Marvell Offers Compelling Upside

For those who are looking to accumulate a severely undervalued technology company, you ought to consider Marvell (MRVL); the stock has lost nearly 60% since Feb of 2006 as a result of buying Intel's (INTC) communications business for $600 million, and for options backdating. However, none of these two factors should pose a threat to the technology of this company. Besides, the shares have already discounted the news.

Marvell is a fabless provider of chips for communications networking. With more than 130 public fabless companies in the world, the fabless community, semiconductor financial and industry analysts and suppliers are asked to select one public company each year that they most respect in terms of product, vision, strategy and future opportunities. Marvell was selected for this award in 2005. Moreover, public companies that doubled either revenue or net income [no negative quarters, and only financials according to GAAP (no pro forma)] over eight consecutive quarters ending June 2005, are eligible to receive this award for their outstanding financial performance. Marvell received this award in 2005.

The company's parts are used on small form-factor drives. Seagate (STX) in its last quarterly conference call talked about the fact that the only areas showing above-expectations growth right now are notebook drives and small form-factor drives. They also are supplying parts for 802.11 [wireless networking] products, although they haven't announced who their consumer-electronics customers are yet.

A key player in the definition and development of the 802.11n standard, Marvell continually drives the vision of the digital lifestyle with WiFi solutions for the digital home, PCs, and embedded wireless devices. With world-class performance, low power consumption, small size, and amazing functionality, Marvell products are key elements in everything from portable game consoles and dual-mode phones to WLAN routers and triple-play gateways.

That should really pick up for them starting in the third quarter of this calendar year. For Dell (DELL), Cisco (CSCO) and Intel, Marvell supplies chips used in local-area-network interface cards. They also have a networked-switch-component business. For Western Digital and Seagate, they provide core technology for the interfaces on their drives.

Backing out the cash, the company was selling at at 22 times next year's earnings when the stock was at 39. Now, It sells at under five times this year's net revenue, or about three times expectations for next year, with very high margins. Marvell has been growing far faster than the overall chip market, with sales expected to reach $2.4 billion in the January 2007 fiscal year, up from $1.7 billion in fiscal 2006 and $1.2 billion in fiscal '05. And almost all of that has come from organic growth, rather than acquisitions.

Marvell said the deal will give them a strong position in the market for processors used in smart phones. The Intel business changing hands includes a processor used in Research in Motion's (RIMM) Blackberry 8700 device, and another processors used in the Palm (PALM) Treo and Motorola (MOT) Q phones.

The communications business that MRVL bought from INTC has about 1,400 employees, and has been generating about $100 million a quarter in revenue; the company said the Intel unit has margins lower than those Marvell has been reporting. In a conference call with analysts this morning, the company said it expects that starting fiscal 2008 it will expect long-term gross margins of 50% and long-term operating margins of 24%. In a company where the top execs still control 20% of the stock, management is not out there doing stupid acquisitions. They are willing to take a short-term earnings hit for a deal that will be accretive in the long haul.

As to management, Marvell Technology Group has been selected as one of the Best Managed Companies in America by Forbes. Please refer to Forbes's detail review (.pdf). The Company is #1 on the semiconductor top 10 list based on five year annualized total return. The Forbes list of best managed companies was culled from an exhaustive search of 1,000 publicly traded companies with at least $1 billion in sales, positive book value and a price of at least $5. See this for more on their selection process, plus long and short term sales and earnings growth rates.

For those looking for an entry at today's price, you might consider buying the shares while hedging them with the Nov 18.75 strike calls at nearly 70 cents/contract. That gesture will give you a .70 cent/share downside protection, providing you the opportunity and the affordability to dollar cost average should the stock decline. Thereafter, you could consider buying more shares and hedge with the 17.50 strike price.

All in all, if you can risk a 2 point downside in exchange for a 20 point upside on a stock, MRVL is a great pick!

Disclosure: The author is long MRVL

MRVL 1-yr chart: