Thursday, November 29, 2007

Marvell Technology (MRVL) Valuation

Marvell (MRVL) management, employees and long-term investors were probably shocked by the huge drop in the stock price yesterday, the day following release of Q3 data (really fiscal Q3 2008, the 3 months ending October 27, 2007). While there are specific reasons that make a valuation of Marvell's stock widely open to interpretation, for the most part the drop reflects Wall Street trading program and analyst focus on short-term profits being mismatched with Marvell's strategy for long term growth.

I'm assuming you've have some background on Marvell Technology, which I've followed for a number of years and which I own stock in. If not you might want to check the following before reading further:

my Marvell page at Openicon (which has links to my prior articles on Marvell and to my summaries of Marvell analyst conferences).

No one is disputing, now, that Marvell is able to grow very quickly, both growing its interal divisions and by making strategic acquisitions. Q3 revenues were $758.2 million, up 15% sequentially and 46% from the year-earlier quarter. They were also well above guidance management gave at the beginning of the quarter. That is exceptionally fast growth for a company of Marvell's size. But it is just getting back to trend for Marvell. Here are annual revenue figures for the past few years:

2002 $505 million
2003 $819 million
2004 $1,224 million
2005 $1,670 million
2006 $2,238 million

The current annual run rate is $3,032 million. Call that $3 billion. Six times 2002 revenues.

But where's the beef? Using GAAP Marvell lost $6.4 million in Q3. And I like to use GAAP. On the other hand I like companies that make short-term sacrifices in order to be able to dominate an industry in the long run. The semiconductor chip industry is very diverse. What Marvell has done successfully is pick an area, become dominant, then pick a new area (or two or three) to compete in. Marvell always starts at the high end of the markets it chooses, introducing revolutionary technologies. Then it gains market share as these technologies spread to the middle market and then to the low-priced market segment.

Wall Street is mad because Marvell invests a lot of money in research. Not me. This investment is going to bear fruit.

Unless we enter a global recession 2008 is going to be a year of good profitability, on top of continued revenue growth, for Marvell. Here's why.

First, the profit figure is not as bad as the GAAP figure indicates. Marvell also released a non-GAAP figure, which was a Q3 profit of $86.2 million. This figure eliminates (from the GAAP numbers) $37 million in amortization expense and $56 million in stock-based compensation expense, which is a non-cash expense.

Well, GAAP requires stock-based compensation to have a $ equivalent because it dilutes shares. It is non-cash, and I believe in giving employees a stake in the company. The amortization expense is real too.

Keeping that firmly in mind, nevertheless on a cash basis Marvell was up $33 million. So they are cash flow positive. They also increased inventories in line with business to the tune of $85 million.

Going forward, Marvell announced a decrease in headcount of 400 workers or 7% of the workforce. In Q4 there will be a $8 million one time charge and about $4 million of benefit. In Q1 benefit shoud rise to around $10 million.

In addition, revenues (which are somewhat seasonal in semiconductors) should rise at least $30 million in Q4, which was management guidance. With operating expense being held nearly flat, and cost of goods sold should increase less than $15 million, a good guess is that net income will icnrease by about $15 million.

So at very least I expect GAAP net income to be in the black in Q4, with rapid acceleration upward after that.

There are a number of other factors that should accelerate profit growth. One is that the former-Intel application (cell phone) processor division's costs are set to go down as Marvell will no longer have to buy the processors from Intel at contracted prices. Instead they will be made in an Asian fab, which has already made sample chips and will be gearing up in 2008.

Marvell Technology has also had a large number of design wins that are going to ramp up revenue in 2008. They have introduced advanced video processing chips that will go into an increasing number of flat panel displays. They also announced breakthroughs in a Green technology for analog power supplies that are the result of 5 years of research and development.

Marvell could please the nearsighted wage-slave analysts of Wall Street by drastically cutting back on research and development ($252 million in Q3) and just marketing the hell out of the technologies they already have. Short-term traders would love that. But with a $3 billion revenue run rate, $1 billion a year in R&D begins to look reasonable. If Marvell cuts back R&D slightly and hits a $4 billion a year revenue run rate by the end of 2008, everyone will be heaping praise on CEO Sehat Sutardia and his team for their wisdom and perseverance.

All stocks are risky. At $15 a share today, I don't think Marvell has much risk left in it, aside from macroeconomic risk, but always diversify your portfolio and remember, if you don't buy low you can't sell high.

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