LSI Corp. (LSI) is a great case study of how low valuations can go for a company with favorable long-term trends, but also a lot of fires in the kitchen.
LSI’s merger with Agere Systems (which just closed a few weeks ago) is proving itself to be drastically ill-timed, as Agere warned in March that first quarter sales would be down 12% sequentially from the December quarter.
This merger of “unequals” consists of an LSI that turned its first net profit in 5 years during 2006, and an Agere that turned its first operating profit ever last year. The 1st quarter earnings report (which was sans Agere results) offered weak guidance, with management predicting a loss of ($0.49) to ($0.40) in the 2nd quarter and meager profits for the full year.
And with so much of the $4b merger purchased with LSI equity (379 million shares were issued to fund the purchase), shareholder value has been massively diluted in the past year.
LSI shares currently trade for $8.55, down over 15% in the past month, and yes, still down nearly 80% from its bubble peaks. Agere shareholders – most of them utterly disappointed with their own stock’s performance in the past few years – probably took the 28% purchase premium as a welcome exit strategy, and have put a ton of selling pressure on LSI shares.
Two of LSI’s three business segments are facing hard times; Seagate (STX) is one of their largest customers and faces both a price war and weakening PC demand in the hard drive segment. LSI’s consumer chip business is being hamstrung by weak mobile phone sales and a lack of tier-one customers.
Both the networking and consumer segments are up for “strategic review” by the company, meaning both are on the hot seat and could be divested. The current environment wouldn’t be the most favorable to sell into, and LSI would be better served by holding out until the latter half of the year when tech spending is expected to pick up.
LSI’s storage business, on the other hand, appears well-positioned, with room to gain market share (LSI’s share is consistently in the 20’s across its business lines). SAS controllers are winning gaining a large fan base to the tune of IBM and HP, and LSI is also gaining share in the small and mid-size business markets.
With the assets of Agere now under LSI’s belt, expect to see the combined company really try to torque value out of Agere’s intellectual property assets. Abhi Talwaker, CEO of LSI, has stated outright that Agere’s IP portfolio was one of, if not THE key to deciding to pursue the company. For a first move, Agere went for a fastball, challenging Microsoft’s (MSFT) VoIP technology in a nasty legal filing made mid-March.
I am a big believer that intellectual property is going to grow into a market lifeblood down the road; it just might be the last technology battleground. But there will be winners (like QCOM) and losers (very large graveyard). Agere is the former brain repository of Bell Labs, which give Agere as much “street cred” as anyone in terms of valuable IP.
It wouldn’t be surprising to hear about some job cuts, as LSI expects to realize about $125 million in cost savings from the merger – and it’s pretty hard to do this without some reduction in the payrolls. Also, it is of utmost importance for LSI to solidify its cash flow; they are undercapitalized and in need of a stronger cash position to really drive production growth for the remainder of the decade. Even to get favorable debt terms (they have less than $500 million currently) LSI will have to show some kind of consistent cash flows.
While the target is moving fast, earnings estimates currently call for a rebound in the second half on higher PC demand and increased tech spending. The midpoint of full-year EPS estimates is $0.28, with revenue of $2.72 to $2.95 billion expected. For 2008 the EPS estimates jump to $0.51, giving a forward multiple of 17.1 times.
That valuation by itself is nothing special, but with so much of the operating costs up in the air, earnings aren’t the best metric at our disposal. A look at the trailing price/sales ratio shows LSI going for just 1.2x sales, very favorable when compared with industry averages for semiconductors at more than twice that. Somewhere around here is likely a floor on the stock, where it will likely sit, highly leveraged to both the health of the corporate customer and the advancement of intellectual property rights and precedents.
Ryan Barnes
April 30, 2007
Ryan Barnes can be reached at ryanbarnes@247wallst.com; he does not own securities in the companies he covers.
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