10/31/18 11:30 AM EDT
STOCK REPORT: MICROCHIP TECHNOLOGY (MCHP)
Takeaway: We added MCHP to Investing Ideas on the short side on 10/17.
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THE HEDGEYE EDGE
Microchip isn’t Microchip anymore. You can’t own Microchip Technology (MCHP) for industrial HPA like performance with organic growth, singular focus on share gains in large markets, and innovation curves that continue to prove out.
The organic share gains are done, the second biggest revenue category is a creation of Analog Frankenstein that doesn’t grow much, and Microsemi Corp (MSCC), now at ~30% of revenue, will be dilutive to the growth rate of the entire entity. The long game of fixing vertical analog product inside a general purpose company is not a no-brainer fix and maybe hasn’t really been done successfully in the past. Investing, healing, and re-growing individual product lines wrapped up in the MSCC mess will take some time. In addition, capital intensity and taxes seem to remain as surprise factors.
The nose dive implied here is a shift of investors who used to own MCHP as a proxy for LLTC, knowing that cash flow would come their way in increasing ways (via dividend) and that they could confidently buy short term inventory led equity value contractions. But they can’t own MCHP for those things anymore as MCHP downshifts growth rate, mix of businesses, balance sheet, and strategy into a ‘tier 2’ type category more exemplary of ON Semiconductor Corp (ON), STMicroelectronics (STM), and NXP Semiconductors (NXP).
INTERMEDIATE TERM (TREND)
The June quarter was the first negative year-over-year volume growth print in a long time after a healthy cycle suggesting a classic post cycle peak is now in the rearview. Management is now tempering outlook expectations, which typically takes 2-3 quarters to sort through to lower EPS with gross margin compression inevitably realized last.
Furthermore, a new lawsuit was filed (see filing HERE) by the former CEO of Microsemi Corp, which Microchip Technology acquired earlier this year. Details of spurious distributor programs, channel stuffing, and a failure by MCHP execs to access major sections of information in the data room during the due diligence process creates an open invitation for lawsuits against MCHP (if true).
Essentially, the plaintiff is claiming that the surprises that MCHP have been discussing in earnings calls, were all there in plain sight, if only MCHP had actually performed normal due diligence.
Microsemi’s trailing 5 year revenue CAGR is in the -1% to +1% zone. However, if we read MCHP CEO Steve Sanghi’s comments right, and if we read Jimmy P’s unwitting confessions right in the defamation lawsuit, even this putrid growth rate was over-stated thanks to creative inventory programs with distributors which unnecessarily extended weeks of inventory in the channel.
Depending on which MCHP comment is most relevant, management has talked about 1.5+ to nearly 3 months of excess channel inventory, which might imply something like a half-week to one week of extra shipment per year, or a 100bp to 200bp growth adder per year…oh boy.
The defamation lawsuit is bad news for both Jimmy P/MSCC as well as Steve/MCHP. The ongoing disclosure and legal tit for tat only helps the Shorts as more disclosure, in this case, as well as allegations of securities fraud, may rise in volume in the headlines. Jimmy P’s conspiracy theory is not totally without merit. What if Steve is removed from his position? This does not end well.
We think there is still an additional -25+% downside from current levels.
ONE-YEAR TRAILING CHART