10/15/18 12:40 PM EDT

MCHP | Happy is the Short Who Presses When Target Sues Acquirer for Defamation

Ami Joseph

Takeaway: Jimmy P spits back from the other side

“To the last, I grapple with thee; From Hell's heart, I stab at thee; For hate's sake, I spit my last breath at thee.” - Herman Melville in Moby Dick

Jimmy? Is that you? Methinks I see you, in my mind’s eye. You look marvelous. How’s the champagne? What a great tan. Oh, how I’ve missed you.

Happy is the day when Jimmy P spits back from the sunset, spewing legal venom at MCHP and its CEO Steve Sanghi. There is only one winner in that hullabaloo; the guy who is Short MCHP. Oh Happy Day.

In case you missed it, Jimmy P and the former MSCC executives filed suit against MCHP and its CEO (see filing HERE). It is an awesome document and reads like Jimmy scribbled it himself (we couldn’t find the legal definitions of “Microsemi was on a roll” or “double-down”). Jimmy P has a new career writing legal briefs! We are kidding of course but wouldn’t the world just be a better place if he did?

Top takeaways from the lawsuit that get us excited:

Details on distributor programs and channel stuffing
The assertion, not totally without merit, that the MCU market may be facing a future of commoditization
Jimmy P admits a lie in his public SEC filings regarding mix of internal and external front end wafer manufacturing (10-K)
Jimmy P admonishes Sanghi for a ‘growth-through-acquisition’ strategy. Uhhhh, Jimmy, you forgettin’ something? Uhhh, that was kinda the MSCC thing, right?
MCHP failed to access major sections of information in the data room. I think this straight up creates an open invitation for lawsuits against MCHP (if true)
MCHP standalone June revenue came in at the low end of guidance (i.e. missed Street)

All the most salient dirt that investors will care about culled from the 56-page document:

Jimmy P is a conspiracy theorist. Who could have guessed it! He believes that A) Steve bought MSCC to hide problems at MCHP and B) to plunge MCHP stock to give himself more cheap options. He makes a pretty darned good case for both.

This one is too juicy to summarize, we’ll just sub-title it “Stuff It” and show it to you in full text:

“To address the long manufacturing lead times associated with many Microsemi products, Plaintiffs also spearheaded a Production Incentive Program (“PIP”) that provided incentives if OEM and CM customers could provide demand forecasts up to six months and, depending on those forecasts, agree to carry a buffer of inventory. This provided manufacturing certainty for Microsemi, allowing the Company to optimize manufacturing resources, and provided distributors and customers with a reliable supply of product to meet their forecasts. Upon information and belief, since the Microchip acquisition, Sanghi has discontinued the PIP program.”

Another one, too good to summarize, we will simply call “Non-recurring Profit”:

“Finally Microsemi and its largest distributor, Arrow Electronics (“Arrow”), leveraged the Arrow Supply Assurance (“ASA”) Program to smoothly and economically ramp down production of end-of-life (“EOL”) products, without jeopardizing the needs of customers that still relied on EOL products. Through the ASA program, Microsemi granted Arrow the exclusive right to sell EOL products during and after the period that Microsemi ramped down and ended production. This allowed Microsemi to reallocate manufacturing and other resources to newer products, while ensuring that customers could still purchase EOL products through Arrow. Arrow, exercising its independent business judgment, understood that it could ensure profitability for the ASA program by increasing the price over time for the ever-dwindling supply of the EOL products. The ASA program was essentially a win-win-win deal for all stakeholders. Upon information and belief, since the Microchip acquisition, Sanghi has discontinued the ASA program, despite the fact that ASA represented a $90 million revenue stream for Microsemi over the next year.”

Whoa – he is bringing some words here. Serious question: are Jimmy P and Steve Sanghi going to meet in a dark alley, mano e mano? Is this going down? Can I watch?

