MorningWord 6/2/15: The Surge to Merge

by Dan June 2, 2015 9:31 am • Commentary

There are specific themes that seem to dominate the various stages of a bull or bear market.  For the better part of 2013 and 2014 capital return in lieu of top line growth was the theme. There was an endless string of special dividends and accelerated share repurchases alongside steady increases of regular divs and buybacks, all encouraged by vocal investors.

At some point in the last six months the theme turned to M&A. And last month’s activity reached a fever pitch, representing the single largest total ever. Per

The overall value of deals in US-bound mergers and acquisitions activity amounted to $243bn in May compared to $226bn during the same month in 2007 and $213bn in January 2000, the previous biggest and second biggest months respectively, according to Dealogic data.

With nearly $50 billion in just two semiconductor deals in the last week, investor focus seems keenly focused on figuring out who’s next in technology.  Which is why headlines like this from data storage vendor NetApp (NTAP) this morning are immediately considered as an opening for a deal:

from Bloomberg
from Bloomberg

NTAP has been the target of activists in the past (Paul Singer’s Elliott Management took a 5% stake in 2013, but exited in mid 2014) with an eye on the company’s $5 billion in cash on their balance sheet, or about 50% of their current market cap, or ~40% net of debt.   Shares of NTAP are down 24% from their 52 week highs, down 45% from the 14 year highs made in 2011 and down 20% in 2015:

NTAP 5 year chart from Bloomberg
NTAP 5 year chart from Bloomberg

As for evaluating the merits of deals for different acquirers, in many instances it is like comparing Apples to Pineapples.  Avago (AVGO) paid about 4x BRCM’s $8.5 billion in sales (marking the largest Technology deal ever at $37 billion), while INTC paid about 9x ALTR’s expected $1.8 billion, or about $16.5 billion. INTC is gaining a company whose 66.8% gross margin will modestly help their expected 61.4% gross margin, albeit on a much larger revenue base of $55 billion.

While BRCM’s 51.8% will have a much greater in impact on AVGO’s $7 billion in expected sales that currently have a 59.5% gross margin.  AVGO and BRCM’s deal while eye popping in size will be judged on the two company’s ability to merge operations that have very little overlap.  In the case of INTC, the bet is that the integration of ALTR’s technology will expand their product offering’s and help with higher margin programmable server chips. They paid through the nose and any evidence of success will be difficult to grade.

But back to NTAP. It’s currently trading at less than 2x their expected fiscal 2016 sales of $5.8 billion with an expected gross margin of 62.8%.  The real question is whether or not the recent stretch of poor financial results from NTAP is the start of a long winter for hardware vendors, or the result of poor execution by exiting management?  Either way, NTAP’s balance sheet, commitment to capital return, revenue base and valuation screen as cheap and at least activist bait again, and possibly a takeover candidate in the prevailing bull market sentiment.