This has been a pretty disappointing year for semiconductors in general, so criticism of underperformance at Marvell Technology (Nasdaq:MRVL) ought to be tempered by that reality. Nevertheless, for a company that needs to prove that it can build strength outside of its traditional hard drive controller business, current trends are not encouraging. Marvell does look undervalued, even based on moderate assumptions, so there's potential here, but that potential is tempered by a risk of the stock languishing due to a perceived lack of growth potential on the Street.
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A Disappointing Step Back in Fiscal Q2
There wasn't a lot to celebrate in Marvell's fiscal second quarter.
Revenue fell 9% from last year, but rose 2% from the fiscal first quarter - coming in about 5% shy of sell-side guesses. Mobile declined 5%, while networking rose 4%. The 7% growth in storage looks reasonable, but is disappointing relative to expectations.
Gross margin weakened sequentially - about 80 basis points by GAAP and 90 basis points adjusted - and here, too, the company missed expectations. Operating income was also disappointing, falling 4% from the first quarter (rising 1% by non-GAAP accounting) and down by more than half (or 41% non-GAAP) from last year.
SEE: Understanding The Income Statement
PCs a Known Problem, but What About Share?
Marvell's storage business is still hugely important, making this quarter's miss even more disappointing. One of the problems here is what you might call a "known unknown" - there have been more than a few rumbles that PC production rates/shipments haven't improved as hoped. That said, the disappointing performance during a quarter where Western Digital (Nasdaq:WDC) did well isn't going to help tamp down the story that Marvell's share at Western Digital is up for grabs.
On a more positive note, Marvell does have a new flash SSD controller in play, and perhaps that can drive share at SSD players like SanDisk (Nasdaq:SNDK) or Toshiba and give the company some much-needed leverage to anticipated ultrabook and tablet growth.
Mobile Not Connecting
In the up-and-down world of mobile and communications infrastructure, nobody should overreact to one bad quarter. Nevertheless, there are reasons to be concerned about Marvell's decision to try to diversify away from hard drive controllers into mobile.
Research in Motion (Nasdaq:RIMM) continues to melt, and the best that can be said about this is that sooner or later RIM is going to be such a small part of Marvell's business that it can't hurt the company any further. Unfortunately, the China opportunity isn't shaping up yet to be all that was hoped, and the combo faces an uphill climb to compete with Broadcom (Nasdaq:BRCM) and Qualcomm (Nasdaq:QCOM) in combo chips.
The Bottom Line
I say this so often that it's practically a mantra by now, but value-inclined investors must appreciate that value-priced tech stocks often languish in the absence of revenue growth momentum and/or optimism about accelerated capital returns to shareholders. I would be surprised if either changed dramatically at Marvell during 2012 - the semiconductor rally just isn't happening (though I expect analysts to come out in October or November with optimistic outlooks for 2013), and I think the company ought to consider using its cash to buy its way into more promising growth markets.
SEE: 5 Must-Have Metrics For Value Investors
Nevertheless, it doesn't take dramatic optimism to suggest that these shares could be undervalued. Project mid-single-digit revenue growth and only very modest incremental free cash flow leverage, and you can arrive at a 10-year free cash flow growth rate estimate of just 3.5%. That sounds weak, and it is, but it's enough to power a fair value in the mid-to-high teens. Now it's certainly true that Marvell's hard drive business could erode and that diversification efforts could fail, making even that growth rate optimistic, but it seems like the Street is already relying on a pessimistic outlook today.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.