MaxLinear (“MXL” or the company) is an integrated circuit provider for the connected home, wired and wireless infrastructure, and industrial market. The company’s main products are sold to cable hardware manufacturers (Arris and Technicolor) and ultimately end up in homes and businesses within cable modems and other infrastructure products. Aside from its core markets, the company has grown substantially through $878mm of acquisitions over the last 4 years, and claims to have a heavy R&D operation, creating an aggregate $9bn future TAM opportunity versus $463mm of pro forma revenue in 2017. Management promotes this story of an innovative and R&D heavy company that is geared up for large future growth drivers, but our research as detailed below has given us cause to be skeptical.
We previously wrote up EXAR on VIC in November 2016, and while we believed at the time that EXAR was well-situated to be acquired, we were surprised when the buyer was MXL. We have since followed MXL and currently do not believe the MXL bull case based on our fundamental work and primary diligence. Our short thesis revolves around the following points:
Intense and increasing competition in MXL’s core broadband segment
Expected growth drivers also face intense competition and headwinds
Our checks indicate little strategic rationale for the EXAR acquisition, and the acquisition is already underperforming expectations
A host of accounting red flags including elevated DSOs and DSIs, “spring loading” of the EXAR acquisition (holding back revenue until the deal closed), obfuscating organic growth with numerous acquisitions, and other flags may be artificially inflating earnings
Forward estimates are currently for MXL to grow at increasing and accelerating rates each quarter starting in 2H 2018 and ramping through 2019. We see significant risks to estimates over that period especially, based on primary research and a detailed look at the accounting. One time boosts in 2017 create a scenario where the earnings base from which forward estimates are grown off of in 2017 is inflated, creating a higher need for growth than most investors realize to hit 2018/19 estimates.
We believe a pattern of earnings misses combined with lack of visibility into growth opportunities is likely to cause a scenario of multiple compression from MXL’s current 14.6x P/E and 4.1x EV/Sales multiple. We see MXL closer to 3-3.5x revenue or 11-12x P/E (where it has traded in the past) yielding a price target in the range of $17, or ~30% downside.
MaxLinear is a provider of “system on chip” solutions for broadband data/video and data transmission infrastructure markets. MXL started primarily as a company that made chips for cable set top boxes or gateways to convert input into high speed data and video and has since grown organically and through acquisitions. The business operates in three segments:
Connected Home consisting of cable modems and set top box integrated circuits converting RF signals to data and video (moving data around the home). MXL says this is a “low growth” market with 5-10% growth with the main customers being Arris/Technicolor who manufacture modems and boxes for cable telcos
Infrastructure consisting of broadband and wireless infrastructure integrated circuits (getting data to the home). MXL says this is a “high growth” market with 30-40% growth with the ultimate end customers being wireless providers
Industrial and Multi-market consisting mostly of power management products for industrial applications. This segment is primarily from the EXAR acquisition. MXL says this is a “low growth” market with 5-10% growth, served through distributors
In 2017, 25% of MXL’s revenue was sold to Arris ($105mm), and another 8-10% to Technicolor - the two major global cable modem and set top box providers.
Over the years MXL has grown both organically, as well as through $878mm of acquisitions. It has made the following acquisitions since 2014:
October 2014: Physpeed, a high speed data center interconnect business ($10mm)
April 2015: Entropic, a chip company that specialized in data/video over coax cables ($289mm)
July 2016: The wireless infrastructure backhaul business of Broadcom ($80mm)
April 2016: The wireless infrastructure access business of Microsemi ($21mm)
April 2017: G.hn, a last mile data access company over telephone and power lines ($21mm)
May 2017: EXAR, an analog and mixed-signal fabless semiconductor company specializing in power management ($457mm)
The company’s acquisition strategy is to enter new markets and expand TAM which is supported by the fact that two thirds of its R&D spending the last few years has been related to markets where they currently have zero revenue. According to the company, the acquisitions and organic opportunities have a TAM of $9bn by 2020.
Note: All figures are $ in millions unless otherwise indicated. MXL’s fiscal year ends 12/31
Background and Bull Case
We believe looking at the short case for MXL starts with looking at the consensus/bull case. Over the last few years, management has spun a story of an R&D heavy company with entry into upcoming growth markets. The current consensus/bull case incorporates this view as a “second half 2018 story” where the company will start to ramp its new products, diversify its revenue, and eventually get a higher multiple as growth increases.
The bull case revolves along the following growth drivers:
DOCSIS 3.1: Within its core Connected Home segment, there is an upgrade cycle from the DOCSIS 3.0 to DOCSIS 3.1 standard. This updated standard allows for faster data transfer rates into the home and is seen as essential to the “connected home” future. DOCSIS 3.1 enabled modems are currently being sold by some cable operators with full roll out expected to gain steam in late 2018 and onwards.
Data Center Networking: MXL has been a first mover in the 400gb PAM-4 data center interconnect market, which is a new upgraded standard taking data transfer rates from 100gb to 400gb to better connect high speed data centers together. The company expects the TAM here to be approximately $1bn ($100 of content x 10mm servers) over the next 3-5 years.
5G Infrastructure: MXL has developed a 5G wireless access chip as well as wireless backhaul infrastructure, which is expected to be used in wireless modems as infrastructure is built out to upgrade 4G to 5G. The company expects the TAM here to be approximately $1bn depending on how many antennas go on each base station over the next 5+ years.
Integration of EXAR and cross sell opportunities: MXL announced the purchased EXAR in March 2017, and at the time talked about cross sell opportunities by integrating power management onto its existing integrated circuits (such as in set top boxes), as well as integrating their RF chips onto EXAR’s products - namely the server power management space which has an $800mm TAM (10mm servers at $80 of content).