Magnachip: Market Considers This Deal Dead

Summary

• The market seems to consider the deal by Wise Road Capital for Magnachip to be dead in the water.
• I wouldn't take the under on that bet on a 50/50 proposition.
• But the payout in case of a completed deal seems very large compared to the longer term losses in case of a deal break.
• Looking for a portfolio of ideas like this one? Members of Special Situation Report get exclusive access to our model portfolio. Learn More »

gorodenkoff/iStock via Getty Images

Magnachip Semiconductor (NYSE:MX) makes OLED display drivers. These are used in the automotive industry, TVs, and smartphones. The company has a market cap of $826 million and is based in South Korea. A Chinese private equity firm called Wise Road Capital is trying to take the company private with a $29 per share bid. This bid was made official on March 26, 2021, and the company has been trading downwards since. The market is extremely skeptical this deal will be completed at $29 per share if at all. Shares can be had for as low as $17.75.

Data by YCharts

$18.8 per share is what the company views as the unaffected price before the Wise Road bid. The company called $16.6 the 3-month volume-weighted average share price.

It looks like a pretty good deal to me at $17.75 per share.

Assuming the deal doesn't close. When I look at semiconductor indexes, these are mostly up sizeable percentages since March 24.

Data by YCharts

If the deal doesn't go through, Magnachip picks up $100 million+ in break-up fees. This is $2 per share in cash.

The merger agreement shows there was a bidding war going on for Magnachip. Between these bidders, there were at least two parties from the U.S. My takeaway is that they were primarily giving up on the asset because of demands around break-up fees. There were at least two strategic bidders (instead of financials like Wise Road). In general, strategic bidders can go a bit higher due to synergies and things like that. Wise Road took the "prize" with a bid for $29 per share but party A went up to $25, party C went up to $28, and party G was willing to go up to $29 (but probably not match the break-up fee).

The reason the market is betting on the deal falling apart is the fact that CFIUS, the Committee on Foreign Investment in the United States, more or less recommends the President of the U.S. to block the deal.

There's still a chance though because CFIUS allowed the company to withdraw and re-file their CFIUS notice. The aim of the refining is to "further discussion with CFIUS concerning potential options for permanently mitigating risks to the national security that have been identified by CFIUS".

The parties now presumably know what CFIUS views as critical issues and can address these. There's quite a bit of room for Wise Road to accept mitigations that harm the economics because if the deal falls through, it is on the hook for $100 million anyway. The review ends October 28th but can be extended to another 45 days. The merging parties have extended the outer date of their agreement to the end of December 2022.

Analysts, according to SA data, put the EPS for 2022 at around $1.02.

Data: Seeking Alpha

The company has $5.85 per share in cash. It gets another $2 in cash if the deal breaks. That's $7.85. The capital structure is really inefficient with no debt to speak of. The cash is pretty much all excess cash.

You are really paying 10x earnings on an unlevered semiconductor company that views itself as a growth company in an attractive market (slides from a 2021 presentation to investors):

The company expects some step-up growth in this power semiconductor division in 2022:

Automotive is cyclical but solar, wind, and 5G should be secular growth drivers:

There are some risks as the company recently posted less than stellar numbers. It is blaming semiconductor supply chain issues and I'm sympathetic to that argument because it is all over the papers all the time. There's demand but they can't meet it because of not having the components or manufacturing capacity contracted.

As recently as August, Magnachip reiterated in an 8-K that it's committed to earlier announced 2020-2023 goals; growing revenue at a double-digit compound annual growth rate (that's fast), getting gross profit margins above 30% in 2023 (currently 26.83%), operating expenses below 18% of revenue, and get its free cash flow ratio above 8%. What the company can't say yet (as it's still moving along a deal) is what it will do about its capital structure.

Holding hundreds of millions of the balance sheet, having no debt while having 8% cash flow after growth investments that's sub-optimal and very unnecessary.

