In 2015, I published an article on small cap semiconductor companies that I saw as M&A candidates. A bit to my surprise, within 2 years, about half the companies discussed there have been or are in the process or being acquired. In particular, most of the companies involved in linear/analog ICs (including Audience, Entropic, Exar, ISSI, IXYS, Micrel, Pericom, and Intersil, all discussed in the prior article) have M&A deals. At this point, two of the companies in this analog semiconductor space, Alpha and Omega Semi (AOSL) and Maxlinear (MXL) are still stand alone companies.
I have doubled down my investments in both in recent months, as I see good futures for them, including the arguments for them seeing M&A deals of their own. The hypothesis is that the success of the semiconductor business over the last few years has created an interesting problem from their own good fortune. First, they make a lot of money and second they need to figure out a path to continuing to keep a rate of growth that made them successful. Sometimes companies can keep up the pace through organic growth, but that is not always a predictable or straightforward option, since it relies on key customers maintaining their own growth. Companies get nervous if they are sitting on too much cash, it makes them tempting targets of everyone from competitors to hedge funds. But as everyone knows, there is a one quick solution to having too much cash. Go buy something. If that something generates revenue and profits of its own, that are additive to the company bottom line, then you have solved both problems at once. This scenario has played out repeatedly over the last few years, sometimes playing out well for the acquiring company, sometimes not, but generally always working out well for the company being acquired. So, a fundamental question becomes, what are companies to consider as acquisition candidates. Perhaps the simplest place for me to start was my previous list, which looked at companies thru the lenses of cash (enterprise value discount to market cap) and IP (Patents and other intellectual property not accounted for under book value.
One candidate that still looks attractive is Alpha and Omega Semiconductor (AOSL). AOSL was founded in 2003 and has a pretty direct focus on one area – power semiconductors. This is a fundamental piece of almost every other piece of electronics, so they have a diverse customer base who may also be acquirers. I see AOSL as a compelling value and M&A story based on the following:
In 2015, AOSL looked attractive to me, they had half their market cap sitting in cash and they had a larger patent portfolio for a company their size. My main concern was that they were not profitable in 2015 and did not project to be in 2016 (probably one of the factors in AOSL not being acquired). Well, in 2017 they are profitable. Reasonably, their stock price has increased with time and profitability, but even with the stock doubling since 2015, they are may be cheap, with a 2017 PE of 31 dropping to 15 in 2018. This number is deceptive however, as they are still sitting on $115M in cash (27% of their $430M market cap). If we factor out this cash hoard, the future PE goes to 11. Growth, as expected for a specialized but mature market segment (power devices) appears to be moderate (2015 revenue of $327M increasing to 2018 projection of ~$400M), but steady.
Another AOSL consideration is that it’s CEO and founder is 72 years old. While age is questionably not a direct factor in M&A, there is an undeniable correlation between founders wanting to cash out when it comes to retirement. See IXYS (IXYS), currently in the M&A process and its CEO, Dr. Zimmer, for just one example of older CEO/founders cashing out.
The second company on my list, is interesting to me for different reasons. MXL is also in the analog space – but it has its own acquisition story, in that for the last 2 years it has been busily buying up several companies, including 2 (Entropic, Exar) that were on my original list. While I am a fan of M&A, I have seen the turmoil that integrating companies get into in the process, and have generally preferred to wait for the dust to settle. With paying for its acquisitions, MXL no longer has the enterprise value discount to market cap it once had, but is now a larger player on the broadband and communications space, and projected to have $500M+ in 2018 revenue, compared to ~$300M in 2015. MXL had negative earnings in 2015 (due in part to swallowing companies roughly its own size) but appears to have finishing up digesting its new parts and is profitable, and while not cheap at current PE of 41, is projected to see tripling revenue growth with a 2018 PE of 13. With its acquisitions, it has more than doubled its patent portfolio as well.
Not quite the bargain of AOSL, MXL's virtue is that it is in the middle of this strong acceleration in revenue and earnings, and is poised to transition from a small to a mid-cap player in the semiconductor market. This is a sweet spot for M&A, which is always looking for a growth story, in that MXL is one of less than a half dozen semiconductor companies in the $1B-2B market cap range. This allows larger market cap companies to make an acquisition that provides some substantive revenue and earnings boost to their 2018 results. One of the blind spots in my 2015 article was that I set my market cap bar too low, as semiconductor companies in the $1B-2B market cap range saw even higher rates of M&A than those under $1B.
As the semiconductor market matures into a current market darling, bargains become harder to find. If we assume the cycle has time to run and that semiconductors will do well in 2018, then it is likely that M&A will continue to be of interest to larger companies, for reasons as previously discussed. In that case, smaller companies may have dual advantages of increased revenue and earnings (high tides lift all boats) and being potential M&A targets.
If this topic holds interest, I will be looking at trying my hand at additional articles on the small semiconductor company market and looking at other companies discussed in the 2015 article.
As always, I am not the expert and could have it all wrong. Do your own research and best of luck.
Disclosure: I am/we are long MXL, AOSL IXYS. 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.