It's hardly news to say that Wall Street plays favorites and in doing so sometimes goes well past the bounds of reality with respect to a company's real underlying value. For every ARM Holdings (Nasdaq:ARMH) or Analog Devices (NYSE:ADI), there seems to be at least one undervalued company. The question for shareholders is whether Marvell (Nasdaq:MRVL) deserves to be included in that latter group. While the valuation seems quite undemanding, this company still has a ways to go to convince investors that it still has the competitiveness and the business model to drive better long-term results.
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Another Solid Quarter
Two quarters proves almost nothing, but at least Marvell has logged another solid positive quarter, and at a time when many other chip companies are struggling to make their numbers. Even so, the results are not exactly great in an absolute sense.
Revenue fell 8% from the year-ago quarter and 5% from the prior quarter, though that was good enough for a nearly 2% beat relative to the average Street estimate. Storage led the way with 9% revenue growth (and flat sequential performance). Mobile and wireless revenue dropped 42% and 24%, respectively, while networking was flat and down 2%.
Margins were better than expected, but sustainability may limit investor enthusiasm. Gross margin improved slightly from the year-ago level and beat estimates by about 160bp on a better mix and one-time benefits (namely, selling previously written-down inventory). Operating income fell by more than one-third, but beat the average estimate by more than 20% and the operating margin was two points higher than expected.
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Storage – Winning In A Down Market
There's really no good news in the company's core storage market. Whatever the reason (some are blaming Microsoft's (Nasdaq:MSFT) Windows 8), PC shipments remain very weak, and that is limiting underlying demand for hard drive controllers. Countering that, the company is seeing market share growth (at LSI's (Nasdaq:LSI) expense) and the company's ramp at Seagate (Nasdaq:STX) could support above-market results in storage for a little while longer.
Looming over this is the company's ongoing legal battle over IP infringement. Carnegie Mellon University has sued the company for infringement and won the initial ruling. Marvell will appeal this verdict to the hilt, which means further wrangling over both the outcome of the case and the final damages. While the initial benchmark ruling would have Carnegie Mellon getting nearly $1.2 billion and a royalty payment of $0.50 per controller (a fairly sizable piece of the ASP), the university has argued that it should receive treble damages due to willful infringement by Marvell. I won't pretend to have enough legal knowledge to handicap the outcome, but I will say it will likely be some time before this matter is resolved.
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Wireless Certainly Worth Watching
Mobile and wireless revenue plunged this quarter in large part due to a faster decline in the sales of BlackBerry's (Nasdaq:BBRY) BlackBerry 7. Management expects a meaningful turnaround in the next quarter, though, as new design win launches start translating into revenue.
I will be very interested to see how the company fares in the mobile space over the next couple of years. The company has excellent share in TD-SCDMA, and various design wins could give the company as much as $10 to $15 in content per handset in China. My question is how the company manages the competition – Qualcomm (Nasdaq:QCOM) and Nvidia (Nasdaq:NVDA) are shooting for the high end, while Spreadtrum (Nasdaq:SPRD) and MediaTek threaten the mid- and low-end markets and MediaTek is already gaining share with its low-speed quad core chips. My concern is that Marvell isn't particularly well-suited to win either battle (features v. low-cost) and may see faster than expected share erosion.
The Bottom Line
On one hand, Marvell has shown that it can still grow its share in the storage controller market, while also establishing solid market share in areas like mobile baseband and network processing. On the other hand, Marvell has shown itself to be slow in diversifying its business and preparing for the generational shifts in technology in its core markets. To that end, Marvell has seen revenue and margins decline over the past three years while rivals like LSI and Qualcomm have seen improvements.
I'm projecting long-term revenue growth of just 3% for Marvell, well below what I project for rivals like LSI, Qualcomm, and Broadcom (Nasdaq:BRCM). I also expect the company's free cash flow (FCF) margin to be lower over the next 10 years than it has over the past 10, leading to free cash flow growth of just 2%. Even so, those numbers suggest a fair value of almost $15 (excluding the potential payout to Carnegie Mellon, which would reduce the value by almost $2.50 if damages aren't trebled). Against a share price of roughly $12, that's at least enough to make Marvell worth a closer look. I'm more inclined to go with Broadcom, Qualcomm, Nvidia, or LSI today, but I'm willing to acknowledge that expectations are low enough here that financial outperformance could still mean a great deal to the stock price.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.