Investors seeking ways to profit from the slow down in China may be tempted to seek short positions in semiconductor stocks. Many have exposure to China between 30 – 50% of revenues. Unfortunately (for bears), most are well-capitalized, and may not have the downside short sellers are seeking.
One microchip specialist that stands out for its relatively high leverage is Microchip Technology, Inc. (MCHP). Although the company is highly profitable, and sports cash of over $2 Billion, it has $2.7 Billion of debt vs book equity of $2.12 Billion. At February 3, MCH trades at $42 per share for a market cap of $8.54 Billion.
Two caution signs have emerged at MCHP. The questionable acquisition of Atmel and a rising level of inventories. I will focus on the ATML acquisition here, and leave the inventory question to a later post.
MCHP investors will be diasappointed to know that their company is spending massive amounts of capital on Atmel, a semiconductor firm with declining sales and strong headwinds in Asia. On January 9th, 2016, Atmel agreed to sell to MCHP for $3.5 billion, or $8.15 per share. This amount is funded from approximately $500 million in MCHP stock and $3 Billion ($7 per share) in cash. The deal represents a nice escape hatch for Atmel shareholders who have seen the stock languish between $5 – $10 per share for several years.
MCHP will spend $2.175 Billion in cash on hand (virtually its entire cash position at the end of 2015), issue $495 million of stock, and add $786 million in debt by drawing on a line of credit. What does MCHP get in return? According to investor presentations, ATML will provide $170 million in “synergies”. Even if this $170 million materializes, it represents a paltry 4.86% return on capital for MCHP shareholders.
The deterioration at ATML is clearly evident in the chart below. MCHP will struggle to achieve any meaningful return on its investment.
Interestingly, MCHP also had to pay a $137 m fee to Dialog Semiconductor plc to walk away from their proposed offer to purchase Atmel. Dialog is probably relieved to take their money and run.
ATML has been deteriorating along with the Chinese economy. With $1.43 Billion in revenue in 2012, the company will likely only post revenue of $1.173 Billion in 2015. In ATML’s defense, the company remains profitable and has shown consistent cash flow. The cash from operations less capital expenditures has declined from $165 million in 2012 to about $85 million in 2015.
The January 13 press release, prior to the acquisition announcement, shows ATML listing badly. Revenues are expected to come in between $261 and $262 million vs. expected revenue between $266 and $286 m. The company noted “weaker than expected billings, primarily in Asia”. ATML offered the limp excuse that the pending acquisition had caused orders to drop.