Nvidia Clears The Last Major Hurdle In The Mellanox Deal

It took longer than expected, but Nvidia (NVDA) announced on Thursday (April 16, 2020) that it finally secured Chinese government approval to proceed with its acquisition of high-speed interconnect specialist Mellanox (MLNX). With that, Nvidia believes they can close the deal in about 10 days (April 27), bringing the company the acknowledged leader in high-speed interconnect for data centers.

From the perspective of someone who has followed Mellanox over the years, I find this a bittersweet development. The $125 per share in cash is arguably nice to have, particularly given the current uncertainties in the market, but as I wrote in other articles, I believe Mellanox could likely have surpassed that value on their own had the deal broken up. Now, though, investors will need to redeploy that cash into other ideas.

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Nvidia Clears The Last Major Hurdle In The Mellanox Deal

Mellanox More Than Biding Its Time Into The Nvidia Deal Close

With Chinese approval of the proposed Nvidia (NVDA) acquisition of Mellanox (MLNX) still an “any day now” event, there’s been no new developments since my last update for arguably the most important driver of Mellanox shares now. I had hoped that approval would come before the Chinese New Year, but that didn’t happen, and with the added issue of the coronavirus outbreak, Mellanox and Nvidia shareholders may have to sit tight a little while longer.

I continue to believe that there’s little long-term risk in playing this opportunity. Yes, I expect Mellanox shares would be weak in the immediate aftermath of a deal cancellation, but with the strength seen in Mellanox’s business lately, investors look likely to come out ahead either way.

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Mellanox More Than Biding Its Time Into The Nvidia Deal Close

Mellanox And Nvidia One Step Closer, But Mellanox Still Fine If The Deal Doesn't Happen

There’s been a meaningful “will they or won’t they” discount with Mellanox (MLNX) shares since the announcement of Nvidia’s (NVDA) offer for the company. While discounts to bid prices are normal, Mellanox had until recently been pretty much stuck in a band between $106 and $115 (below the $125 bid price) as investors wondered and worried if the deal would get all of the necessarily regulatory approvals.

Whether China approves the deal is the big remaining unknown, as Nvidia and Mellanox together will have a significant influence over China’s data centers and AI developments. Likewise, the Chinese government may view the deal approval as a point of leverage in ongoing, often contentious, discussions with the U.S. regarding trade policy (including restrictions on Huawei and on technology sales more broadly. While Mellanox shares would certainly fall if the deal were to collapse, I think support isn’t all that far away and Mellanox could well attract another buyer.

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Mellanox And Nvidia One Step Closer, But Mellanox Still Fine If The Deal Doesn't Happen

Different Mix, Same Results For Mellanox

Weak commentary from Intel (INTC) and Nvidia (NVDA) regarding high-end Ethernet NIC demand from data center customers wasn’t good news, but Mellanox (MLNX) showed again that they can deliver strong growth even in a period of “digestion” for major customers. Mellanox continues to do quite well in the high-end data center market, and I expect 2019 to be another year of double-digit growth with margin improvement. Getting another chance to buy Mellanox in the $80’s would be nice, certainly, but today’s price still offers enough upside to keep this on a buy list.

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Different Mix, Same Results For Mellanox

Xilinx Emerges As A Semiconductor Unicorn And Shivs The Shorts

Not too many semiconductor stocks have reported as of this writing, but with the Texas Instruments (TXN) and Intel (INTC) reports in, it looks like the market's fears of another round of downward guidance revisions for the first quarter are materializing. But then, there's Xilinx (XLNX) - quite possibly a true unicorn this quarter in not only reporting very strong growth (revenue up 34% yoy and 7% qoq) but also guiding UP for the next quarter.

