LATTICE SEMICONDUCTOR CORP LSCC S
September 25, 2017 - 12:53pm EST by
of21
2017 2018
Price: 5.25 EPS 0.15 0.25
Shares Out. (in M): 126 P/E 35 21
Market Cap (in $M): 663 P/FCF N/A N/A
Net Debt (in $M): 212 EBIT 39 48
TEV ($): 875 TEV/EBIT 22 18
Borrow Cost: General Collateral

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Description

Recommendation: Short Lattice Semiconductor (“LSCC”, “the Company”, or “Lattice”) as 2018 estimates will be difficult to achieve and are ~60% above current run-rate EBIT

On November 3, 2016, Lattice announced an acquisition agreement with Canyon Bridge, a Chinese private equity firm, at $8.30/shr. On September 13, 2017, President Trump blocked the deal after a lengthy CFIUS review. Lattice provides field-programmable gate array (“FGPA”) and application specific standard product (“ASSP”) semiconductors to customers in a variety of end markets. Lack of management and investor engagement during this lengthy process has led to stale estimates and a lack of appreciation of several non-recurring or rapidly declining programs that benefitted trailing twelve-month financials but will fall away on a going-forward basis.

Against trailing twelve-month revenue of $430mm and management quarterly opex targets of $40mm, consensus estimates and the implied valuation (~11x EBIT) look reasonable. However, as noted above reported financials reflect a number of non-recurring or rapidly declining revenue streams. True going-forward revenue and EBIT adjusted for these items (even reflecting management’s large $15mm share based compensation ad-back) are closer to $370mm and $48mm putting the current valuation at 18x EBIT. This contrasts with consensus estimates of $426mm in revenue and $77mm in EBIT for 2018.  The table below includes each of the necessary adjustments by business line.

Mobile and Consumer revenue includes legacy FGPA sales from the iPhone 7, which will taper off as Apple begins its upcoming product cycle. Lattice components had not been included in any previous iPhones prior to the 7 and teardowns of the recently released iPhone 8 do not include any Lattice content.

Industrial and Automotive revenue includes one-off shipments related to a “programmable logic device ("CPLD") conversion program, for which shipments predominantly occurred in fiscal 2016 but did not recur in fiscal 2017.”

Licensing and Services revenue includes $18mm of non-recurring patent sales. These particular sales are lower margin than the Company’s remaining licensing revenue. We have reflected this in the assumption that licensing gross margin expands from 89% to 98%. On the positive side for Lattice, 1H’17 results do not include any revenue from the HDMI royalty sharing agreement. A new agreement is currently being negotiated and we expect one will be successfully negotiated, but at a lower share to LSCC. LSCC’s royalty share has been declining (24-25% in 2015 went to 20% in 2016) and the Company stopped acting as agent (responsible for promoting and administering the specification) at the end of 2016. The pro forma estimates reflect these puts and takes.

In addition to these shorter-term headwinds, the Company’s business has been in decline for a number of years. Lattice acquired Silicon Image in March 2015 for $444mm. At deal announcement, pro forma revenue was $625mm. Pro forma revenue since then has declined at a 13% CAGR.

At a generous 13x (Canyon Bridge’s acquisition offer implied ~12x management bull case 2017 EBIT) our run-rate EBIT estimate, fair value is ~$3.30/shr or >35% below the current price.  

 

Clearly, a key risk is another acquisition offer. However, we believe the likelihood of an offer at a meaningful premium to the current price is low. Given President Trump’s actions, we think most potential Chinese acquirers -- which make up the majority of the universe of potential buyers -- would be precluded from future offers. Furthermore, strategic interest outside of China was limited in the prior process. Only one US party submitted an offer, “Party L” and this party’s offer was “at a significantly lower price than the offer from Canyon Bridge.” Cypress Semiconductor has also been a rumored buyer in the past but despite an approach by Lattice during most recent process did not submit an offer. Lastly, Lattice’s financial results have drastically underperformed the proxy projections provided in the fall of 2016. At that time, management was projecting EBIT between $86-107mm and $101-119mm in 2017 and 2018, respectively. In contrast, the Company looks to be on track to report ~$40mm of EBIT in 2017 and modestly more in 2018.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Rebase of expectations and estimates. Management is holding an investor event on October 12th. They have been promotional in the past and tend to stick with aggressive forecasts (which they later miss) so it is unclear if they will use the investor event to rebase expectations or simply let them bleed lower over time.

