Description

Magnachip’s (“MX”) 6.625% bonds due 7/2021 trading at 80 cents on the dollar are a favorable risk-reward as accounting restatements and the subsequent firing of the CEO & CFO have left the bonds for dead.  A new management team has been put in place and MX is current on all SEC filings leaving the accounting issues a thing of the past.  Through the bonds, you can create MX for ~10% of sales and 1.0x normalized EBITDA versus foundry peers trading at 1.4x sales and 5.4x EBITDA. 

While MX’s equity value has increased ~$144 million from the 2015 post-restatement lows, MX’s bonds still trade at a significant discount.  This is surprising as the bonds are the only debt outstanding; there are no covenant issues; MX has $72.7 million of unrestricted cash on its balance sheet; and there is $317 million of equity value behind the bonds.  The bonds are largely ignored because of low liquidity ($225 million outstanding) and lack of coverage.  This will change as MX’s recent engagement of Barclays to evaluate strategic alternatives is the catalyst to drive the bonds back to par or 101 (given there is a 101 change of control).  Additionally, the company is embarking on a cost optimization program and a business turnaround that should lower cash burn and significantly improve earnings over the next 12 months.

Business Overview:

MX’s equity has been written up to VIC in the past and prior posts provide a more detailed overview of the business for those interested.  However, a quick summary of MX’s two businesses:

1.       Semiconductor Manufacturing Services (47% of sales):  MX’s Semiconductor Manufacturing Services provides analog and mixed-signal foundry services mainly for fabless and Integrated Device Manufacturer (“IDM”) semiconductor companies that primarily serve the consumer, computing, communication, industrial, automotive and IoT applications. 

2.       Standard Products Group (53% of sales):  MX’s standard products group is comprised of two business lines:  display solutions and power solutions.  Display products provide flat panel display solutions to major suppliers of large and small flat panel displays.  Power products include discrete and integrated circuit solutions for power management in consumer, communication and industrial applications.

MX’s foundry business is currently under-earning due to lower than normal utilization levels and high fixed costs.  Global capacity for MX’s 200mm fabs is tight and MX’s new management has begun the process of backfilling the fabs with new business – this will improve utilizations as new projects ramp over the next 12 months.  The combination of +40% incremental margins in the foundry business and a $40 million cost savings plan currently being implemented will drive MX’s profitability back to normalized levels beginning next year.

Asset Value:

Given tight capacity globally, many of MX’s foundry peers are in the market for 200mm fabs.  Based on our diligence, foundry peers will pay $7,000 per 8” equivalent wafer per month for the equipment value alone – an amount many noted would be an exceptional value.  Applying this to MX’s 8” wafer capacity implies $800 million of asset value, significantly more than all liabilities, providing a substantial margin of safety for bondholders.

Catalysts:

MX’s board engaged Barclays to evaluate strategic alternatives in June 2015.  Our diligence supports the view that many competitors would like to own MX’s assets – their fabs are underutilized, they have great relationships with top tier North American and European customers, and are located in a favorable geography.  In addition to willing buyers, we believe that many top MX shareholders would support a sale of the company.  The largest shareholder, Avenue Capital, owns 11.8% of the company and has 3 of 7 board seats and wants to exit.  The second largest holder, Pleasant Lake, owns 9.4% of the company and has recently called for the board to maximize shareholder value (Pleasant Lake’s MX presentation:  http://www.sec.gov/Archives/edgar/data/1325702/000092963815000638/ex99-1.htm).  Another activist, Engaged Capital, owns 7.3% of the company.  With willing buyers, willing sellers, and Barclays already engaged in evaluating alternatives, there is a high likelihood MX is sold within the next 6 months and bondholders get 101 providing a total return of 30%.

Catalyst

With a current YTW of 11.3% and significant asset and equity value supporting its bonds, we believe MX’s 6.625% bonds due 7/2021 trading at 80 cents on the dollar are a favorable risk-reward.  As MX backfills its fabs and implements its cost savings programs, profitability should improve significantly.  There is a high probability MX is sold to a larger competitor in the near-term providing a clear catalyst to MX bondholders.