10x earnings seem like an undemanding valuation in this market. If you consider that's on an unlevered technology business, it seems very cheap. If the deal breaks due to CFIUS concerns, apparently, the company has technology in development or in production that is deemed very important (after all, this is otherwise a small potatoes company). If the deal breaks, at worst, today's price seems like a fair price (I do admit it could trade down due to arbs getting out). Also, keep in mind, I could very well be wrong in my assessment.

If the deal were to pass somehow, it is hard to fathom; but let's say the company manages to persuade CFIUS, certain IP can be secured and the $800 million market cap is allowed to close the deal. That's a 64% gain. The best part is that we'll likely know in early 2022 what it is going to be. I think the payoff is asymmetric. The market may well be right odds of the deal falling apart are high.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of MX either through stock ownership, options, or other derivatives. 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.

Comments

[Jion]

We have to give credit to the author, he was right about this deal. The arbitrage hunters should check JOBS. I think there the risk is much lower.

[Albert Lin, CFA]

Thanks for the article. MX and Wise Road actually extended the merger date to December 2021, not 2022. This is directly from MX 8K.

"In accordance with Section 7.2(a)(ii) of the Merger Agreement and pursuant to a written notice delivered by Parent to the Company, the Termination Date under the Merger Agreement has been extended from 11:59 p.m. (New York time) on September 25, 2021 to 11:59 p.m. (New York time) on December 25, 2021."

[Value Digger]

Based on the worst case scenario, MX will receive from $70 million to $105 million in breakup fees, which translates into about $2 per share in cash, if the deal does not go through.

Meanwhile, the unaffected closing price on March 2, 2021 was $18.83 per share, as shown below:

www.prnewswire.com/...

Therefore, MX is cheap at today's price of $18 per share, based also on its key ratios (i.e. EV-to-Revenue, EV-to-adj. EBITDA) and the fact that MX will keep growing its business in the next quarters.

[Jion]

A Korean analyst agrees with the author, the deal looks to the most as dead. But he thinks that Cornucopia will come back if this happens and the negotiations with Magnachip will continue:
english.etnews.com/...

[WTAY]

@Jion latest summit between Biden and Xi , may open up new opportunity for such deal to flow again. Looking forward to further developments in Q1 ,2022

[Spare me the platitudes.]

Why does CFIUS have so much influence in this deal? MX is largely Korea based. Is deal price a reflection of CFIUS’s influence on the ROK regulator?

[mmmanu]

@Spare me the platitudes. because wise road is a PE firm based in china

[Bram de Haas]

@Spare me the platitudes. you're not wrong to wonder: Magnachip has little real presence in the United States. Indeed, according to its May 2021 8-K: (i) all of Magnachip’s manufacturing and research and development activities take place in South Korea; (ii) the company’s sales activities occur primarily in South Korea, with the remainder of sales operations in China, Hong Kong, Taiwan, Japan, and Germany; (iii) the company does not have any employees, tangible assets, or IT systems in the United States; and (iv) all of Magnachip’s intellectual property is owned by its operating company or other non-U.S. subsidiaries.[4] With that in mind, to assert jurisdiction over the proposed transaction, CFIUS presumably (we say presumably because there is no publicly available explanation from CFIUS regarding its jurisdiction in this case) relied on the fact that Magnachip was a U.S.-listed company incorporated in Delaware with a Delaware subsidiary. www.clearytradewatch.com/...

[Rgarga]

@Bram de Haas what do you think of the update? Looks like they are aligning with a Chinese customer ??

[Jion]

Great analysis. If this deal fails, then the next suitor has to offer $29 plus $2 to make the company accept his offer.

[settembrini007]

It is the Samsung concentration that is the key risk. Of course, Samsung can't risk its supply chain but Samsung and Korea are likely to be key players in this game. I think CFIUS will not block it if Korea gives the go ahead. Just like Syngenta was allowed to go ahead as the Swiss government did not request CFIUS to stop it.

[Vikdan]

I took a small position a few weeks ago. The spread seems too good and, as you wrote, someone else will buy the company if the deal blows. Hopefully we will know this year, but seems unlikely. Thanks for writing