With strong earnings and the 5G opportunity seeming to come through sooner than expected, Xilinx shares shot up almost 20% and set a new 52-week high. Xilinx has a legitimate, differentiated opportunity with its strong FPGA and FPGA/SoC portfolio, including near-term opportunities like 5G wireless and auto ADAS and longer-term opportunities like data center/AI and autonomous driving. Although I think Xilinx can generate double-digit long-term revenue growth and that today's DCF-based fair value isn't unreasonable, it's certainly not an overlooked opportunity at this point.

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Xilinx Emerges As A Semiconductor Unicorn And Shivs The Shorts

A Sell-Off On M&A Noise Is An Opportunity With Mellanox

Seeing the company lose around $400 million in market value upon the announcement of his hiring is probably not the beginning that new Mellanox (MLNX) CFO Doug Ahrens was looking for, but it’s also not all that unexpected, as the shares had been bid up in the hope that a buyout announcement would soon be coming. From my perspective, I certainly don’t think the hiring of a CFO precludes a deal, and I think Mellanox is worth owning deal or no deal – particularly now that the share price is back in the $80s.

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A Sell-Off On M&A Noise Is An Opportunity With Mellanox

Inphi Shares Pricing In Significant Growth In Data Center And Optical

There is a long list of companies in the chip and networking space leveraged to meaningful growth in optical deployments (long-haul and metro) and expanding adoption of higher-speed networking technologies in the data center. Inphi (IPHI) is uncommonly focused on this market; while adoption of 200G and 400G technologies is important to Mellanox (MLNX), Broadcom (AVGO), Finisar (FNSR), MACOM (MTSI), MaxLinear (MXL), and Semtech (SMTC) to varying degrees, Inphi is intensely focused on DSPs, drivers, TIAs, and PHYs used by equipment companies like Cisco (CSCO), Huawei, as well as hyperscale data center customers like Microsoft (MSFT) and Amazon (AMZN), and lacks the diversification of rivals like Broadcom.

There have been more than a few bumps in the road for Inphi, as data center deployments haven’t always matched up with bullish projections, and the company has been vulnerable to volatile spending patterns in markets like Chinese optical deployments. What’s more, the shares aren’t exactly cheap, as they already factor in meaningful revenue acceleration over the next three years and significant margin expansion. While Inphi does have strong technology and engineering capabilities, and I believe there is likely an M&A “backstop” to valuation, the markets Inphi participates in are intensely competitive.

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Inphi Shares Pricing In Significant Growth In Data Center And Optical

Broadcom Beats, But Rebuilding Confidence Takes Time

Short of repudiating the CA (CA) acquisition and announcing a huge buyback, there’s really not much Broadcom (AVGO) could have done with its fiscal third quarter results that would restore enthusiasm for the shares back to its pre-deal announcement levels. And frankly, I’m not sure that would have done it either, as the shares had been trending down since late November anyway.

There are still a lot of positives to the Broadcom story, including a very strong market position in switch silicon, underrated (still) capabilities in heavy-duty AI ASICs, and cash-generating businesses in areas like networking ASICs and enterprise storage. Add in a possibly improving Wireless business and an undemanding valuation, and I believe Broadcom shares still have a lot of appeal. Set against that appeal are the concerns about Broadcom going too far out of its area of expertise with the CA deal and a wider slowdown in the chip space.

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Broadcom Beats, But Rebuilding Confidence Takes Time

Mellanox Looking Like A Multiheaded Growth Monster

A lot of things are starting to go right for Mellanox (MLNX). Not only is Mellanox well-placed to benefit from the growth of high-performance computing demand in general, it is taking share from rivals like Broadcom (AVGO) and Intel (INTC) as customers upgrade beyond 10G Ethernet and now stands to benefit from both reacceleration in enterprise storage demand, but also the commercial ramp of its Bluefield chip. Add in the fact that management has committed itself to significant operating margin improvements over the next couple of years, and I think Mellanox is a rare mix of expanding markets, growing share within those markets, and improving margin leverage.

