It is no longer a secret that the world tied to semiconductors has been consolidating into larger and stronger companies. The wave of chip-sector mergers reached a zenith in 2015 and 2016, and some investors and analysts have speculated that even more semiconductor mergers and acquisitions seem likely in the year or years ahead. Could Xilinx Inc. (NASDAQ: XLNX) find itself as the next major technology merger play?
Credit Suisse’s John Pitzer has issued an analyst upgrade on Xilinx, raising the official rating to Outperform from Neutral and raising its target to $70 from $65 — up some 21% from the $57.96 prior close. This $70 target was almost $10 higher than the consensus analyst price target from Thomson Reuters, and it now matched the highest analyst price target on Wall Street.
What should stand out the most here is that analysts in general are quite negative when it comes to Xilinx. Monday’s report showed that only about 25% of analysts rate Xilinx with an Outperform/Buy bias.
While Xilinx was more tightly tied to PC and other markets around the catch-all programmable logic segment in years past, it is now targeted into multiple core growth markets in the chip space. It is into responsive and reconfigurable vision systems, machine learning, connected devices, 5G wireless solutions, immersive displays, the industrial Internet of Things, cloud computing and more.
Could all this boil down to Xilinx being the next big chip sector merger candidate? Before knocking this, know that Xilinx was considered to be a buyout candidate in years past. In fact, some old merger rumors and speculation in this name date back into the late 1990s. Credit Suisse also brings up the possibility of this ahead.
Monday’s upgrade was based on Xilinx’s structural acceleration leverage, signaling that the company is at an important multiyear inflection point. Pitzer noted that since 2010, revenue has been flat while operating expenses rose about 25%. This was handily under peers in the semiconductor space.
The report noted how difficult comparisons after the 3G build-out in China, accelerating R&D burdens to support node migrations and new markets (ADAS, AI) have all driven years of negative leverage. What is more important than the past is that Pitzer believes that those old negatives are starting to reverse. He sees growth acceleration in data center efforts and in and 5G trials coming soon. These could help to push revenue growth to high single-digits over the next several years — and that is above the consensus estimates on Wall Street.
Pitzer noted that Xilinx is at an attractive entry points with several catalysts. It has underperformed the SOX sector itself so far in 2017 and is at a 10-year low versus sector valuations. Xilinx analysts look at it as the least favorable rated stock in the firm’s coverage universe as well. They believe the valuations simply do not reflect future growth potentials. Another coming catalyst is that Xilinx is set to host an analyst day on May 22 in New York.
Before getting all hopped up on this as an earnings play, note that Pitzer did warn that second-quarter expectations are muted:
We are not making a call on the quarter, but a risk to our upgrade is recent weak China Wireless CapEx, which has biased sentiment negative and Street estimates have declined 3% in recent months despite China Wireless being approximately 5% of revenues and Industrial/Auto (two areas of strength) at approximately 35%. For a sector where investors expect beat/raise, for Xilinx an inline C1Q/C2Q would be a beat. In addition, we expect Xilinx to provide FY18 revenue and operating expense guidance, which should point to operational leverage, a reversal of FY-2017 trends. Lastly, the street is over-modeling share count by about 14 million, which could be roughly 5% accretive to street consensus.
Credit Suisse went into detail about the valuation for Xilinx being cheap relative to its peers. Pitzer addressed a potential for M&A, and he said:
Xilinx currently trades at a ~15% premium to historic levels on NTM EV/FCF, albeit a ~11% discount to Semis (group includes ~55 Semi companies). The relative downturn starting in Feb16 was a fair response to (1) an upturn that was primarily driven by wide-spread speculation of M&A interest in Xilinx, (2) structural concerns on the lack of Rev growth accompanied by outsized OpEx growth – a phenomenon specific to XLNX and not experienced by peers, and (3) emerging concerns as Xilinx valuation rose to a premium relative to Semis in late CY15/early CY16. However, we would argue that concerns around historic multiples are partially unjustified as Semi multiples in general have been expanding, albeit for better reasons than Xilinx. Specifically, Semis trade a ~18.5 EV/FCF, a ~17% premium to the historical median of 15.8x. As such, we believe relative valuation is more important than historic valuation – and would highlight that Xilinx trades at a ~11% discount to peers, below the 5-yr median of ~6%.
Xilinx shares responded positively along with a strong market on Monday. Its shares were up 4.5% at $60.30 in mid-Monday trading. Its 52-week trading range is $41.53 to $62.24.
One more consideration is that Xilinx was not even a $15 billion stock based on Friday’s closing price. At the end of 2016, Xilinx had almost $1 billion in long-term debt and it had better than $3.25 billion in cash and short-term investments.
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