(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of SWKS.)

Chips stocks are soaring after Broadcom Ltd. (AVGO) made an unsolicited offer to acquire Qualcomm Inc. (QCOM) for $103 billion, or $70 per share. The bid is sending shares of the group higher, with the iShares PHLX Semiconductor ETF (SOXX) rising by over 1 percent, while several chipmakers increased by more than 2 percent.

Broadcom's bid could lead to the next round of M&A activity in the space, driven by economies of scale and the need to get larger to continue to compete. At the very least, the news is helping the market to re-value the sector.

Companies such as Skyworks Solutions Inc. (SWKS), Qorvo Inc (QRVO), and Cypress Semiconductor Corp. (CY) are all rose more than 2 percent in early trading following news of the proposed merger.

More Mergers 

Another company in potential M&A talks is Marvell Technology Group (MRVL), whose shares are surging by nearly 9 percent after reports surfaced late Friday that it's considering merging with Cavium Inc. (CAVM), creating a combined company worth $14 billion. 

Valuations

Companies like Skyworks, Qorvo, and Cypress trade at reasonable valuations, with one-year forward P/E ratios in the 12 to 15 range that are certainly not stretched. A merger with any of these three companies could bring another layer of growth to some of the more prominent players. 

SWKS PE Ratio (Forward 1y) Chart

SWKS PE Ratio (Forward 1y) data by YCharts

Growth Component

Analysts expect Skyworks to grow earnings by roughly 14 percent in 2018, while Qorvo is expected to increase its profits by approximately 18 percent. Cypress is expected to grow its earnings by nearly 40 percent in 2018, based on data from YCharts.

The valuations of these companies, given the projected annual growth for 2018, would be compelling for any corporation looking to acquire them. 

Revaluing The Sector

Whether acquisitions happens or not, Broadcom's surprise bid helps give a metric on how to value the other companies within the group. At $70 per share, Qualcomm would be valued at nearly 20 times 2018 earnings estimates.

You can see that shares of the other chipmakers are currently valued at levels well below the proposed valuation of Qualcomm. At a valuation of $103 billion, Qualcomm would trade at roughly 4.5 times 2018 sales estimates. 

This suggests that some of these other companies could be worth significantly more because they are trading at steep discounts. The companies do not even need to see a full valuation equal to that of Qualcomm to see multiple expansion. 

Broadcom's bid to acquire Qualcomm could ignite a round of mergers in the chipmaker space. Or, at the very least, it may lead investors to conclude that some of the companies may be undervalued. (See also: Broadcom's Raised Forecast Is Great News For Chip Stocks.)

 

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdingsInformation presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.

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