MA-COM TECHNOLOGY SOLUTIONS MTSI
August 12, 2013 - 11:52am EST by
cobia72
2013 2014
Price: 15.85 EPS $0.93 $1.28
Shares Out. (in M): 48 P/E 14.8x 10.7x
Market Cap (in $M): 764 P/FCF 0.0x 0.0x
Net Debt (in $M): -106 EBIT 62 87
TEV ($): 658 TEV/EBIT 10.5x 7.6x

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  • Semiconductor
  • Illiquid
  • Out-of-Favor
  • margin expansion
  • Product Expansion

Description

M/A-Com Technology Solutions is a rejuvenated high-end semiconductor company with the possibilities of accelerating revenue growth and significant margin expansion.  For ten years M/A-Com was a subsidiary of TYCO Electronics and was run as a cash cow with little investment in R&D.  As a consequence, the company's product line got long in the tooth and had declining gross margins and lost significant share to competitors.  As an illustration, when the company was purchased in 2009 by technology investor John Ocampo it had 36% gross margins compared to 70% gross margins at Hittite Microwave (HITT), its closest competitor.  Ocampo's first move as owner of the company was to double the R&D staff and charge them with focusing on high margin (70%+) products.  This strategy is beginning to play out as aggregate gross margins have risen to 45% in 2012.  At this level of gross margins, the company was able to deliver a 20% operating margin last year.  Over the next couple of years, the company is targeting gross margin levels of 55% and operating margins of 30%+.  To put this into perspective, Hittite currently generates 70% gross margins and 40% operating margins in generally the same spaces.
 
Part of M/A-Com's strategy is to use its willingness to absorb somewhat lower gross margins that Hittite to displace Hittite from some of its customers.  Over the years of TYCO's ownership of M/A-Com, Hittite was able to cherry-pick the highest margin sockets at each of its customers and also grow quickly as it did not have a formidable competitor in the space.  Many of these customers became disgruntled by Hittite's approach and were willing to speak with other, broader line suppliers.  M/A-Com's strategy is now to go back to all of these customers and offer them a complete solution consisting of both higher and lower margin chips and enabling them to cut down on their number of suppliers which is a priority for many of them.  This strategy is beginning to be realized in the P&L statements of MTSI and HITT as M/A-Com is currently outgrowing Hittite (in addition to growing its own gross margin).  As there is currently a lot of room between M/A-Com's and Hittite's gross margins, there is ample opportunity for the company to target Hittite's current customer base.  Of note M/A-Com just signed two major military deals with customers that could become the largest contributors to revenue over the next few years.  They signed a deal with Northrop Grumman to supply chips called MMICs into a major Northrop radar application.  This is significant both for its potential size as well as the fact that MTSI did not make MMICs until its R&D rejuvenation in 2009.  The second deal is with ELTA Systems, an Israeli military manufacturer, which could also become quite sizable over the next couple of years.
 
Now that I have laid out the thesis, what does M/A-Com actually do?  The company is semiconductor manufacturer at the very high end of the market.  MTSI makes chips that are very high frequency / bandwidth that are used in applications such as radar (both military and commercial), microwave backhaul (taking traffic from basestations back to the core wireless network), fiber optic drivers and amplifiers (40G and 100G), test and measurement equipment, etc.  Since these chips need to be very high performance, they cannot be fabricated in a traditional silicon process but rather are fabricated in such materials as Gallium Arsenide, Gallium Nitride, Indium Phosphide, etc.  This is a relatively well protected market as few companies have expertise with these materials and those who do have long track records and fairly entrenched customer relationships. 
 
From a stock perspective, MTSI is very underappreciated.  Part of this stems from its relative illiquidity, trading on average 70,000 shares a day on a $16 stock price.  Another factor is that it markets are almost all currently challenged from a macro perspective.  Historically its largest market has been microwave backhaul with a concentration in Europe, which has been in the dumps for two years now.  Military, which is a 10% end market is challenged by sequestration.  Automotive has performed well for the company but its growth has recently slowed and it is a lower margin business.  The most recent quarter was a solid growth quarter for the company with its catalog business (onsies and twosies sold to 6000 customers worldwide) performing well in line with the recent focus on this area.  The company's fiber optic business is also doing well in an accelerating 100G market.  
 
