Why Analysts Have a Mixed View on the Cavium-QLogic Merger

June 16, 2016 by Jon C. Ogg

approve disapprove
Source: Thinkstock
Cavium Inc. (NASDAQ: CAVM) is buying QLogic Corp. (NASDAQ: QLGC) for $1.4 billion. Cavium’s market capitalization prior to the share drop, often typical of an acquirer, was roughly $2.75 billion.

24/7 Wall St. noticed that Cavium shares were indicated down 14% at $41.20 on Thursday’s early indications. While acquirers often see their stock drop when they announce an acquisition, the reality is that Cavium’s management probably wasn’t expecting such a large drop.

A question comes to mind: do analysts and investors alike hate this merger? The price reaction would indicate that they do. Analyst notes indicate a much more mixed view.

The proposed merger was agreed to by QLogic’s board. What is planned by Cavium is to marry its semiconductor products for intelligent processing for enterprise, data center, cloud, wired and wireless networking with QLogic’s high-performance networking infrastructure solutions. All in all, the reactions have been mixed, even if the downgrades seem to be winning.

Cavium was downgraded to Hold from Buy and the price target was cut to $48 from $61 at Canaccord Genuity. Jefferies also downgraded the stock to Hold from Buy, lowering its target to $45 from $61. Oppenheimer lowered Cavium’s rating to Perform from Outperform, thus removing an upside price target. Pacific Crest downgraded it to Sector Weight from Overweight.

But what about other analysts? There are still quite a few positive ratings intact, with most cutting expectations for how much upside has been seen. Several other calls were seen as follows:

  • Merrill Lynch maintained a Neutral rating, noting that the deal adds defensive accretive earnings while diluting its growth.
  • Brean Capital maintained its Buy rating. While it sees the deal as a positive, it does acknowledge slower growth metrics, and the firm lowered its target to $60 from $67.
  • Morgan Stanley maintained its Overweight rating. Still, it lowered the price target to $55 from $60.
  • Raymond James still has a Strong Buy rating on last look. It lowered its price target to $65 from $75.
  • Wedbush Securities maintained its Outperform rating, but the firm lowered its price target to $51 from $68.

A bit of what was expected to be seen from the merger was outlined by the companies ahead of knowing the reaction. The first item of gain is an opportunity to drive significant growth at scale in data center and storage markets. Another note showed that the companies would get substantial customer and revenue diversification, versus what they have individually. Cavium projected that it would see $0.60 to $0.70 in earnings per share accretion to its calendar year 2017 non-GAAP earnings.

What investors need to consider here is that the pre-reaction price was represented as being QLogic common stock for approximately $15.50 per share. This merger was shown to be comprised of $11.00 per share in cash, and Cavium was also going to include 0.098 of a share of its own common stock for each QLogic share. The pre-reaction transaction valued QLogic at approximately $1.36 billion, inclusive of approximately $355 million of cash that is on QLogic’s balance sheet.

I'm interested in the Newsletter
 

QLogic shares were last seen up 9.9% at $14.89, versus a consensus analyst target price of $13.33 and a 52-week trading range of $8.37 to $15.75.

After about 40 minutes of trading on Thursday, Cavium shares were down 15.5% at $40.58. The stock hit a 52-week low of $39.58, something not very attractive at all, and Cavium’s 52-week high is $77.42. The 15% drop gave Cavium an adjusted market cap of $2.32 billion.

Some mergers are good. Some are not. The initial view here is that the merger may not have been Cavium’s best use of cash. After all, the market is nowhere close to 52-week lows, and hitting a 52-week low often is a wake-up call for management as it means that any new shareholders are now losing money on their investment. Comments from management have been included as well.

Syed Ali, president and chief executive officer of Cavium, said of the deal:

Today’s acquisition of QLogic is highly complementary and strategic to Cavium and it creates a diversified pure-play infrastructure semiconductor leader.

QLogic’s industry leading products extend our market position in data center, cloud and storage markets, and further diversifies our revenue and customer base. In addition to the compelling strategic benefits, the manufacturing, sales and operating synergies will create significant value for our shareholders.

Christine King, executive chairman of QLogic, said:

QLogic with Cavium is a winning combination for customers and employees and is financially compelling for QLogic shareholders. The scale of operations of a nearly $1 billion revenue business will allow the combined company to deliver better solutions for customers and create more career opportunities for employees.

Shareholders will benefit from both the immediate premium, as well as the opportunity to participate in the long-term value creation from the combined company’s strong growth prospects.