New Trade – $AMAT: Early Bird Gets the Worm?

by Dan October 15, 2015 12:49 pm • Commentary

U.S. tech companies are in a full on merger mania.  It feels like every day there is a new semiconductor company that has put themselves up for sale, or in talks to merge (just this week, SNDK confirmed in talks with WDC and/or MU, and MXIM and ADI are in talks to merge, coming a week after SWKS agreed to pay $2b in cash for PMCS.  Oh and in case you forgot, earlier in the year, AVGO agreed to buy BRCM for $37 billion, and INTC agreed to buy ALTR for $17 billion. And I’m sure I missed a few.

I have long thought that a mega-merger between INTC and QCOM would make sense given their lack of overlap and INTC’s disappointing progress diversifying to mobile chips from pcs and servers, from Jan:

But what about a merger with PC and server chip behemoth INTC who has been losing billions in their efforts to break into the mobile chip business. Given both companies lack of overlap in their core, I suspect there would be little concern by regulators as one is factory heavy while the other is basically factory-less. The combination would create a $300 billion market cap company that could better compete with Chinese rip-offs and with Samsung. Also, given the proximity of both companies in California, there are cost savings from redundancies. Both companies are cash rich with what would be a tiny debt load (just INTC’s $14 billion) so the combined entity could lever up in a massive way while rates are still very low. Debt would likely be a huge part of getting a deal done that would be acceptable to QCOM shareholders. As for shareholders, Blackrock, Vanguard and State Street own a combined 16% of each company and would likely see both stocks appreciate on a proposed merger.

Obviously, this is pie in the sky sort of stuff, but it would make sense. QCOM will most certainly be forced into some sort of deal as either an acquirer or acquiree given their balance sheet (38% of $93 billion market cap in cash, 26% net of cash).

And this leads me to another topic. If nearly every semiconductor company is going to link up with a rival, then the logical progression would be for their customers to do the same.

The companies that make the equipment that make semiconductors (AMAT & KLAC) will most definitely need to consolidate. Earlier in the year AMAT and Tokyo Electron called off their planned merger, and AMAT has been in the tank ever since.

AMAT 1yr chart from Bloomberg
AMAT 1yr chart from Bloomberg

A quick look at the five year chart shows the stock’s recent bounce off of support at $14, but a huge air-pocket down to massive long term, support at $10:

AMAT 5 year chart from Bloomberg
AMAT 5 year chart from Bloomberg

AMAT is a cheap stock trading 13x expected eps growth of 9% this year and 12x next year’s expected 11% growth.  The company has a decent balance sheet, $2.7 billion in cash, $2 billion in debt, with a market cap of $19 billion, trading at just less than 2x sales.

One last point, you can look at the options market to get a sense if AMAT is on traders’ speculative radar. I’d say that with open interest and options volumes both at a one year lows, it’s not. Early bird gets the worm??

AMAT 1yr chart of options open interest and volumes from Bloomberg
AMAT 1yr chart of options open interest and volumes from Bloomberg

The next identifiable catalyst for AMAT will be fiscal Q4 earnings on November 12th, the options market is implying about a 8% move between now and then. We like the idea of fading any near term movement (before that earnings event) in order to own out a few months. So here’s the trade: 

Trade: AMAT ($15.68) Bought Nov 6th weekly/January 16 call calendar for .48

-Sold to open 1 Nov6th weekly 16 calls at .27

-Bought to open 1 January 16 call for .75

Breakevens on Nov 6th expiration:

Profits: max gains on calendar with stock at 16 with trailing profits above and below.

Losses: if stock goes down from entry or well through the 16 strike to the upside. Max risk the .48 in premium paid for the calendar.

Rationale – we want to give this thesis time to play out and the weeklies that expire just before the November 12th earnings allow us to finance the just out of the money January calls.  If we get to Nov 6th weekly expiration and the stock is in a similar spot we will look to sell a higher strike call against the Jan 16 call that we own to further reduce the premium at risk.