Xilinx: AMD Spread Blows Out

Summary

• Xilinx shares decline as acquisition hopes fade.
• Spread to AMD buy price soars to new highs.
• If no deal, look for meaningful share buyback.

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It was late last year when chipmaker Advanced Micro Devices (NASDAQ:AMD) announced an agreement to purchase Xilinx (XLNX). The $35 billion deal was celebrated by many in the market initially, but concerns have been building recently. While AMD management said recently it still expects the deal to close by the end of this year, the market is currently telling us that completion is far from a guarantee.

I've been talking for several months now about the spread between what Xilinx shares are trading at versus the implied deal price. The pure size of the deal combined with a decent spread started a rise in short interest in AMD that has continued for a number of quarters now. Up until the end of Q2, Xilinx shares were trading at a level that would provide 9-12% upside to their implied deal price based on a deal ratio 1.7234 shares of AMD.

The Xilinx spread started to widen a bit in July, but the past week has really seen an explosion as I mentioned in my latest AMD article. AMD shares have staged an impressive rally that's put the name above its average street price target as well as in overextended territory based on technical factors. At the same time, not only are Xilinx shares not rallying in stride, but on days like Wednesday, they are actually declining. Look at what that's done to the spread as seen in the two charts below.

(Last data point on chart is for close of 8/4)

This week, it appears that Xilinx investors are very worried about the deal closing, particularly in getting approval from China. There is no love lost between the US and its main technology rival, as a number of major acquisitions in this sector are coming under increased scrutiny. CNBC's David Faber is also reporting that risk arbitrage traders are worried about the rising spread here, as they would be unable to handle the downside should the deal fall through. Short interest in Xilinx is also up significantly since late last year, although the mid-July number was a little bit off its April peak.

Lost in all of this craziness has been the strong business performance that Xilinx recently reported. The company handily beat analyst estimates with its fiscal Q1 report, showing more than 20% revenue growth and beating on the adjusted bottom line by more than a dime per share. Xilinx is solidly profitable and is producing nice free cash flow, and the company is projected to show decent revenue and earnings growth in the coming years.

When the AMD acquisition was announced, Xilinx's board suspended the company's share repurchase program. As a result, the company's financial situation has improved quite a bit over the past year. Xilinx finished its latest fiscal quarter with about $1.9 billion in net cash, up from just $1 billion twelve months earlier. Should the AMD deal fall through, the buyback will likely return, and it will certainly be more impactful of Xilinx shares fall. Xilinx could kick off well over $1 billion in free cash flow during its fiscal year, adding more financial firepower.

With worries over the AMD-Xilinx deal increasing this week, the Xilinx spread has blown out this week to more than 41%. AMD shares have staged a tremendous rally, with its buyout candidate not performing very well. At this point, it seems like the market is saying there's a very high risk that the deal won't go through, but Xilinx on its own is still a very good company. Should the buyout not happen, we likely will see Xilinx decline initially, but then the company will likely go back to using its strong financial position to bolster the stock.

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