A curious thing about the ATML acquisition.

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Atmel is being acquired by Microchip Technology. Shareholders can find evidence of the dubious quality of the acquisition quite easily.

Microchip Technology announced its pending acquisition of Atmel in January for $3.5 billion. I have doubts about the merits of the acquisition. Ironically, MCHP inadvertently flagged ATML as a dud while touting its own masterful abilities as an astute acquirer of other businesses during a December 1 slideshow.

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In my homework on how MCHP’s other acquisitions have fared, I discovered an interesting nugget. Apparently, I am not the first person to question their prior acquisitions. On December 1, 2015, MCHP went so far as to release a slide show presentation of just how well its acquisitions have worked.

They show organic net sales have expanded at an 8.3% compounded rate for the past six years, and 6.3% for the past three years. Meanwhile, including acquisitions, net sales expanded at 17.3% per year for the six year period and 13.1% per year over three years.

In the next slide, MCHP takes a victory lap by showing itself atop a league table of other semiconductor companies. MCHP, with its acquisitions, grew net sales more than three times the industry average during the past six years. Who sits at the bottom of the list? None other than Atmel with a dismal -0.4%.

Just over six weeks later, MCHP decided ATML wasn’t so bad after all. MCHP claims that the acquisition will provide $170 million in “synergies”. But even that optimistic  number represents a return on capital of less than 4.9%.

The downside risk is evident: Both companies have very high exposure to Asia (over 40% of sales), and revenues at ATML have dropped by almost 17% during 2015. Meanwhile, MCHP is enlarging its business by 47%, expanding debt from $2 billion to $2.8 billion, and expending nearly all of its $2 billion in cash to finalize the deal.

In fairness, MCHP generates over $500 million in operating cash each year, so replenishing the coffers won’t take long. The debt is growing, but can be easily serviced. But shareholders would be better served by a share buyback than the purchase of a business in decline.

MCHP Shareholders Should Question The Acquisition Of ATML.

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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.

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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.