        
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Revenue should accelerate going forward with a combination of the catalog business, the fiber optic business, and the recent design wins contributing.  As revenue drop-through stands at about 60%, incremental revenue will significantly raise both gross and operating margins.  Additional major design wins could serve as catalysts, as well.
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    Description

    M/A-Com Technology Solutions is a rejuvenated high-end semiconductor company with the possibilities of accelerating revenue growth and significant margin expansion.  For ten years M/A-Com was a subsidiary of TYCO Electronics and was run as a cash cow with little investment in R&D.  As a consequence, the company's product line got long in the tooth and had declining gross margins and lost significant share to competitors.  As an illustration, when the company was purchased in 2009 by technology investor John Ocampo it had 36% gross margins compared to 70% gross margins at Hittite Microwave (HITT), its closest competitor.  Ocampo's first move as owner of the company was to double the R&D staff and charge them with focusing on high margin (70%+) products.  This strategy is beginning to play out as aggregate gross margins have risen to 45% in 2012.  At this level of gross margins, the company was able to deliver a 20% operating margin last year.  Over the next couple of years, the company is targeting gross margin levels of 55% and operating margins of 30%+.  To put this into perspective, Hittite currently generates 70% gross margins and 40% operating margins in generally the same spaces.
     
    Part of M/A-Com's strategy is to use its willingness to absorb somewhat lower gross margins that Hittite to displace Hittite from some of its customers.  Over the years of TYCO's ownership of M/A-Com, Hittite was able to cherry-pick the highest margin sockets at each of its customers and also grow quickly as it did not have a formidable competitor in the space.  Many of these customers became disgruntled by Hittite's approach and were willing to speak with other, broader line suppliers.  M/A-Com's strategy is now to go back to all of these customers and offer them a complete solution consisting of both higher and lower margin chips and enabling them to cut down on their number of suppliers which is a priority for many of them.  This strategy is beginning to be realized in the P&L statements of MTSI and HITT as M/A-Com is currently outgrowing Hittite (in addition to growing its own gross margin).  As there is currently a lot of room between M/A-Com's and Hittite's gross margins, there is ample opportunity for the company to target Hittite's current customer base.  Of note M/A-Com just signed two major military deals with customers that could become the largest contributors to revenue over the next few years.  They signed a deal with Northrop Grumman to supply chips called MMICs into a major Northrop radar application.  This is significant both for its potential size as well as the fact that MTSI did not make MMICs until its R&D rejuvenation in 2009.  The second deal is with ELTA Systems, an Israeli military manufacturer, which could also become quite sizable over the next couple of years.
     
    Now that I have laid out the thesis, what does M/A-Com actually do?  The company is semiconductor manufacturer at the very high end of the market.  MTSI makes chips that are very high frequency / bandwidth that are used in applications such as radar (both military and commercial), microwave backhaul (taking traffic from basestations back to the core wireless network), fiber optic drivers and amplifiers (40G and 100G), test and measurement equipment, etc.  Since these chips need to be very high performance, they cannot be fabricated in a traditional silicon process but rather are fabricated in such materials as Gallium Arsenide, Gallium Nitride, Indium Phosphide, etc.  This is a relatively well protected market as few companies have expertise with these materials and those who do have long track records and fairly entrenched customer relationships. 
     
    From a stock perspective, MTSI is very underappreciated.  Part of this stems from its relative illiquidity, trading on average 70,000 shares a day on a $16 stock price.  Another factor is that it markets are almost all currently challenged from a macro perspective.  Historically its largest market has been microwave backhaul with a concentration in Europe, which has been in the dumps for two years now.  Military, which is a 10% end market is challenged by sequestration.  Automotive has performed well for the company but its growth has recently slowed and it is a lower margin business.  The most recent quarter was a solid growth quarter for the company with its catalog business (onsies and twosies sold to 6000 customers worldwide) performing well in line with the recent focus on this area.  The company's fiber optic business is also doing well in an accelerating 100G market.  
     
            
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Revenue should accelerate going forward with a combination of the catalog business, the fiber optic business, and the recent design wins contributing.  As revenue drop-through stands at about 60%, incremental revenue will significantly raise both gross and operating margins.  Additional major design wins could serve as catalysts, as well.
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