Investors seeking ways to profit from the slowdown in China may be tempted to seek short positions in semiconductor stocks. Many have exposure to China between 30% and 50% of revenues. Unfortunately (for bears), most are well capitalized, and may not have the downside short sellers are seeking.
One semiconductor specialist that stands out for its relatively high leverage is Microchip Technology, Inc. (NASDAQ:MCHP). Although the company is highly profitable, and sports cash of over $2 Billion, it has $2.7 Billion of debt vs. book equity of $2.12 Billion. MCHP has a market cap of $8.41 Billion.
MCHP and the ATML acquisition
MCHP's investors will be disappointed to know that their company is spending massive amounts of capital on Atmel (NASDAQ:ATML), a semiconductor firm with declining sales and strong headwinds in Asia. On January 9th, 2016, ATML agreed to sell to MCHP for $3.5 billion, or $8.15 per share. This amount is funded from approximately $500 million in MCHP stock and $3 Billion ($7 per share) in cash. The deal represents a nice escape hatch for Atmel's shareholders who have seen the stock languish between $5 and $10 per share for several years.
MCHP will spend $2.175 Billion in cash on hand (virtually its entire cash position at the end of 2015), issue $495 million of stock, and add $786 million in debt by drawing on a line of credit. What does Microchip get in return? According to investor presentations, ATML will provide $170 million in "synergies". Even if this $170 million materializes, it represents a paltry 4.86% return on capital for MCHP shareholders.
Interestingly, MCHP also had to pay a $137 million fee to Dialog Semiconductor plc (OTC:DLGNF) to walk away from its proposed offer to purchase Atmel. Dialog is probably relieved to take its money and run.
ATML faces double-digit percentage revenue declines from challenges in Asia
The January 13 press release, prior to the acquisition announcement, shows ATML listing badly. Revenues are expected to come in between $261 million and $262 million vs. expected revenue between $266 million and $286 million. The company noted "weaker-than-expected billings, primarily in Asia". ATML offered the limp excuse that acquisition discussions had caused orders to drop.
The deterioration at Atmel is clearly evident in the chart below. MCHP will struggle to achieve any meaningful return on its investment.
ATML has been deteriorating along with the Chinese economy. With $1.43 Billion in revenue in 2012, the company will likely only post revenue of $1.173 Billion in 2015. In ATML's defense, the company remains profitable and has shown consistent cash flow. Cash from operations less capital expenditures have declined from $162.4 million in 2012 to about $71.4 million in 2015.
Is MCHP biting off more than it can chew? CEO Sanghi raises doubts
MCHP has been through the acquisition game many times, but ATML is different. It enlarges the business by 47% and takes on a company facing serious headwinds in Asia. It also increases debt from about $2 Billion to $2.7 Billion at a time when leverage appears to be a growing problem for companies exposed to Asia. The February 3rd conference call raised some eyebrows about the lack of preparation for such a huge acquisition.
MCHP CEO Steve Sanghi didn't exactly inspire confidence:
Well, we're not learning much about the business at this point in time. Atmel is essentially not sharing anything about the business. We still see that Antitrust hasn't cleared and we still see the businesses as competitive. We're largely getting through the people, we tour the facility, we're learning where people are located, we're starting to formulate some initial thoughts about how we will go about the integration. We have done enough of these that we know what buttons we have to push and what we have to do so we can get there quite quickly. But in the two weeks that have passed, they are not letting us into the business yet.
I don't find it surprising that Atmel is holding its cards close to the vest, but I do find the belief in perceived "synergies" to be wildly optimistic for a CEO that has barely scratched the surface of the ATML integration.
MCHP didn't rate ATML very highly in December
Ironically, MCHP inadvertently flagged ATML as a dud while touting its own masterful abilities as an astute acquirer of other businesses during a December 1 slideshow.
In my homework on how MCHP's other acquisitions have fared, I discovered an interesting nugget. Apparently, I am not the first person to question its prior acquisitions. On December 1, 2015, MCHP went so far as to release a slide show presentation of just how well its acquisitions have worked.
It shows organic net sales have expanded at an 8.3% compounded rate for the past six years, and 6.3% for the past three years. Meanwhile, including acquisitions, net sales expanded at 17.3% per year for the six-year period and 13.1% per year over three years.
In the next slide, MCHP takes a victory lap by showing itself atop a league table of other semiconductor companies. Microchip, with its acquisitions, grew net sales more than three times the industry average during the past six years. Who sits at the bottom of the list? None other than Atmel with a dismal -0.4%.
Just over six weeks later, MCHP decided ATML wasn't so bad after all. In fairness, MCHP generates over $500 million in operating cash each year, so replenishing the coffers won't take long. The debt is growing, but can be easily serviced. But shareholders would be better served by a share buyback than the purchase of a business in decline.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.
Additional disclosure: Other than some comments here and there, this is my first post on Seeking Alpha. I welcome your comments and discussion, but please be gentle. I have no position in either ATML or MCHP, however, I am looking for ways to short Chinese exposure. I am not a financial advisor, nor does this post represent any recommendation for the securities mentioned. I provide this information as interesting observations.