3 Reasons for Investors to Like the MaxLinear-Silicon Motion Deal

MaxLinear (MXL 0.72%) recently announced its intentions to buy Silicon Motion (SIMO 1.60%) in a mixed cash-and-stock deal valued at roughly $3.8 billion. The tentative acquisition has created a merger arbitrage opportunity, which is a short-term investing strategy of buying stocks of companies trading below their acquisition price.

Silicon Motion's "spread," or the percentage gap between the stock's trading price and buyout price, is unusually high at 40%. Typically, a high spread indicates investors believe that the deal is unlikely to go through due to either regulatory concerns or a lack of shareholder support.

Still, here are three good reasons to invest in Silicon Motion and wait until mid-2023, when the company expects the deal to close.

1. Merger arbitrage 

Per the acquisition terms, Silicon Motion shareholders will receive $93.54 in cash and 0.388 shares of MaxLinear common stock. With MaxLinear recently trading for about $36 per share, the stock portion of the agreement would be valued at about $14 for each Silicon Motion share, representing a spread of about 19% for the stock portion of the deal. Additionally, as of this writing, Silicon Motion stock trades at $77 per share, meaning the spread for just the cash portion of the deal is about 21%. If you combine the stock and cash spread, Silicon Motion is trading about 40% below its acquisition price. 

However, it might take some time to see that return, as the deal won't likely close until mid-2023, according to MaxLinear CFO Steve Litchfield.

Any time your money is tied up in a merger arbitrage play, you want to consider the opportunity cost over what could be almost 12 months. For comparison, the historical annualized average return of the S&P 500 is about 10.5%, which is significantly lower than the cash portion of the Silicon Motion deal. 

2. The new company is worth owning

Beyond the potential for a 20% cash return, Silicon Motion shareholders will need to decide whether it's worth keeping their MaxLinear shares. MaxLinear management forecasts that the new company will immediately produce $2 billion in revenue, save $100 million in synergies, and be "highly profitable."

For a better look at how the new business might perform, MaxLinear generated revenue of just over $1 billion with operating income -- the profit realized from a business's operations after deducting operating expenses such as wages, depreciation, and cost of goods sold  -- of about $140 million over the trailing 12 months. Meanwhile, SiliconMotion produced revenue of $1 billion, along with operating income of about $275 million during the same time period.

It is important to note that MaxLinear plans to take on considerable debt to fund the acquisition. The semiconductor company currently has a net debt of only about $10 million but will need to borrow about $3 billion to finance the deal, which is about equal to its current market capitalization. 

Still, management believes the acquisition would create one of the top semiconductor suppliers in the world and sees a total addressable market of $15 billion. So while the new company's projected annual revenue would begin at around $2 billion, management is bullish on its growth prospects.

3. Silicon Motion is worth owning even if the deal falls through

MaxLinear's acquisition of Silicon Motion must pass certain closing conditions before the deal can go through. In this case, Silicon Motion shareholders already approved the merger, so now it will be up to regulatory bodies to sign off on the acquisition in various jurisdictions.

In any merger arbitrage play, investors should always be prepared for a deal to fall through, so it's important to like the underlying business regardless.

Silicon Motion's stock is up about 3% over the past 12 months, outperforming the S&P 500, which is down roughly 12% during the same time period. But beyond the stock price, second-quarter revenue grew 14% year over year from $221.1 million to $252.4 million. The company also increased its operating income about 11% year over year from $60.4 million to $67.1 million.

Additionally, Silicon Motion also will continue to pay its quarterly dividend of $0.50 per share, which equates to a dividend yield of about 2.6%, while investors wait on the fate of the acquisition. 

Investor takeaway

In a turbulent market, a merger arbitrage play like Silicon Motion provides a relatively safe floor with an upside that could well outpace the historical annualized return of the S&P 500.

And even if the deal does fall through, Silicon Motion is a growing business in the semiconductor industry, which has proven to be vital to the worldwide economy. Therefore, investors should consider holding or buying Silicon Motion shares for a mixed cash-and-stock return of 40% with limited downside over the next year.