Marvell: A Bolt-On Deal To Drive Appeal, Down The Road

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About: Marvell Technology Group Ltd. (MRVL), AQ
by: The Value Investor
Summary

Marvell announced a bolt-on deal which has gone largely unnoticed by the market.

The company is still working on the full integration of the Cavium deal as benefits of the deal are ''hidden'' by recent softness in the market.

Marvell still has lots to prove in my mind, although solid serial acquirers in the wider semiconductor industry have potential to create a lot of value for investors.

Marvell Technology (NASDAQ:MRVL) announced an interesting deal earlier this month, a transaction which warrants an update on the investment thesis on the company. The company has acquired some long-term promising technologies, and while Aquantia (NYSE:AQ) will not add meaningfully to sales, let alone add to the bottom line, potential synergies look rather compelling.

I like deal-making efforts in capital and R&D-heavy industries, yet believe that Marvell still has to deliver on the full synergies from the Cavium deal, as the market setback has limited the actual realisation of the promise of that deal.

The Deal

Marvell Technology has reached a deal to acquire Aquantia in an effort to accelerate its leadership position in Ethernet technology. The deal should allow the company to better capitalise on automotive in-vehicle networking for enterprise infrastructure, data center, and access. With the deal, Marvell will extend the position in multi-gig Ethernet segments, particularly in automotive.

CEO Matt Murphy believes that Marvell will hold a strong leadership position in the transformation of in-care network to high-speed Ethernet. Marvell will pay $13.25 per share in cash for the shares of Aquantia, which comes down to a $452 million valuation, adjusting for the net cash position of the company.

Pro Forma Impact

Aquantia reported sales of $121 million last year, a 17% increase on an annual basis. Despite the growth in the operations, the company reported an operating loss of $10.5 million, which compares to a $3 million loss in 2017. Momentum faded towards the end of the year, and 2019 has started on a soft note as well, with more than half of sales derived from the data center market. First quarter sales fell 40% on an annual basis to just $17.0 million, on which the company reported an operating loss of $13.2 million.

Based on the 2018 results, Marvell is paying a 3.7 times sales multiple for Aquantia, yet sales will likely fall in 2019, although the degree to which they will fall is unknown. Promising is that Marvell believes that it can squeeze out synergies worth $40 million a year. If that is realistic, Aquantia could boost operating earnings by $27 million a year, based on the 2018 results, which looks relatively solid in relation to the purchase price and long-term growth prospects of the firm.

The $13.25 per share price tag marks a reasonable premium compared to levels of $7-8 per share at which the shares traded earlier in March, yet the offer price is quite a bit below the highs of $17 seen earlier in 2018. Momentum at the time came after the company went public at $9 per share late in 2017.

While Aquantia has some challenges, to say the least, synergies make the deal worthwhile, and thus, investors in Marvell have not really reacted in response to the deal announcement on May 6, as it really is a bolt-on deal.

Adding To Marvell

In March, Marvell reported its 2018 results. Like most of the sector, 2018 has been a good year, while the company ended the year with some real challenges. Marvell grew full year sales by 19% to $2.87 billion, yet Marvell is only marginally profitable (on GAAP accounting). Full year operating profits totalled only $43 million, and even adjusting for $77 million in restructuring charges, margins are quite slim. After accounting for net interest expense, the company reported a large loss, to a large extent because the business is so R&D-intensive, with expenses running at $915 million in 2018.

The full year loss for Marvell came in at $0.30 per share on a GAAP basis, while the company reported an adjusted profit of $1.19 per share, or $716 million. That number is quite adjusted, however, as it excludes $198 million in stock-based compensation, $77 million in restructuring charges, as well as inventory-related charges and amortization charges. Adjusted for stock-based compensation expenses, and kindly taken the other adjustments for granted, earnings come in closer to $500 million, or about $0.85 per share.

The company has incurred a net debt position following the Cavium deal. Ending the year with $582 million in cash, Marvell operates with a net debt load of $1.15 billion although that is no major concern, given that the company is solidly cash flow positive. This does not appear to be any problem at all, even if net debt rises to $1.6 billion following the latest deal. With 658 million shares trading at $23 currently, Marvell's equity is valued at $15.1 billion, for a $16.2 billion enterprise value. This values Marvell at 5.6 times trailing sales, a much higher multiple than Aquantia, which should be said has seen a real setback in Q1 sales.

What Now?

In November of 2017, when Marvell announced the acquisition of Cavium, I last looked at Marvell. That $6 billion deal was an effort to diversify and upgrade its business model. I noted that there are some benefits to the deal, yet at the same time, realistic accounting of both firms and substantial financing costs will hurt the bottom line, as seen in the 2018 (GAAP) results.

Shares rose to $23 in response to the deal at the time and, ever since, have come under pressure to a low of $15 by Christmas of 2018 amidst a general sell-off in the market and semiconductor shares, in particular. Shares have seen a big recovery ever since, but still trade at $23, marking zero returns in about 18 months since the deal was announced, in albeit a difficult environment.

With first quarter sales for Marvell seen around $650 million, it is clear that we can ''look forward to'' another loss-making quarter and, probably, year as fourth quarter revenues for 2018 came in at $745 million. Note that loss-making applies to GAAP accounting in this case, as the company is solidly cash flow/adjusted earnings power-positive.

With realistic earnings seen around half a billion in 2018, earnings multiples are elevated at 27 times. This assumes that earnings will be flat in 2019, which might be a challenge, given the softer market, although realisation of synergies from the Cavium deal will continue to role in, of course, and debt levels come down (excluding the latest deal).

For now, I am still not convinced that I should buy shares here, although I like savvy deal-makers in the wider semiconductor space. The company has real potential if recent deals can be fully integrated and end markets recover, yet I feel that other shares in the sector have similar rosy prospects and trade at less demanding valuations, making me a cautious watcher from here.

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.