Lattice Semiconductor Has To Get Back To Business As Usual

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Stephen Simpson
18.07K Followers

Summary

  • Lattice's sale to Canyon Bridge was blocked by an Executive Order from the U.S. President, and recent revenue and margin trends have not been encouraging.
  • Lattice is one of four credible players in FPGAs, with a focus on low-power products and opportunities in consumer devices, wireless, datacenter, industrial automation, and auto.
  • Lattice also has significant margin leverage potential, but it may take an acquirer to dig it out.
  • The near-term financials aren't great, but the cost synergy value to an acquirer can support a fair value above $7, as can near-20% margins in two or three years.

After around a year of speculation and worry, Lattice Semiconductor (NASDAQ:LSCC) finally got resolution on the $8.30/share Canyon Bridge takeout offer, as an executive order from President Trump blocked the deal on security grounds after a recommendation from the Committee on Foreign Investment in the United States. This decision wasn't exactly a surprise, as the company had multiple go-arounds with the Committee (including two re-filings), and the shares were down about a quarter year-to-date.

Lattice has a lot of work to do. Guidance and context have been lacking, as management elected not to host conference calls while the Canyon Bridge deal was pending, but revenue and gross margins have been choppy. On the other hand, the company's IP and capabilities in low-power programmable logic devices (including FPGA) and app-specific standard products have value, and the company's cost structure could offer meaningful (and attractive) synergies for the right acquirer.

Will Another Buyer Emerge?

With decent gross margins (mid-to-high 50%'s), an inflated operating cost structure, and scarce capabilities in PLD/FPGA, the dissolution of the Canyon Bridge deal may not be the end of the M&A story for Lattice. In terms of “gettable” FPGA technology, there's Xilinx (XLNX), Microsemi (MSCC), and Lattice. Xilinx is much more focused on the high end of the FPGA market and Microsemi has done a good job of building their low-to-mid range offerings (with a strong focus on security), but Lattice still has value in its low-cost, low-power offerings.

The question is how easily Lattice might find another suitor. In the proxy that came out after the Canyon Bridge deal, management disclosed that it had reached out to 17 different companies as part of the sale process, with two U.S.-based companies expressing interest and one signing an NDA. Subsequent court proceedings have disclosed that Cypress (CY) has had a long-standing interest in the company, having tried three times to acquire the company. Cypress could still be a potentially interested party, but the list thins out after that.

Adding more FPGA capabilities and targeting significant cost synergy could appeal to Microsemi, and Lattice's exposure to markets like human-machine interface, machine vision, and industrial automation (as well as automotive) could offset the less-attractive (to MSCC) exposure to consumer markets (including handsets. Broadcom (AVGO) could conceivably want FPGA/PLD technology, but Xilinx would seem more in keeping with their normal M&A practices. Marvell (MRVL) could possibly be an interested party and maybe Xilinx would have some interest in rounding out their FPGA IP range (I don't really expect so, but it's possible).

I don't believe another buyer will look to match Canyon Bridge's offer, but a deal in the $6 to $7 per share range could still materialize.

On Their Own, There Are Opportunities

Lattice has been having some operating challenges, but the company does not need a deal to survive. Including the add-backs for stock options, Lattice has been FCF positive in three of the last four years, and there are meaningful opportunities to improve the company's margin structure.

Lattice manufactures (or rather, its fab partners) at 40nm and above, and transitioning to 28nm would improve the company's cost competitiveness, but there's no need to follow Intel (INTC) and Xilinx to below 20nm for its product offerings. On the operating side, the company's expenses have been elevated through the Canyon Bridge deal process, but the termination of that deal should lead to lower spending. Along similar lines, management has not been looking to rock the boat with the deal pending, and I believe going it alone would incentivize management to start restructuring and cost-cutting efforts.

I also see opportunities on the revenue side. Although the company's weak guide for the third quarter may not bode well for the company's status within Apple's (AAPL) iPhone ecosystem (although other soft markets like Chinese wireless could be responsible), management seems to be getting some traction with its iCE40 for voice user interfaces.

In consumer, Lattice is looking at ongoing success and FPGA uptake in handsets (including those iCE40 FPGAs) for uses like antenna tuning, touchscreen control, and dual-SIM management, as the company offers lower-power, lower-cost options with small footprints, and PLDs in general offer OEMs faster times to market. FPGA On the consumer side, Lattice is also looking to exploit opportunities in UBS 3.1, VR, and HDMI/UHD.

Communications includes opportunities in mmWave backhaul, acquired with Silicon Image back in 2015, as well as FPGA opportunities like ECP5 in base stations and MachX03 in datacenters. I'm more interested in the opportunities in Industrial and Auto; Lattice's FPGAs and video solutions have broad applications in machine vision, human-machine interfaces, industrial automation, and surveillance / security. With Lattice driving power needs, costs, and sizes down further and further, Lattice's FPGAs are increasingly attractive options next to the ASIC and ASSP chips that have traditionally been used in these applications. It also most definitely helps that machine vision and human-machine interface are important drivers in automation, which itself is a growing market opportunity.

The Opportunity

On its own, I think Lattice could generate mid-single-digit revenue growth, with non-GAAP margin potential into the low 20%'s in the next three to five years. At some point, though, I do believe the company's size is a limiting factor – I believe the company can continue to leverage its low-power FPGA capabilities, but R&D leverage is tricky for companies of this size. Likewise with operating costs; I believe Lattice can get more efficient from here, but that sweetspot of 30%-plus operating margins is going to be hard to reach on its own.

Lattice doesn't look that cheap on the basis of its near-term margins, but if you believe that the company can/will get those non-GAAP margins closer to 20% in the next two or three years, a fair value in the neighborhood of $7.50 becomes more plausible. Valuation based on DCF is less-impressive today, but I'm not surprised, as I think it will take a few years to get to double-digit FCF margins. Looking at the synergy potential for a buyer like Microsemi (or Cypress), though, a fair value in the $7's starts to make sense.

The Bottom Line

Lattice has been on a bad run of underperformance relative to expectations, though I suppose you could argue the lack of conference calls in recent quarters has played a role. Still, it's hard to argue the “buy on the fundamentals” case when revenue trends have been soft (this will be the first year in five with a revenue decline) and margins have likewise been lackluster. Maybe some of this is due to the distractions caused by the deal or transient end-market issues, but then maybe rivals like Microsemi have been out-executing and the company's value propositions in low-power PLDs aren't as strong as bulls want to believe.

The “but” is the potential of a new bidder emerging. I do expect Lattice to get bought, and even a 20% haircut to Canyon Bridge's bid offers some worthwhile upside. Buying on the hopes of M&A is not a great policy in general, but in this case it is keeping this name on my watchlist and it has some appeal as a high-risk speculation.

This article was written by

Stephen Simpson profile picture
18.07K Followers
Stephen Simpson is a freelance financial writer and investor. Spent close to 15 years on the Street (sell-side, buy-side, equities, bonds); now a semi-retired raccoon rancher. That last part isn't entirely true. Probably.

Disclosure: I am/we are long MSCC, AVGO. 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.

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