Description

MSPD is a fabless semiconductor company that is likely to be acquired in the near-term at a substantial premium. The company has three product segments: high performance analog (HPA), wireless infrastructure (3G/LTE small cell chips), and communications processors (CPE, WAN, VoIP). The stock declined sharply after the company warned that Q2 revenue would come in sharply below estimates due to weak 3G small cell demand. However, in conjunction with Q2 earnings, MSPD announced it had hired Morgan Stanley to evaluate strategic alternatives.

The timing of the MS announcement was peculiar given MSPD’s stock was at multi-year lows. The only logical reason MSPD would explore strategic alternatives is if the company was approached. Management confirmed this on the call: “We announced that we're working with Morgan Stanley to explore strategic alternatives. In the context of changing industry conditions, our financial profile, as well as approaches by third parties, we believe it is prudent to evaluate our alternatives thoroughly.”

Given the value of MSPD’s assets, I believe the strategic alternatives process will result in a sale of MSPD at a significant premium to the current market price. Large shareholders have communicated to MSPD’s board and management that a sale is the best option to maximize shareholder value. The named executive officers have $15.3mm in change of control payments, including $8.7mm for the CEO. The directors and NEOs own 5.7% of MSPD, including the CEO at 2.4%. Management’s interests should be aligned with shareholders. Furthermore, Morgan Stanley is the leading semiconductor banking franchise and MSPD’s banker is Mathew Hein. MS is getting paid on the bank-end and assigned their A-team to this deal. For MS to take this assignment from a dinky $160mm EV semiconductor would not make sense unless there was a significant M&A transaction in the pipeline.

Valuation

MSPD is very cheap on a sum of the parts basis. In addition, an acquirer could realize significant cost synergies. This leads me to believe that an acquirer will likely pay a substantial premium.

Sum of the Parts

Based on comparable M&A transactions and the market prices of comparable companies, I believe MSPD is worth roughly $320mm on a sum of the parts basis ($245mm for HPA + $60mm for communications + $40mm for small cell - $25mm net debt).

High Performance Analog ($70mm TTM Sales)

HPA is MSPD’s most valuable business. Analog is a great business with very high gross margins and very long product life cycles. MSPD’s HPA chips are primarily used to enable high-speed communications in the datacenter, FTTH (fiber to the home), and broadcast video equipment. MSPD’s HPA business generated ~$70mm in TTM revenue with 70%+ gross margins. Growth is expected to be 10% in fiscal 2013. Competitors include TXN, SMTC, and MXIM.

At current prices, MSPD trades for 2.2x EV/HPA sales. This, of course, ascribes zero value to the wireless and communications segments.

Gennum Acquisition by Semtech

A key acquisition comparable is SMTC’s purchase of Gennum in January 2012. Gennum’s and MSPD’s HPA products are direct competitors in the networking, optical networking, and broadcast video markets.

At the time of the acquisition, Gennum had TTM sales of $136mm with gross margins of 72%. SMTC paid $473mm EV for Gennum, or 3.5x EV/Sales. The price paid for Gennum was a 120% premium over the previous close.

The history of the Gennum deal can shed some light onto the parties potentially interested in MSPD. On Oct 25, 2011, Gennum received an unsolicited all-cash bid at a significant premium to market price. In response, Gennum formed a Special Committee of the board to explore strategic alternatives. On Nov 4, Gennum received another unsolicited all-cash bid.

Gennum’s bankers then contacted 11 parties, including SMTC, and 7 parties came back to sign NDAs. Of these 7 parties, 5 submitted written indications of price and 1 submitted a verbal indication. In addition, one party who did not previously sign a NDA submitted a written indication.

Of those 7 indications, Gennum permitted 4 parties to conduct due diligence and receive management presentations. On Jan 12, 2012, Gennum received proposals from SMTC and another party. Both of the proposals included increased prices. The SMTC deal was announced on Jan 23.

Upon information and belief, the last three parties standing in the Gennum process were SMTC, ADI, and SLAB. Other parties involved in the process include TXN, ISIL, and IPHI. The Gennum has been performing very well for SMTC and SMTC may take this opportunity to consolidate a competitor.

