The market may not be willing to value semiconductor stocks at the same rate as just a year ago, but industry insiders have no such problem. Broadcom (Nasdaq:BRCM) announced a deal for high-performance processor company NetLogic (Nasdaq: NETL) on Monday that gives the selling shareholders a premium valuation that accounts for a lot of the growth potential of the company.
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Broadcom announced that it will pay $50 a share, or $3.7 billion in total net cash, for the shares of NetLogic. That is a 57% premium to the Friday closing price of NetLogic, as well as a price that exceeds NetLogic's all-time high and roughly matches the high watermarks for price-sales valuation.
NetLogic has generated a little more than $400 million in revenue over the past year, with a trailing growth rate in the high single digits. That may not sound so impressive, but that has been accomplished in an environment where end-use customers like Cisco (Nasdaq:CSCO), Juniper (Nasdaq:JNPR), and Alcatel-Lucent (NYSE:ALU) have seeing some pretty tough markets. While the three to five year growth rate estimates provided by sell-side analysts are near worthless, the fact remains that the sell-side community expects NetLogic to grow at a high-teens clip for several years (and the valuation suggests similar, or greater, expectations from the buy side).
What Broadcom Is Getting
Broadcom is shelling out a lot of good money for this deal, so what exactly is the company getting for it?
NetLogic makes a variety of high-end chips - multi-core processors, knowledge-based processors, and low-power embedded processors - that are designed into network products like switches, routers, security and storage appliances and wireless infrastructure products like base stations. With this deal, then, Broadcom significantly increases its exposure to network infrastructure and data centers, as well as becoming more of an end-to-end communications chip provider.
Said differently, Broadcom will now have chips that go into the Alcatel, Ericsson (Nasdaq: ERIC) or Huawei base station, the Cisco or Juniper network, and the end-user Apple (Nasdaq: AAPL) iPhone.
Less Concentrated, But Still Focused
NetLogic has done a good job of diversifying its client base. Cisco is still more than a 20% customer as of the last quarter, but it used to be roughly three-quarters of company sales. Alcatel is also a sizable customer and Huawei and ZTE combined make up about one-quarter of sales.
While management has done a good job of reducing single customer reliance, there is still a great deal of overall exposure to the networking/data center market and that is a risk factor. It may also play a part in why management decided to sell - large rivals like Intel (Nasdaq: INTC) have the resources to weather market downturns without needing to worry about cash flow or cutting back R&D.
Broadcom clearly has its eye on becoming a diversified chip company, which is likely a good move if the company has ambitions of remaining independent and competitive for the long haul. In the meantime, this deal may put NetLogic's rivals and peers in play as well.
Freescale (NYSE:FSL), Cavium (Nasdaq:CAVM), and PMC-Sierra (Nasdaq:PMCS) are roughly similar in size (though not identical in products/markets) and could be attractive me-too candidates if a company like Qualcomm (Nasdaq:QCOM) decides that it needs to make a move as well. Likewise, smaller companies like Applied Micro Circuits (Nasdaq:AMCC) and Vitesse (Nasdaq:VTSS) will probably see a "me too" trade on Monday, but their size and market positioning make them less likely to be the targets of a major bid.
The Bottom Line
With Cisco having a lot of internal issues to work through, and likely not handling as much internal chip development, Broadcom could definitely make some hay with this deal. Of course, for the price that the company is paying, they pretty much have to or it will go down as a silly waste of shareholder capital.
Chip investors should also take some solace from this deal. With companies like Texas Instruments, Intel and now Broadcom doing deals in recent months, it is pretty clear that the large chip companies view the current downturn as just one of those lulls that goes with being in the business. Accordingly, it still seems like a reasonable move to spend some time sifting through the wreckage and buying the beaten-down shares of good chip companies. (For additional reading, take a look at A Primer On Investing In The Tech Industry.)
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