“Unlike Microsemi’s diverse suite of products, consisting of high-performance and precision integrated circuit used by the aerospace industry and the military, the bulk of Microchip’s products have become commoditized, in particular Microchip’s flagship product – its line of PIC microcontrollers (“PICs”). Due to the commoditized nature of Microchip’s products, manufacturing them is simpler and therefore requires shorter lead times than for Microsemi’s products, and demand is more predictable. Because of this, Microchip needs less inventory in its distribution channel. Microchip typically maintains only two to three months of inventory in the channel, compared to the three to four month inventory buffer that Microsemi maintained in the channel…”
Our view: a casual observer of the industry would disagree about MCU commoditization, but…it is a fair observation that as the MCU industry shifts more towards 32-bit MCU they increasingly overlap application demand and functionality with the lower end of the MPU industry, especially with IoT and Auto/Industrial framing demand tailwinds for both parties, as well as considering that ARM has crashed the party on both sides causing some natural dislocation. But if Jimmy’s proof of commoditization is only # of weeks of inventory in the channel…then Linear Tech was the biggest commodity in the semis industry? “Thank you Grace, but I think you're wrong” (from FBDO).

THERE IT IS! HE ADMITS A LIE IN THE MSCC 10-K:

“In addition, Microchip owns and operates one hundred percent of its manufacturing, and thus has absolute control over timing and prioritization of their products’ lead times. Microsemi, however, utilized external foundries and subcontractors to manufacture seventy percent of its products, resulting in lead times being subject to the capacity of the external manufacturer and, thus, longer lead times.” He admits the LIE. In the 10-K MSCC said “nearly 100%” of their wafer manufacturing needs were met by foundry, and MCHP had bought that line talking about MSCC as purely outsourced and thus lower capital intensity. Oh BOY!

POT CALLING KETTLE – is he really calling out MCHP for growth via acquisition?!? Ahem – Jimmy, uhhhhhh, you forgetting something?

“Given these price pressures and an ever-crowding marketplace, how then could Sanghi continue to grow Microchip? The answer was taking on an increasing debt burden to “purchase” growth. Over the past decade, Sanghi has grown Microchip through the acquisition of at least fourteen companies. This growth-through-acquisition strategy has accelerated along with the recent consolidation trend in the semiconductor industry. To satisfy Microchip’s shareholders’ demand for growth, Sanghi has chased exponentially larger and larger acquisitions.”

This one is just called "LAWSUIT":

“Upon information and belief, Microchip and its attorneys wholly neglected to access a large portion of the information and documents in the Data Room prior to the Closing.”

OH NO! (Well, oh yes for the Shorts)

“As a result of this termination, Microsemi has been forced to accept Arrow’s return of EOL products, losing Microsemi millions of dollars in the process.”

FAKE NEWS + FAKE REVENUE = FAKE MERGER: “FAKE revenue process has caused a revenue decline of ~10% and a $100MM reduction in cash flow.”

He might be right on this one as the Q implies y/y organic unit contraction for MCHP x MSCC, a first in many years: “Despite this apparent skullduggery by Plaintiffs, however, Microchip refused to split out Microsemi’s financials from Legacy Microchip. Unbeknownst to the investors, this was due to the fact that Microchip, not Microsemi, had far underperformed against its forecast, and Sanghi was desperate to deflect attention and redirect it to his contrived issues with Microsemi.” "Specifically, Sanghi claimed that Plaintiffs utilized a “[f]ake revenue process [that] has caused [Microsemi] a severe revenue decline and $100 million reduction in cash flow for the quarter, . . . and more, because there’s still high inventory and there’s another $80-100 million that’s not going to get shipped this quarter.” Sanghi described as '[occurring] every quarter [when] they would identify some products as ‘end of life,’ y’know, build a two, three, four years of inventory, ship it into distribution, take it all as a revenue.'"
We agree with this point as far as the June-Q based on what we have been able to discover: "Upon information and belief, however, in June 2018 Microsemi contributed approximately $195 million in revenue to Microchip’s Q1FY19 financials, 8.3% more than the high end of Microchip’s own guidance, despite Sanghi’s claim that Microchip shipped $100 million less than expected. Classic Microchip, on the other hand, accounted for only $1.022 billion in revenue for the entire quarter, or just under 1% over Microchip’s lower end guidance. If Sanghi had split out financials, the struggles of Microchip would be laid bare. In reality, Microsemi saved Microchip’s quarter."