If you haven’t read the news yet, MCHP guided out-quarter revenue 5% below consensus and begins its journey of discovery around the mess that is MicroSemi. For more news, see below on “additional details.” Now, let’s break it down:
Most important point from the night was not mentioned on the call (only in 10-Q)
- June-Q saw a NET VOLUME DECREASE Y/Y first time since 2012
Stop and absorb that first. Because that is the cyclical side of the business. My secular thesis is clearly also playing out, but if the cycle just broke on MCHP then we are in for quite a ride. And the last time MCHP missed Street estimates on a forward revenue guidance midpoint by as much as 5% was September 2015.
Second most important point of the night
- Stuffing the channel ahead of being sold is a time-honored tradition in Semiconductors going back at least 30 years. If that is the extent of the “discovery” so far for the MCHP management team, then they have not really found the problems in R&D, roadmap, manufacturing, etc. (And yes, we loved hearing about Jimmy P's expensive sports suites and private planes but that’s fixable, the other stuff ain’t).
Points III – VI
- If a CEO has to say “I want to be clear there was no fraud involved,” there might as well have been
- To Steve: Blaming bitcoin for guidance miss? You guys now making ASICs for mining coin? Demand turned down on you? Tough, tough. Sorry to hear it. Anything else? Butterfly in Thailand got sick? Shucks, man. To investors: he really thinks you are stupid.
- How does a $20B Semis giant spend $10B on an acquisition with no due diligence? If we knew all these problems about MSCC, then MCHP should have known them too. Or, at least called us! Our service isn’t that expensive!
- “If we don't get out of our box, our growth opportunities are limited.” With ~14% market share in MCU, and a CEO who constantly boasts about share gains, why do you need to get out of your box? We have pointed out that in the last few years, MCU share gains were inorganic, or pricing (see below re recent gains). We have also pointed out in our BB (HERE) that the other acquired businesses, such as analog, have not grown at all, they are just stacked one inorganic piece on top of the other. The point is – we are witnessing the slow decomposition over time of a once high-quality technology growth asset into an acquirer of garbage based on strategic gobbledygook, which is already begetting a deteriorating multiple and organic full company growth rate.
THESIS
Our thesis on MCHP Short (Black Book HERE) was not directly about the June/Sept setup. It has to do with the natural conclusion of MCHP’s path = Broadcom. Namely: buy junk, strip some OPEX, use cash flow, buy the next uncorrelated, unconnected, non-strategic piece; we are seeing the maxed out ending for a cheap debt fueled financial engineering cycle in which several tech companies have gone down the path of garbage disposals, i.e. mimics of private equity.
That said, the dual impacts of slowing cycle (net volume down) after three straight positive years plus a long road of discovery ahead related to MSCC makes the timing of our MCHP June call even sweeter.
ADDITIONAL DETAILS OF WHAT WENT WRONG
MicroSemi discovery problems: it turns out that MSCC mgt was extremely aggressive in shipping inventory into the distribution channel (they made special deals and offered discounts to contract manufacturers so that they could recognize revenue on a sell-in basis to inflate revenue and GM%s). Now, it’s MCHP’s problem and undoing this practice will result in a headwind to revenue, EBITDA, and cash generation for the next few Qs, at least.
Non-MSCC related problems: 4 other (non-MSCC) items resulted in further degradation of the forward guide – 1) lead times on passive components continue to be pushed out. 2) Tariffs and trade war effects are hurting customer confidence and delaying decisions, 3) being unable to fully ship to ZTE (more heavily weighted towards MSCC) 4) a fall in bitcoin values has resulted in a major decline in demand for MCHP power supply products specific to that space.
GM%: Aside from better revenue, the Street was also looking for integrated GM% of 61.9%, whereas this time the mid-point is 61.6% on guidance. OH, THE VECTRON!
Revenue: Per the 10-Q, MSCC accounted for 19.4% of the Y/Y growth in total revenue (GAAP) which means that MCHP standalone grew 5.3% Y/Y, below the MP of its pre-MSCC guide of 6.7%.
Volume decline: in a period that saw a 6.8% increase in ASP, the company saw a net decrease in volume for the first time since 2012 (per the 10-Q disclosure).
Net Debt to EBITDA: climbed to 5.0x, remember when mgt said down 1.0 turn per year? Well, year 1 is now expected to be down 0.75x of a turn instead.
Disclosure: the board has decided to not break out on future calls standalone MCHP vs. standalone MSCC because as the CEO said last night they “don’t want to engage in the old controversy of organic vs. inorganic” and something along the lines of, “you guys just like clean spreadsheets, but the world is too complex on our side and there are too many moving parts.” Really, we are more interested in giving credit where credit is due, and this prevents us from accomplishing that.
BOTTOMLINE
The quarter was rough for MCHP – it’s hard to put it any other way. But as we said in June, this is just the beginning of a long road to discovery around MSCC (it’s a big yellow flag when the CEO has to clarify several times that a certain practice “wasn’t fraud”) that will make it more and more difficult to focus on important things like innovating great product and perfecting operational execution. This is the foreshadow of what happens when companies buy low quality assets and rely on exogenous factors to move the needle all around the peak of the cycle. We don’t underestimate CEO Sanghi’s ability to execute but the headwinds that the company is facing compound and sooner or later the company will need to acquire again and they will be in a worse position to do so. On the call last night, management said that the operational integration with MSCC will now be a “2-3 year project”…in our view, this acquisition is a dud and MCHP will quickly move to the next one in ~12 months to cover up the missing hole. The company may also lean more heavily on price increases…yes, customers are captive – in the current design cycle – but press that button enough and they won’t be customers in the next design cycle. Then watch all the years of MCHP MCU share gains begin to reverse.
Please call or e-mail with any questions.
Ami Joseph
Managing Director