Although Mellanox does not look all that cheap on an adjusted DCF basis, growth tech stocks rarely do. What's more, operating margin is typically a powerful driver/determinant of multiples for companies like Mellanox, and progress toward a high 20%s operating margin could put a $100-plus fair value on the table by this time next year.

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Mellanox Looking Like A Multiheaded Growth Monster

Broadcom Shares On Pause, But The Business Isn't

I expected some turbulence at Broadcom (AVGO) when I last wrote about the company, and that has indeed been the case, but the shares have held up reasonably well. While the SOX index is pretty much flat since the time of my last article on Broadcom, the company's shares are up close to 5% - more or less keeping pace with the Nasdaq (although the trailing one-year comparisons are much worse). Although the market has been concerned about the company's wireless business, with weak unit volumes at Apple (AAPL) and some share loss to Qorvo (QRVO), the company's wired business is still in fine shape and will likely accelerate as 2018 moves on. I continue to believe that Broadcom is among the better bargains in a sector where most of the cheaper-looking names are "scratch and dent" merchandise with some operational issues.

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Broadcom Shares On Pause, But The Business Isn't

Mellanox Improving Its Execution Just As Another Cycle Seems To Be Ramping Up

Although I suspect that Mellanox (MLNX) management would be loath to admit it, the involvement of Starboard has seemed to light a fire under them with respect to margin improvement and increased candor about the business. The margin improvements are particularly notable, as they have a disproportionate impact on valuation, and it increasingly looks like these improvements are coinciding with another up-cycle in the business. All of that is good news for shareholders, though these shares have had a good run of late relative to the semiconductor sector, and I wouldn't call the valuation strikingly cheap.

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Mellanox Improving Its Execution Just As Another Cycle Seems To Be Ramping Up

Mellanox Pushed Toward Higher Margins, But Ample Uncertainties Remain

Although I've generally been bullish on Mellanox (MLNX) over the last five years, this semiconductor company (and stock) has had its issues, including an apparent unwillingness (or inability) to communicate clearly with investors regarding strategy decisions and priorities. On top of that, the company's R&D-heavy business plan has kept a lid on margin expansion - one of the prime value drivers for semiconductor stocks, and particularly, now as the world seems to think that Broadcom's (AVGO) margin-driven strategy is better than the revenue growth-driven strategies of yesteryear in semiconductors.

While management seems to regard the involvement of Starboard (a noted activist investor) as an unwelcome distraction, the reality is that Starboard is not wrong in taking management to task for the underwhelming stock performance - over the past five years, you would have done far better with Broadcom, Cavium (CAVM), Marvell (MRVL), or even Intel (INTC) than Mellanox. With management paying more attention to margins, the shares actually look a little undervalued now and potentially more significantly so as an M&A play.

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Mellanox Pushed Toward Higher Margins, But Ample Uncertainties Remain

Mellanox Knocked Around, But Definitely Not Knocked Out

It’s not uncommon for elevated volatility and controversy to surround growth stocks, but Mellanox (MLNX) seems to get more than its share. It certainly doesn’t help that the company competes with heavy-hitters like Intel (INTC) and Broadcom (AVGO), nor has it helped that the company’s InfiniBand revenue (once the prime attraction of the story) has fallen off significantly. Add in elevated spending concerns, and it has been a bumpy ride for shareholders.

That bumpy ride has also been relatively productive for shareholders recently. Between a well-known activist shareholder taking a stake and management ratcheting down operating expenses, the shares have shot up this year and finally started outperforming the sector again.

I liked Mellanox back in May of this year, but as things sit today, I think most of the remaining value lies in the extent to which Mellanox attracts solid M&A attention and/or provides credible visibility to renewed InfiniBand growth. The stock price already assumes mid-teens growth in adjusted free cash flow, but a buyout bid would likely start in the high-$60's, if not the $70's.