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    Description

    Recommendation: Short Lattice Semiconductor (“LSCC”, “the Company”, or “Lattice”) as 2018 estimates will be difficult to achieve and are ~60% above current run-rate EBIT

    On November 3, 2016, Lattice announced an acquisition agreement with Canyon Bridge, a Chinese private equity firm, at $8.30/shr. On September 13, 2017, President Trump blocked the deal after a lengthy CFIUS review. Lattice provides field-programmable gate array (“FGPA”) and application specific standard product (“ASSP”) semiconductors to customers in a variety of end markets. Lack of management and investor engagement during this lengthy process has led to stale estimates and a lack of appreciation of several non-recurring or rapidly declining programs that benefitted trailing twelve-month financials but will fall away on a going-forward basis.

    Against trailing twelve-month revenue of $430mm and management quarterly opex targets of $40mm, consensus estimates and the implied valuation (~11x EBIT) look reasonable. However, as noted above reported financials reflect a number of non-recurring or rapidly declining revenue streams. True going-forward revenue and EBIT adjusted for these items (even reflecting management’s large $15mm share based compensation ad-back) are closer to $370mm and $48mm putting the current valuation at 18x EBIT. This contrasts with consensus estimates of $426mm in revenue and $77mm in EBIT for 2018.  The table below includes each of the necessary adjustments by business line.

    Mobile and Consumer revenue includes legacy FGPA sales from the iPhone 7, which will taper off as Apple begins its upcoming product cycle. Lattice components had not been included in any previous iPhones prior to the 7 and teardowns of the recently released iPhone 8 do not include any Lattice content.

    Industrial and Automotive revenue includes one-off shipments related to a “programmable logic device ("CPLD") conversion program, for which shipments predominantly occurred in fiscal 2016 but did not recur in fiscal 2017.”

    Licensing and Services revenue includes $18mm of non-recurring patent sales. These particular sales are lower margin than the Company’s remaining licensing revenue. We have reflected this in the assumption that licensing gross margin expands from 89% to 98%. On the positive side for Lattice, 1H’17 results do not include any revenue from the HDMI royalty sharing agreement. A new agreement is currently being negotiated and we expect one will be successfully negotiated, but at a lower share to LSCC. LSCC’s royalty share has been declining (24-25% in 2015 went to 20% in 2016) and the Company stopped acting as agent (responsible for promoting and administering the specification) at the end of 2016. The pro forma estimates reflect these puts and takes.

    In addition to these shorter-term headwinds, the Company’s business has been in decline for a number of years. Lattice acquired Silicon Image in March 2015 for $444mm. At deal announcement, pro forma revenue was $625mm. Pro forma revenue since then has declined at a 13% CAGR.

    At a generous 13x (Canyon Bridge’s acquisition offer implied ~12x management bull case 2017 EBIT) our run-rate EBIT estimate, fair value is ~$3.30/shr or >35% below the current price.  

     

    Clearly, a key risk is another acquisition offer. However, we believe the likelihood of an offer at a meaningful premium to the current price is low. Given President Trump’s actions, we think most potential Chinese acquirers -- which make up the majority of the universe of potential buyers -- would be precluded from future offers. Furthermore, strategic interest outside of China was limited in the prior process. Only one US party submitted an offer, “Party L” and this party’s offer was “at a significantly lower price than the offer from Canyon Bridge.” Cypress Semiconductor has also been a rumored buyer in the past but despite an approach by Lattice during most recent process did not submit an offer. Lastly, Lattice’s financial results have drastically underperformed the proxy projections provided in the fall of 2016. At that time, management was projecting EBIT between $86-107mm and $101-119mm in 2017 and 2018, respectively. In contrast, the Company looks to be on track to report ~$40mm of EBIT in 2017 and modestly more in 2018.

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise do not hold a material investment in the issuer's securities.

    Catalyst

    Rebase of expectations and estimates. Management is holding an investor event on October 12th. They have been promotional in the past and tend to stick with aggressive forecasts (which they later miss) so it is unclear if they will use the investor event to rebase expectations or simply let them bleed lower over time.

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