M&A Watch: Could Cree Become Buyout Bait? (CREE)

Things have been slowing down at Cree Inc. (NASDAQ: CREE).  The promising field of light emitting diodes, or LEDs, has run into growth problems and oversupply.  Cree also makes silicon carbide based diodes for power control and makes wafers for communications, but it is the LEDs market which many investors are focusing on for the company’s lifeblood.

It was just last summer when the growth trends finally started to show breaks and we have seen two such instances where the expectations ahead have taken the life out of Cree shares. At $45.60, its 52-week trading range is $42.76 to $83.38 and its market cap is still about $5 billion.  

This morning came news that Cree and Osram GmbH signed a worldwide patent cross-license agreement to speed up the adoption of LED lighting.  The cross-license agreement covers patents owned by each company in the fields of blue LED chip technology, white LEDs and phosphors, packaging, LED luminaires and lamps, and LED lighting control systems.

What we cannot avoid considering is when or if Cree could become the target of an acquirer.  Admittedly, it is very hard to go from a massive growth stock to a buyout stock just on share price performance.  In the tech sell-off of late-2008, Cree shares got almost as low as $15.00.  They peaked north of $80.00 last year and shares are still well under $50.00 today.  Back during the 2000 tech bubble, shares were briefly north of $90.00 at the peak and its shares split three times from 1995 to 2002.  Cree could ultimately find itself as the target of a suitor.  Keep in mind that “Ultimately” is a far cry from immediately.

Another issue is valuation.  A larger buyer would likely have to be able to milk out more profits and more synergies than Cree can do just on its own.  The earnings from Fiscal June-2010 operations were $1.71 EPS, and earnings estimates have come screaming down in the last few months.  Now we have earnings Thomson Reuters estimates of $1.82 EPS for fiscal June-2011 and $2.04 EPS for fiscal June-2012.  These estimates were $2.36 EPS for 2011 and $2.69 EPS for 2012 before its latest earnings warnings.  Still, the stock trades today at about 22.5-times 2012 earnings expectations and that is without considering even a 1% premium from any sort of merger offer. 

With revenue expectations at about $988 million for 2011 and almost $1.2 billion for 2012, this pre-premium valuation today is still more than four-times next-years expected revenues.  That is not super expensive on revenue multiple comparisons, but a conglomerate or a different shrewd overseas acquirer cannot afford many acquisitions out there at 22-times forward earnings.  Still, Thomson Reuters has a consensus price target north of $58.00 today.

Cree is one of those companies that can go it alone or it could seek an exit via a sale.  Finding a buyer at current prices will not be an easy feat.  Either the shares have to stagnate and earnings have to catch up or investors have to hope that some larger buyer can milk out more synergies and cost efficiencies than Cree can on its own.

The good news about our own analysis is that it is simply raw data.  If you back out the $1.1 billion in liquidity (cash and short-term securities) and factor in that there is hardly any long-term debt, the forward multiples begin to look much more reasonable. 

Cree could find itself as a target in a merger down the road.  Perhaps the biggest issue is that for a deal to get approved it needs to see a further rotation of shareholders who own this one at lower prices than the existing shareholder base.  That would be the only real hope of a deal getting shareholder approval.

It would be very rare for a major growth company with a bruised share performance to suddenly attract a buyer in a deal that could easily be approved with a shareholder revolt.  For now, investors have to evaluate Cree on its own metrics for a long-term thesis rather than as a company which is likely to attract a buyer in the short-term. 

JON C. OGG