A clear trend has emerged in the semiconductor industry. Focus has shifted to enterprise infrastructure equipment, and chip designers of all sorts are trying to expand their portfolios in this large and expanding market. Tiny chip designer MaxLinear (MXL -1.41%) is no exception. It is in the process of acquiring fellow chip designer Silicon Motion (SIMO -1.25%), a deal it hopes will be complete by the middle of 2023.
Mergers between companies that rely on the development of intellectual property (in this case, current and future chip engineering designs) can present an interesting opportunity for investors. This case is especially interesting because MaxLinear and Silicon Motion have both been blasted by the bear market as their tie-up is pending. Are these two small infrastructure chip stocks a buy right now?
Deal details and why China's regulators might want to torpedo it
MaxLinear announced in May 2022 its intention to acquire Silicon Motion, a leader in controllers for NAND memory chips. The addition would complement MaxLinear's internet infrastructure business, which specializes in wireless connectivity chips as well as broadband internet chip designs.
The offer to Taiwan-based Silicon Motion is $93.54 in cash per share of Silicon Motion, plus an additional 0.388 shares of new stock in MaxLinear. Based on MaxLinear's share price of $33.96 as of this writing, the total consideration to Silicon Motion is nearly $107 per share. Silicon Motion stock at this writing only trades for around $62 per share (a nearly 60% discount). The deal is expected to close by the middle of 2023, so why the big discrepancy in share price from the buyout offer?
All mergers and acquisitions have to go through regulatory approval in various countries wherever a company's operations are present. For chip designers in an age where technology is omnipresent and considered a matter of national security, that means just about every major regulatory body is going to weigh in. At an investor event in November 2022, MaxLinear CFO Steven Litchfield said that regulatory approval in China was causing the holdup. Litchfield said regulatory approval of mergers is taking 12 months or sometimes longer, though MaxLinear still believes approval will be granted by the middle of 2023 (which would be about a year or so from the deal's announcement).
But there's obvious doubt in the market that approval will be given, which explains why Silicon Motion is trading for such a hefty discount to the buyout offer. Silicon Motion is a Taiwan-based chip designer, and China has made it clear it still views Taiwan as its own. Taiwan's status is a huge geopolitical risk for the world's largest chipmaker, Taiwan Semiconductor Manufacturing (TSM -4.86%), not to mention for the global economy.
It's highly likely China could shoot down Silicon Motion getting acquired by California-based MaxLinear. For now, it looks like investors should assume a MaxLinear-Silicon Motion merger is a low-probability event, given political intrigue.
Two stocks standing on their own merits
Though a merger may be improbable, there's still a lot to like about MaxLinear and Silicon Motion on their own. Each stock deserves its own separate deep dive, which is a topic for future articles, but a cursory look shows impressive performance. MaxLinear revenue grew 24% year over year in the third quarter of 2022 to $286 million and generated a nearly 22% operating profit margin. Big gains in its wireless connectivity portfolio, driven by the current upgrade cycle to Wi-Fi 6E, drove the gains.
As for Silicon Motion, its sales fell 1% year over year in Q3 2022 to $250 million, driven by declines in the memory chip market -- especially in the faltering consumer electronics space as personal computer spending hits the skids. Enterprise memory markets have also slowed, though they remain healthy due to data center upgrades in support of cloud computing and AI. However, although the memory market is in a steep decline, Silicon Motion is still highly profitable, with a 22% operating profit margin in its latest quarter.
MaxLinear stock currently trades for a paltry 9.5 times trailing-12-month free cash flow, mostly in anticipation of its booming growth slowing down in 2023. Silicon Motion stock trades for 28 times free cash flow, a metric that could get worse given the current severe downturn in memory chips, although free cash flow should improve later in 2023 as the company's investments in new enterprise computing technology last year will ease.
After both stocks were clobbered by the bear market of 2022, MaxLinear and Silicon Motion look like interesting semiconductor stocks to keep on your radar right now -- whether they are allowed to merge or not.
