This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines feature opposing views of the two companies involved in this week's big radio-frequency semiconductor merger -- TriQuint Semi (UNKNOWN:TQNT.DL) and RF Micro Devices (UNKNOWN:RFMD.DL). This story is a bit complex, though, so before we get too far into it, let's first take a quick look at our third story of the day:
Why Goldman Sachs hates silver
Since reporting its big $1.94-per-share Q4 loss last week, shares of Pan American Silver (NASDAQ:PAAS) have gone on a bit of a tear, rising 8.6% in three trading days. If that sounds like a strange reaction to you, though, then you're in good company. Goldman Sachs thinks it's a weird way to respond to a huge GAAP loss as well.
This morning, Goldman announced that unlike everyone else in the market, it seems, it has decided to go negative on Pan American Silver, downgrading the stock to "sell." Quoted on StreetInsider.com today, Goldman warns: "Unlike gold, we anticipate the supply response to a decrease in silver prices will likely be limited; more than 70% of mine production comes as a by-product of mining for other minerals, so supply is dependent on demand for other metals such as lead/zinc, copper and gold."
Goldman's referring to the fact that silver prices have fallen 24% per ounce over the past year, to a recent price of just $21.90 per ounce. Ordinarily, you might expect this low price to dissuade miners from looking for and digging up more silver. But what Goldman is saying is that miners basically accumulate silver by accident, in the process of looking for other metals. Hence, there's no reason to expect that production will decline, reducing supplies. And so there's no reason to expect the value of Pan American's silver to rise.
Meanwhile, the price of Pan American Silver -- the company -- looks expensive already. Unprofitable over the past 12 months, the stock trades for more than 40 times earnings. Earnings are expected to decline, not rise, over the next five years. And the company is free cash flow negative to boot. All of which facts suggest Goldman Sachs is right about Pan American Silver. It's in a deep, dark hole right now, and it's not climbing out any time soon.
A merger of equals
Moving now to the big story of the week, we'll take a look at yesterday's announcement of the "merger of equals" between TriQuint and RF Micro.
My fellow Fool Sean Williams told us about this story yesterday. In essence, what is happening here is that TriQuint and RF are merging to form an entirely new company. Once the merger is completed, RF shareholders will get one share in the new firm for each share of RF they now own. TriQuint shareholders will get 1.675 shares of the new company for each TriQuint share they own. This will give shareholders of each pre-merger company about a 50% stake in the post-merger company. (Total shares outstanding will be reduced to 145 million, simplifying the structure a bit, but conducting a 1-for-4 reverse split after the new shares have been handed out and the merger completed).
Management-wise, TriQuint CEO Ralph Quinsey will take the company's top job as Chairman of the Board. Immediately below him will be RF Chief Executive Officer Bob Bruggeworth, who will run the new company as its CEO.
Reviewing all of this, Wall Street is voting in favor of TriQuint's side of the merger, and against RF Micro, with Brean Capital upgrading the former today and Canaccord Genuity downgrading the latter. Long-term investors, though, might be advised to consider what the company will look like after the merger -- since that company will be around a lot longer than the two companies that precede it.
So if you take RF Micro and combine it with TriQuint, what do you get? Combined, the new firm will boast about $2 billion in annual revenue and a market capitalization of perhaps $3.8 billion. Valuation-wise, that works out to a price-to-sales ratio of 1.9. (To put that in context, rival Skyworks Solutions (NASDAQ:SWKS) has similar revenues to the two companies that are merging, but a P/S ratio nearly twice as big -- 3.5.)
Profits-wise, it's hard to say how Skyworks' new nemesis will look. Neither RF Micro nor TriQuint is currently profitable, although RF Micro is earning a positive operating profit margin. The two firms say their merger will create $150 million worth of annual cost saving synergies within two years, though. If they're right about that, it would be enough to turn the pair of money-losers into a single firm earning perhaps $90 million in annual profit -- a 4.5% net profit margin.
Of course, Skyworks already earns a profit margin of 16.6%, and doesn't have to go rooting around in its financial innards to dig out hypothetical synergies to do it. Skyworks is also free cash flow positive, generating nearly $400 million in positive cash profits last year -- nearly a third more than it reported as GAAP net income. Give RF Micro and TriQuint credit for the full amount of the synergies they promise, and their free cash flow production might rise to perhaps $140 million on similar revenues.
Long story short, Wall Street can stake out whatever positions it wants on RF Micro and TriQuint. I still say Skyworks Solutions beats them both, together or one at a time.