Semiconductors have been hard to come by since the COVID-19 lockdowns started a chain reaction of supply side shortages. Three years later, executives across the chip sector largely agree that the tight supply should ease up before the end of 2023.
At the same time, major microchip consumers such as automakers and credit card issuers are still wading through molasses and expect the supply chain to remain disrupted until the second half of the year or even longer.
On that note, many semiconductor stocks have endured dramatic price cuts over the last year. Every low-priced ticker isn't an automatic winner, but some are spring-loaded to deliver amazing returns once the macroeconomic pressure and supply chain strangulation are sorted out. In particular, I'm excited about the potential energy stored in MaxLinear's (MXL 0.72%) deeply discounted shares.
Booming business amid supply chain challenges
MaxLinear's business is booming despite the ongoing supply chain challenges.
The maker of broadband and Wi-Fi connectivity chips has quadrupled its trailing revenues since the summer of 2020. In the recently reported fourth quarter of 2022, strong sales of Wi-Fi 6 controllers doubled the company's connectivity sales compared to the year-ago period. MaxLinear collected more than $1 billion of annual revenues in 2022 for the first time in company history. Thirty percent of that $1.12 billion top-line haul was retained as free cash flows.
At the same time, share prices took a 42% tumble over the last year. When rising profits meet falling stock charts, the pairing creates rock-bottom valuation ratios. MaxLinear's shares are currently changing hands at merely 10.4 times forward earnings and 8.6 times trailing free cash flows.
Could a failed merger benefit MaxLinear's investors?
I haven't shown you the whole picture yet. MaxLinear is attempting to acquire fellow chip designer Silicon Motion (SIMO 1.60%) in a $3.8 billion deal. However, Silicon Motion is a Taiwanese company, and MaxLinear is based in California. Hence, geopolitical tension is likely to scuttle the agreement before the last John Hancocks are in. Silicon Motion's shareholders approved the buyout in August, and the business combination has been stuck in review by the Chinese State Administration for Market Regulation (SAMR) ever since. On the Q4 earnings call earlier this month, MaxLinear's management was still "optimistic for a mid-2023 close," but I'm not convinced.
Curiously, a failed merger might actually lift MaxLinear's stock price.
Concerns about the deal price -- a 48% premium to Silicon Motion's value just before the merger announcement -- contributed to MaxLinear's swooning stock chart last year. The company would need to take on roughly $2.7 billion of new debt to finance the cash portion of the buyout. That's a big ask in a period of high and rising interest rates, and a big financial-structure change from the nearly debt-free balance sheet MaxLinear holds today.
I like the idea of combining MaxLinear's networking expertise with Silicon Motion's storage controllers, creating a diversified business with potential cross-selling opportunities between the original companies' largely separate customer lists. Furthermore, canceling the deal due to a lack of regulatory approvals may result in MaxLinear paying a $160 million termination fee to the jilted partner.
So there are downsides to letting the Silicon Motion merger slip through the cracks, but it could still be a good move if only because it removes a dark cloud of uncertainty from MaxLinear's investment thesis. And if the announcement weighed the stock down, a breakup should have the opposite effect.
This can't be right. Shouldn't MaxLinear's stock be worth more? Image source: Getty Images.
Many upsides and a cheap stock
MaxLinear is a company with tremendous growth potential, and its deeply discounted shares make it an attractive investment opportunity. In the face of industry challenges, MaxLinear has continued to thrive and set revenue records.
The pending Silicon Motion merger could benefit MaxLinear shareholders in two ways: by closing as planned, opening the door to more robust revenue streams with cross-selling synergy options, or by failing, thus taking away the weight of financial and political uncertainty. Either way, the long-running holding pattern this merger is stuck in looks like the worst of both worlds. Whatever the final chapter might be, it'll be welcome.
Finally, don't forget that MaxLinear serves end markets with a predictable supply of growing long-term demand. Networking solutions have tons of staying power, especially in the high-speed market section where MaxLinear makes a living.
And you can buy into this bundle of upsides at bargain-bin valuation ratios today, setting your portfolio up for robust gains when the chip-making shortage finally goes away. What's not to love?
