NXP Semiconductors (NXPI 1.29%) has been in the news recently, but not for the best reasons. Its impending acquisition by Qualcomm (NASDAQ: QCOM) was scuttled by Chinese anti-monopoly regulators' inaction, which caused Qualcomm to end the planned deal in late in July, which sent NXP's stock price back to pre-acquisition levels near $90. That compares to Qualcomm's latest bid of $127.50, which it raised last February after an initial offer of $110 almost two years ago.
NXP hadn't had an earnings conference call with analysts in nearly two years, but did so after the deal was canceled. While there are some potential concerns about NXP's current state as a stand-alone company (since it had been preparing to be acquired), there were also some positives. NXP makes chips that appear in many growth areas like connected cars, mobile payments, and the Internet of Things, so the recent dip may be an opportunity. Was Qualcomm's loss investors' potential gain?
Is NXP's post-deal sell-off an opportunity? Image source: Getty Images.
Getting back on the solo track
Now that NXP is back on its own, some may wonder whether it has the scale to compete. The trend over the past few years has definitely been one of consolidation in semiconductors. NXP was actually an acquirer itself, purchasing microcontroller specialist Freescale back in 2015.
On the recent call, management admitted there was some "deal fatigue" at the company. "Deal fatigue" generally refers to companies that are waiting to get acquired pausing big investments. In that light, some may wonder if NXP has underinvested over the past two years.
There were some signs of this in the recent quarter. Management noted longer lead times crimped the company's ability to meet demand for its Kinetis microcontrollers. As such, the company now plans to spend roughly 7% of its revenue on capital expenditures for the next one to two years, higher than the company's long-term target of 5%, in order to increase capacity and boost gross margins.
Another cost may come in the form of increased stock-based compensation. Waiting for the deal to close, some executives may have been planning to go elsewhere or retire. But if NXP is going to go it alone, it will have to retain its best talent, and that may require more extra equity incentives. Stock-based compensation was $69 million last quarter, or 3% of revenue, but that could very well tick up in the next few quarters.
Finally, NXP also sells a fair amount of equipment to ZTE (NASDAQOTH: ZTCOY), the Chinese telecom that was temporarily blocked from buying U.S. components last quarter. That cost the company about $31 million and caused declines in the company's RF and digital networking businesses.
Cash should get NXP through
Still, I think these current headwinds, combined with the general malaise of ongoing trade tensions, may be more bark than bite.
First, the company will be receiving a hefty breakup fee from Qualcomm to the tune of $2 billion, or about $1.5 billion after taxes. That money will go a long way to paying for the increased capital expenditures in the near term. This is why large breakup fees exist -– to compensate the potential acquiree for "deal fatigue."
Not only is NXP getting that cash infusion, but its balance sheet is also currently in great shape. Management stopped share repurchases when the Qualcomm acquisition was announced, using all free cash flow to lower its debt load from $7.6 billion in 2015 to just $2.4 billion today. Since the company's EBITDA has increased, NXP's net-debt-to-EBITDA ratio stands at only 0.74 times, well below the company's historical leverage ratios.
So, not only will NXP be able to fund capital expenditures, but the board also authorized $5 billion in buybacks. That's a big deal –- in fact, $5 billion is about 16% of NXP's market capitalization. Management said, "If executed before the end of the year, we'll see our leverage at the end of 2018 [at] ... about 1.5 times." That would be much lower leverage than in previous years.
Finally, the company's current margins came in below management's longer-term targets, likely due to these aforementioned headwinds. Management expects it can achieve non-GAAP gross margins between 53% and 57% and non-GAAP operating margins between 31% and 34% over the long term, compared with the past quarter's 52.8% gross margin and 27% operating margin. Shipments to ZTE have also resumed since the ban was lifted back in July.
Uncertainty creates opportunity
Time and a great balance sheet have the potential to cure much of NXP's ills. Increased capital spending should help the company lift margins and meet demand, and ample share repurchases should be accretive for long-term shareholders. While trade war uncertainty continues to weigh on all semiconductor stocks, at only 11.6 times forward earnings estimates, NXP looks enticing.
