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MCHP-SSTI Deal Creates Opportunity

|Includes: INTC, Microchip Technology Incorporated (MCHP), SSTI-OLD

If you are looking for a solid name in the semiconductor sector, take a close look at Microchip Tech (NASDAQ:MCHP). The Company completed its acquisition of SSTI last week and I believe that the analyst community is not taking the benefits into account - - yet.

Microchip produces microcontrollers and analog semiconductors which are used in thousands of consumer electronics applications. Its equity market cap is $5.5 billion (yes, I am disregarding my small cap focus in this instance). Net cash as of the end of Sep 2009 was $1.1 billion. It pays a dividend of $1.36 per share and the current div yield is 4.7%.

My interest in MCHP emanates from SSTI, which was acquired for pittance by Microchip, in my opinion. The facts are as follows.

Microchip paid approx $292 mm for SSTI which had cash and investments of $215 mm so the net cost of acquiring SSTI was $77 mm. Several of SSTI's equity investments had been written down due to the downturn in the semiconductor industry and with the significantly improved environment, could be worth more than book value but we will leave that aside.

In 2009, SSTI generated $252 mm in revenues. Of that, $39 mm was from licensing revenues which have 100% margin. SSTI was an undermanaged and sub-scale Co which had generated a total of $3 mm in free cash flow over the past nine years..

Ignoring the $210 mm of products revenue (in which I don't think MCHP had much interest to begin with), I believe that the licensing business could grow significantly. The reason for my bull thesis is that Microchip is one of the best managed and well respected companies in its sector. It also has the scale to grow the licensing business whereas SSTI spent the last decade trying to (unsuccessfully) figure out how to get its sub-scale products business in the black.

Ignoring SSTI's products business, MCHP paid $77 mm for $39 mm of pretax income with significant opportunity for growth. This has not been taken into account in analyst estimates.

Consensus estimate for Calendar 2010 pretax profit is $332 mm so the Equity Market cap/pretax multiple is 17x. Plug in another $40 mm and apply the current multiple and you get an additional $660 mm in value or $3.60 per share. This does not take into account the improving fundamentals in the semi sector (see Intel's results from last night).

Disclosure: Long