Description

Magnachip is not a new name to this board. There have been a series of writeups that have tracked this name from as low as $4 several years ago. Aviaclara and Azia have provided great detail on the company in the past, though this writeup has more of a special situation focus. Since there are quite a number of moving parts, we felt an urge to provide an update. If you were “Wise” (couldn’t avoid the pun) to sell in the mid to high 20’s, we can’t help but think you’ve been given another chance to re-enter the trade.

This Company has always traded at a discount. We believe that finding an outside buyer for this business was always the right thing to do to maximize shareholder value.

The situation is as follows; the company will either:

i)                    be acquired by Wise Rd. Capital for $29 likely before q1 ’22

ii)                   be acquired by a different entity at a price with an estimated range of $25 - $40, assumed timing of q2 ‘22

iii)                 be forced to run the business as it was before but likely to leverage its balance sheet to compensate shareholders

Why the continued Red tape?

We believe that there has been a significant information gap that has created a dislocation in the price. The Company is highly restricted in the information it can release while engaged in attempting to complete its sale to Wise.

Given a lack of appetite for merger arbitrage, there have been long time holders in this name that found an exit in the mid $20’s. That has thinned out the natural value holders of this name given the regulatory hurdles that must be met over the next couple months.

2^nd quarter results alluded to supply chain issues inhibited OLED deliveries; to date those issues had not been resolved. Supply chain issues in Asia? Shocker. To borrow a recently popular word, we would imagine the supply chain issues to be transitory though again we have gotten little to no feedback from the Company on this point. The power segment showed its best numbers to date in case anybody noticed.

There was a recent CTFN article reporting that Samsung may not be overjoyed to be supplied by a Chinese owned Magnachip. We believe this could potentially represent a short term headwind in any of the 3 scenarios though this could present a tailwind longer term in terms of margin expansion.

The selloff in the broader markets (specifically in semis and small-cap), the opportunities to find potential multi baggers outside of this name along with brokers raising margin requirements on this name have all combined to present an asymmetrically beneficial risk / reward.

i)                    Wise Rd.

This acquisition at $29/share was announced in March of ’21. The Company had initially not expected CFIUS to weigh in on the proposed transaction given the lack of nexus with the US. CFIUS has committed to providing their response by September 13. The Company continues to believe that CFIUS will decide in its favor. The Company has no physical presence in the US. Its ticker does trade on the NYSE. If this regulatory hurdle is cleared, the last step would be MOTIE (Korean regulatory body). Wise has committed to keeping all heads and plants in South Korea. Their history of acquisitions has lent itself to this pattern.

With respect to a potential Samsung divorce, Wise may be undeterred by this risk given their network within Chinese phone manufacturers. We believe and company has spoken to the fact that should Samsung drop them as a supplier (which would be a drawn-out process), they could achieve higher margins from new Chinese customers.

Management is highly incentivized to close this deal given their options and ability to restrike new compensation packages for the new buyer as they continue to operate the company on Wise’s behalf.

One of the more reassuring parts of this whole situation is you have an aligned management team that has overperformed.

ii)                   Other buyer

This scenario is less fleshed out, but we at least have one datapoint in the $35 that was offered by Cornucopia in June of this year. This is truly the essence of the information gap. The Company is hamstrung from revealing the 6 other bidders (and offers) that went through the sales process earlier this year. If the Wise deal was to fall apart, it would seem logical that their bankers would either run a new process or at least target any non-Chinese parties previously involved. We can’t really envision a situation where this wouldn’t fetch at least $25. To put a finer line on it: the Company is precluded from any outreach to outside buyers and is only in a position to receive and in turn announce unsolicited offers to the public. This was what happened with Cornucopia and we would imagine there are others out there that would like to buy up this capacity. The power and OLED markets represent massively growing TAMs, and from our view a buy vs build approach gets speed to market to grow market share.

iii)                 No M&A

This also feeds right into the information gap. If after this process, we understand this to be a growing chip manufacturer that now has a smaller universe of buyers, we would expect the company to announce a formal capital allocation program. Magic has spoken to the company’s commentary in the past, but in short it has been a long road for many of its shareholders. We would envision either a special dividend or some sort of tender offer from a new investor. This again is gray and has likely led to some selling given the path of events that have to happen even to get to this announcement.

The cash balance at June 30^th was ~ $6.5. We expect a slight cash burn this year as the Company has announced an aggressive capital plan earlier in the year. Add in a couple of dollars in a break fee that would initially have to be negotiated with Wise gets us somewhere in the neighborhood of $8.5 in cash.

The investor day that was supposed to happen initially in late ’20 and then early ’21 was expected to announce a 3 year plan of double digit top line targets, 30% gross margin and double digit EBIT margins. That would likely get us a floor of $80 mm in EBITDA for ’23.

How low could this really go? We started the year at $15 without a buyer. We don’t believe its unreasonable that the company could post $2 in EPS in ’23. If you assume no special dividend then its not inconceivable that by ’23 the Company could be sitting on $12 in cash and $2 in EPS. At $15, you could be bagholding this at 1.5X ’23 EPS.

There are easier things to own and yes it may always be cheap. But your margin of safety is just too cheap.

Catalyst

see above