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Mellanox Knocked Around, But Definitely Not Knocked Out

Turbulence Creates Another Opportunity At Mellanox

If you like to trade, Mellanox (NASDAQ:MLNX) may be the stock for you, as there is more than average uncertainty and volatility around these shares as the company looks to benefit from growing adoption of high-speed connectivity products but also faces competitive threats from well-run rivals like Intel (NASDAQ:INTC) and Broadcom (NASDAQ:AVGO).

Although the company has been on an unfortunate run of weaker-than-expected quarters (and weaker guidance), the shares are still up about 15% from the time of my last article (ahead of Intel, weaker than Avago, and in line with the Nasdaq), and expectations have come down significantly. While the competitive threat of Intel still looks manageable, the last few quarters have highlighted that for all of the growth potential in Mellanox's core markets, that growth isn't going to come in predictable clockwork fashion. While I have gotten a little more cautious with my modeling, I still believe these shares are undervalued even with a double-digit discount rate.

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Turbulence Creates Another Opportunity At Mellanox

Brocade Looks Like Another Typical Broadcom (Avago) Deal

Broadcom (NASDAQ:AVGO) (or more precisely, the company previously known as Avago) knows what it wants in M&A and is not afraid to go for it. Management loves to find companies with few competitors, stable revenue, cost synergy potential, and a product/market assortment that slots in opportunistically with the existing business. So even allowing for an ongoing shift away from fibre channel toward Ethernet, Brocade (NASDAQ:BRCD) checks the boxes that Broadcom looks for and looks like a solidly accretive deal.

The Brocade deal appears to add around $10/share to my fair value estimate for Broadcom, and even if Brocade's fibre channel SAN switch business should suffer even greater erosion from the adoption of Ethernet switches, Broadcom has strong existing products there as well. The biggest downside I see to this deal is that it limits Broadcom's short-term M&A options. A rival bid for NXP (NASDAQ:NXPI) (which was not too likely either way) now seems even less likely and likely so too a bid for a company like Xilinx (NASDAQ:XLNX) that could more meaningfully broaden Broadcom's horizons.

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Brocade Looks Like Another Typical Broadcom (Avago) Deal

Qualcomm Seems Frustratingly Reactive

A little over a year ago, I thought Qualcomm's (NASDAQ:QCOM) valuation was potentially interesting, but I couldn't really recommend the shares due to margin erosion and what I saw as a lack of management initiative to make meaningful changes to grow the business. The shares are basically flat since then, due in part to ongoing worries about market share, pricing, and volume in handsets, as well as a lack of movement on the M&A front.

Really very little has changed regarding my outlook and feelings about Qualcomm. I think management's targets and goals for growth outside of handsets are exceedingly ambitious, and I think the royalty issues could linger on as a perpetual concern. I do find the prospect of major M&A to be interesting (most likely NXP (NASDAQ:NXPI)), though I stand by my comment last year that Nvidia (NASDAQ:NVDA) would have been a better long-term idea. While there is some value here, quite a bit of skepticism, and opportunities to do better, Broadcom (NASDAQ:AVGO) offers similar value and what I believe is a higher-quality business and management team.

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Qualcomm Seems Frustratingly Reactive

Mellanox Is Taking Some Hits, But The Pessimism Seems Overdone

When I last wrote about Mellanox (NASDAQ:MLNX) in March, I ended with the following:

"The good news is that these shares seem to routinely post 25% pullbacks that give patient investors a chance to reload. At this point, I'm more inclined to wait for one of those freakouts than chase the shares today."

Since then, the shares have pulled back a little more than 25%, with a big drop in late April/early May around earnings, a rally, another decline in July/August around earnings, and an attempted rally from mid-August to mid-September that hasn't held.

Nothing much has really changed in how I view (or value Mellanox). Intel (NASDAQ:INTC) is making plenty of noise with Omni-Path, some potential Mellanox customers are adopting it, and that is having an impact on Mellanox. But that was always expected (at least by me) - the bigger question is whether Intel is really changing the game in a more meaningful way, and I don't think that's the case. I believe Mellanox will continue to be volatile, but I still believe in the basic story and that the mid-$50's is a reasonable fair value.

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Mellanox Is Taking Some Hits, But The Pessimism Seems Overdone

Seeking Alpha: Ongoing Execution Will Be Mellanox's Best Argument Against The Bears

If companies like Nvidia (NASDAQ:NVDA), EMC (NYSE:EMC), and Microsoft (NASDAQ:MSFT) are right about the growth potential in high-performance computing, high-end storage, and data centers over the next three to five years, Mellanox (NASDAQ:MLNX) should do pretty well for itself selling its high-end Infiniband and Ethernet connectivity switches, boards, and cables. Intel (NASDAQ:INTC) remains a looming risk with its integrated Omni-Path offerings, but Intel has had its issues before with overpromising what it could deliver with integration, and Mellanox has a pretty solid hold of the high end of the market.

Matters with Mellanox have developed largely in line with my expectations when last I wrote, as 2015 revenue was about 4% higher than I'd modeled, and FCF was about 7% better. I wasn't overly impressed with the valuation then, and the shares did fall about 25% at the worst point, while a strong recent rally has them close to 10% above where they traded back in May.

At this point, I'm still pretty ambivalent on the valuation; I can see outperformance with EZChip integration and cross-selling driving better results, as well as increased adoption of 100G Infiniband, but data center spending can be volatile, and Intel still has enough credibility to be viewed as a serious threat to Mellanox. Double-digit revenue and FCF growth assumptions support a mid-$50s fair value in my model, which isn't enough to get me excited about it as a new buy.

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Ongoing Execution Will Be Mellanox's Best Argument Against The Bears

Seeking Alpha: As Mellanox Scales Up, So Do The Challenges

As picks go, I can't really complain about how Mellanox (NASDAQ:MLNX) has been doing. Up about 45% from when I last wrote about the stock, Mellanox has been executing well on the Intel (NASDAQ:INTC) Grantley-driven high-performance computing cycle, but also doing well integrating itself deeper into markets like high-end storage and cloud/Web 2.0. Mellanox has also continued to broaden its horizons, improving the software capabilities of its Ethernet switch products, introducing additional interconnects, and pushing the frontier on its Infiniband interconnects.

Are there threats? Of course. While QLogic (NASDAQ:QLGC) and Avago's (NASDAQ:AVGO) Emulex may not be threats at the high end, Intel and Broadcom (NASDAQ:BRCM) most certainly are. I believe that Mellanox can continue to find success by pushing the outer limits of available performance, but that runs the risk of limiting the company to specialty/high-end applications. I continue to believe that Mellanox can deliver long-term annualized growth of around 10% and generate significant free cash flow growth, but that potential is not nearly so undervalued as it was about a year ago.

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As Mellanox Scales Up, So Do The Challenges

Seeking Alpha: Brocade On Better Footing, But It Won't Be Getting Easier

A year ago I advised patience with Brocade (NASDAQ:BRCD), as I thought the Street was too bearish on the company's prospects for retaining high-margin SAN business and building up its IP networking operations. While the storage challenges are not going away, the company should be in position to benefit from the growing rift between EMC (NYSE:EMC) and Cisco (NASDAQ:CSCO) and growing deployments of all-flash arrays. On the networking side, the VDX line is doing well and the company is assembling a cogent collection of SDN/NFV pieces, but it remains to be seen if the company can grow share and monetize that opportunity.

With the shares up more than 40% over the past year, I'm calling it a day on the Brocade undervaluation call. Management has done a very commendable job with execution (particularly on margins), but now the questions are shifting more towards the company's real growth prospects and I'm not quite as confident about those as I was on the undervaluation a year ago. There are indeed opportunities for Brocade to outperform, but I need a better mix of growth and value here before getting more bullish.

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Brocade On Better Footing, But It Won't Be Getting Easier