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Infineon’s Planned Takeover of Cypress Semiconductor Is in Serious Trouble

By Leo Sun - Mar 9, 2020 at 12:20PM

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A sure bet becomes a speculative one as national security concerns arise.

Last June, German chipmaker Infineon (IFNNY 3.35%) agreed to buy American chipmaker Cypress Semiconductor (CY) for 9 billion euros ($10.3 billion). Cypress' stock, which previously traded in the mid-teens, surged toward Infineon's offer of $23.85 per share.

However, Cypress' stock recently gave up those gains after national security officials at the Committee on Foreign Investment in the U.S. (CFIUS) recommended that President Trump block the deal. According to Bloomberg, CFIUS voiced concerns about Infineon's dependence on China, which accounts for about a third of its revenue, and the sale of Cypress' chips to those Chinese customers.

Cypress sells chips to defense companies, including "defense grade memory" that can withstand "military operating temperature ranges." However, these chips don't include any sensitive technologies that aren't offered by other chipmakers.

Semiconductors on a circuit board.

Image source: Getty Images.

CFIUS previously blocked Infineon's bid for Cree's Wolfspeed unit, which produces chips for telecom and radar systems, as well as Broadcom's bid for Qualcomm and Canyon Bridge Capital Partners' bid for Lattice Semiconductor (NASDAQ: LSCC). The committee cited national security concerns in rejecting all three deals.

That track record indicates that Infineon's bid could be doomed, but did investors overreact by selling their shares of Cypress? Let's see how Cypress is doing as a stand-alone company, and whether or not its sell-off represents a buying opportunity for long-term investors.

What does Cypress do?

Cypress operates two main divisions. Its MCD (Microcontroller and Connectivity Division) unit sells analog, wireless, and wired connectivity chips. The MPD (Memory Products Division) unit sells NOR, NAND, SRAM, F-RAM, and other specialty memory chips.

The MCD unit generated 72% of Cypress' revenue last quarter, and the MPD unit accounted for the remaining 28%. The MCD unit stabilized over the past year, but the MPD unit struggled with cyclically lower memory prices.

YOY revenue growth

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Q4 2019

MCD

0%

(8%)

(4%)

(1%)

13%

MPD

4%

(7%)

(30%)

(37%)

(36%)

Total

1%

(7%)

(15%)

(15%)

(7%)

Source: Cypress quarterly reports.

Cypress sells a large portion of its chips to automotive and IoT (Internet of Things) customers, which accounted for 39% and 40% of its revenue last quarter. The remaining 21% came from sales of legacy chips for slower-growth markets like consumer electronics. It doesn't disclose its sales to defense companies separately.

Cypress generated $830 million in revenue, or 38% of its top line, from China, Hong Kong, and Taiwan in 2019. However, a large portion of those chips are likely installed in products for multinational OEMs assembled in China instead of Chinese hardware.

Nintendo's Switch console.

Image source: Nintendo.

For example, Nintendo's (NTDOY 1.81%) contract manufacturers assemble its Switch console, which uses Cypress' wireless chips, in China -- but it isn't a Chinese product. The same argument can be applied to Infineon, which produces chips for a wide range of industries worldwide.

Margins and profitability

Cypress' gross and operating margins have been battered by macro headwinds, especially in the automotive and industrial markets, over the past year.

Non-GAAP

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Q4 2019

Gross margin

47.8%

47.4%

47%

46.9%

47.1%

Operating margin

24.5%

21.1%

20.4%

21.8%

21.1%

Source: Cypress quarterly reports.

Its non-GAAP gross margin of 47.1% last quarter marked a sequential improvement, but still missed the consensus forecast of 47.4%. That pressure will likely continue as the coronavirus outbreak, China's economic slowdown, and other headwinds throttle demand for its chips.

Cypress didn't offer any guidance last quarter in anticipation of Infineon closing the deal, but analysts previously expected its revenue and earnings to rise 6% and 13%, respectively, this year, as demand from the auto and IoT markets stabilized. Based on that estimate, Cypress looks cheap at 15 times forward earnings.

However, investors should take those forecasts with a pillar of salt, since they don't fully account for the impact of the coronavirus crisis. To make matters worse, Cypress' management might have grown complacent over the past year as it waited for the deal to close -- so it could be ill-equipped to deal with the crisis on its own.

A sure bet turns into a speculative one

The Trump Administration hasn't blocked Infineon's bid yet, but the risk makes Cypress a tough stock to recommend. It's cheap and pays a decent forward dividend yield of 2.3%, but it could struggle to overcome the upcoming challenges on its own. Investors who think Infineon can still close the deal might consider Cypress a good speculative buy which could pop nearly 50% overnight, but cautious investors should stick with more conservative investments instead.

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Stocks Mentioned

Cypress Semiconductor Corporation Stock Quote
Cypress Semiconductor Corporation
CY
Nintendo Co., Ltd. Stock Quote
Nintendo Co., Ltd.
NTDOY
$55.56 (1.81%) $0.99
Infineon Technologies AG Stock Quote
Infineon Technologies AG
IFNNY
$30.55 (3.35%) $0.99

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