Using Gennum’s 3.5x EV/Sales acquisition multiple, MSPD HPA business alone is worth $245mm, or 50% more than MSPD current EV.

Communications ($60mm TTM Sales)

The Communications segment includes various products for telecom networks (WAN), FTTH, and customer premises equipment (i.e., home gateways, broadband routers, etc…). The WAN products are very high margin because of low reinvestment needs, but the business is in decline. The WAN decline is offset by growth in the FTTH and CPE product lines, but these businesses have lower margins.

Good comparables for this segment are AMCC, PMCS, and VTSS. There is some end-market overlap and the margin profile is similar.

Using VTSS’s multiple since it’s the lowest of group, MSPD’s communications business would be worth $60mm.

Wireless Infrastructure ($20mm TTM Sales)

Despite the recent hiccup, MSPD’s small cell business would be a strong asset for any company looking to enter or bolster their position in a growth market. MSPD’s advantages include leading market share (63% of the 3G market), a carrier-proven LTE solution (commercially deployed by SK Telecom), dual-mode 3G/LTE products, and the only SoC solution for TD protocols (China). The small cell chip market should see significant growth over the next few years as small call basestations are the only way for carriers to efficiently increase network density in urban areas.

Parties that may be interested in MSPD’s small cell business include BRCM, CAVM, FSL, QCOM, and TXN. To complement its existing LTE chips and build dual-mode chips, MSPD acquired Picochip for $76.8mm in January 2012 (MSPD wrote down MSPD wrote down $30.5mm of goodwill related to Picochip in Q2 2013). BRCM paid $86mm for Percello in 2010. QCOM reportedly paid either $80mm with a $20mm earn-out or $150mm (depending on what report you believe) for DesignArt, an Israeli small cell startup.

Given the strong growth prospects of the small cell market, MSPD’s small cell business should command a healthy multiple, but for the sake of conservatism, I value it at $40mm, or 2 times sales and close to the carrying value of Picochip.

Acquisition Synergies

MSPD has good assets, but is simply sub-scale. The value of the company’s products is evidenced by strong gross margins and an acquirer should be able to realize significant cost synergies. For example, of MSPD’s 500 employees, only 200 are engineers. SG&A was 30% of sales in fiscal 2012 ($43.3mm) and expected to be roughly 25% of sales in fiscal 2013 ($37.8mm).

I believe a larger semiconductor company could realize $30mm of cost synergies from removing duplicative SG&A. Pro-forma for the cost reduction, MSPD could generate $31mm of EBIT based on estimated fiscal 2013 revenue of $152mm, 60% gross margins, and $60mm of R&D spend. At current prices, MSPD is trading at only 5x EV/EBIT and I believe an acquirer would be willing to pay a much higher multiple for MSPD’s assets.

Potential Dilution

There are potentially 20.6mm dilutive shares, the bulk of which are from two converts: $15mm 6.5% Converts Due 8/1/2013 @ $4.74 (3.2mm shares) and $32mm 6.75% Converts due 2017 @$3.90 (8.2mm shares). There are also warrants for 6.3mm shares of stock @ $16.25 (good luck).

Risk

The primary risk is that MSPD’s management and board choose to continue as a standalone. However, I believe this is extremely unlikely. MSPD’s management has acknowledged that the company is simply sub-scale and worth more in the hands of an acquirer.

The company has cash needs of at least $31mm over the next 12 months, which would necessitate a dilutive equity raise. I believe the board understands that an equity raise, if one were to happen, would force the stock to a sub-$100mm market cap and given the 20% of market cap NASDAQ restriction on equity offerings, would unlikely raise the needed capital. On the Q2 call, the CFO stated in response to a question about a capital raise, “Well, we’re evaluating all strategic alternatives, but I’ll say that we are very mindful of shareholder dilution in that process.”

Furthermore, I believe MSPD’s large shareholders have communicated to the board that the company should be sold and the board understands the potential ramifications of ignoring shareholder preferences.

Conclusion

Catalyst