSense (INVN)
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Summary

A rumor has surfaced that Broadcom is in talks to buy InvenSense.

Plausibility and the likely upper limit of a Broadcom offer are examined.

Other potential suitors and my own pricing thresholds are also discussed.

I'm going to begin this article by pointing out that I don't really have any good way to guess what Broadcom (BRCM) would offer for InvenSense (NYSE:INVN), or even if the rumors have any truth at all to them. I'm already probably the first to go on record pointing out that InvenSense would be an attractive target for Intel (NASDAQ:INTC) or Qualcomm (NASDAQ:QCOM). More recently, I've noted that additions to InvenSense's board support such a thesis, and this work has been referenced by other analysts, such as Ashraf Eassa. My last INVN article gave evidence that company is something of a missing puzzle piece for the mobile ambitions of other companies, and reiterated that the possibility of a buyout could be the best reason for owning shares in the face of short term volatility.

So how much sense does an offer from Broadcom make? At first glance, it's at least plausible. Broadcom has a $25.4b market cap, compared to InvenSense's $1.4b. Both companies are fabless chip designers that make SoCs (system on chips). Since InvenSense is still transitioning into this field, it could presumably benefit from Broadcom's connections and expertise. In terms of functionality, though, the two companies make products with very different functionality, albeit for the same end market.

So even though I have no good way to guess at what sort of offer Broadcom might actually make, I can at least give some quantification on what Broadcom could afford to offer, and follow that up with some support for what I would and wouldn't be happy with. Broadcom had negligible debt and over $3.2b in cash and short term investments as of Sept. 30; based on income trends it could easily be expected to have $3.5b available at this point without raising any capital. If we simply divide that by InvenSense's 90.1M shares, we can figure that Broadcom could afford to pay almost $39 per share with current assets. InvenSense's share count is expected to rise to 93M as the result of its own acquisitions, though. Using that share count drops the price to the $37.50 range. I'd be unhappy with anything under $30.

The problem with this analysis is that premiums over 100% of the recent share price are very rare. The closest analogy in that chart is the Texas Instruments' (NYSE:TXN) purchase of National Semi, for a 74.3% premium. In fact, TI is an equally capable buyer for InvenSense, with at least as much synergy, given its work with wearables and SoCs. Nonetheless, I hope you can see why I'm just a bit skeptical that Broadcom would offer over $30 per INVN share, at least initially.

Don't get me wrong, I think that, for buyout purposes, InvenSense deserves over 100% premium from recent pricing. InvenSense had more in sales last quarter than at any other point in the company's history and that's a trend which should continue. Its customer diversity and leading edge design make it attractive for almost any mobile chip manufacturer. InvenSense's margin problems related to Apple (NASDAQ:AAPL) and Samsung last quarter are an industry-wide symptom of the maturation of the mobile market, as shown by Broadcom's own operating margins:

Broadcom 3Q13 4Q13 1Q14 2Q14 3Q14
Total Revenue 2146 2064 1984 2041 2260
Operating Income 336 186 170 14 111
Operating Margin 16% 9% 9% 1% 5%

So in actuality, larger mobile chip suppliers like Broadcom want InvenSense for its future in the emerging and diverse wearables market in order to help maintain their own pricing power. InvenSense's other margin-wrecking problems related to inventory were one-time charges that should already be dissipating. My summary of that quarterly report forecast a quick return to a 15% operating margin.

Before the latest earnings report, INVN spent almost all of this year above $20, though I spent most of that time warning that the market was overvaluing a deal with Apple. Just as the market overpriced the Apple deal, I believe it is now overreacting in the opposite direction, at least from the long-term perspective that any buyer of the company would have. Even so, the 200-day moving average for INVN has only declined to $20.71. A more reasonable 50% premium from that price point comes in just above $31 per share. That's less than 30% above my 1-year $24 price target, which isn't the highest out there. Any lower and I think Broadcom, or anyone else, would be trading a short-term premium for an extreme long-term value, but then, that's the point of any buy-out, isn't it?

Disclosure: The author is long INVN.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.