Quick Pitch: Long on Marvell (Nasdaq: MRVL)

Marvell (Nasdaq: MRVL)
Current Price: $15.40
Target Price: $20.00
Recommendation: Long
Source: Hedge Fund. Boston, MA.

Summary
Marvell is a great semiconductor company with strong IP which has been hammered due to exposure to HDD, RIMM as well as the effects of an earthquake and massive floods. However despite these challenges, Marvell delivered excellent profitability and free cash flow margins in FY 2012.

The bear case is that HDD is a dying business which will be replaced by SSD. However, Marvell has leveraged its market leadership in the HDD SoC market to provide performance solutions for the fast growing solid state disk (SSD) market. HDD pricing has also improved faster than SSD which should result in HDD growth, vs. market consensus that HDDs are a dying business which is destined to be replaced by SSDs.

Key Thesis Points
1. Strong market position: Marvell has 60% market share across its entire storage franchise and has all five major HDD players as customers. They expect to be at 70% HDD share next year.

2. Fear about HDD secular decline is overdone and the storage business unit is off for a rebound:
- HDD sales had been a drag due to Thailand-flooding and earthquake related issues which are now largely behind the company.
- Overall HDD total addressable market has not changed much in the past few years. There is a decline in the client compute market (PCs / laptops) but it is offset by the growth in the enterprise market.
- External HDD demand is also expected to pick up this year driven by devices that require more local storage (particularly in homes/SMB), such as 8 MP camera standard and 1080 video capture in smartphones which drive up storage needs, growth in the ultraportable market which drives up demand as these models have “lite SSD storage” pushing the need for secondary storage. Adoption of 500G drives should also be faster than expected due to component shortages (MRVL has 100% share here).
- Marvell is one of the few companies exposed to the HDD space that actually benefits from the SSD growth (segment is growing at 30%). The company supplies SSD controllers and has the leading market share in the space. SSD controllers are higher in price point, so if SSD becomes a larger percentage of the business then Marvell also benefits on both sales and margin. SSD controllers are more complex due to error checking / higher caching and as SSD’s move to higher speeds discrete controllers will be needed. Less than 10% of current SSDs use merchant SSD controllers, of which Marvell has a greater than 60% share.
- Hybrid solutions, which offer an SSD alongside an HDD, will become increasingly common in notebooks, as they offer both the instant on-feature of SSD, while providing added storage needs that remain too expensive in SSD-only models.

3. Momentum in TD-SCDMA Smartphones in China: Marvell has an integrated baseband + apps processor unit that occupies 70% share in China’s TD-SCDMA handset market which continues to see accelerating growth. The TD-SCDMA market was at 50 million units in 2011, of which 10 million units were smartphones (this is expected to grow to 20 to 30 million smartphones in 2012). Marvell has first mover advantage in the TD-SCDMA smartphone market, with 8-12 month lead over competitive solutions from Qualcomm and Spreadtrum. Marvell’s TD-SCDMA platform solution has enabled OEMs to build smartphones for under $100 compared to the $60 it costs them to build feature phones, which will increase adoption of TD-SCDMA smartphones. China Mobile, the dominant mobile service provider, is estimated to have a 67% share of China telco subscribers and has adopted TD-SCDMA as its key mobile standard. With over 600 million subscribers at China Mobile who could convert to smartphones as the price continues to come down, the opportunity for Marvell is significant.

4. Growth opportunity in other product categories: Marvell is now a preferred chip provider for Google-powered TVs, which will begin shipping in volumes during late Q2 2013. Marvell is well positioned to capture share in all-smart TV segment as it ramps. Other source of growth includes the EPON/GEPON build-out in China for consumer networking, as well as share gains and 10GigE adoption in enterprise networking.

5. Buyback could make valuation even more attractive: Buyback increased to $638M (7% of shares outstanding) could drive incremental EPS growth of 9%. On December 14, 2011 Marvell’s board authorized an additional $500 million under its share repurchase program; total cumulative share repurchase authorized was $2B. Marvell has stayed committed to its share repurchase program. Marvell repurchased approximately 15 million shares for a total of $215 million in Q3 of F2012. Over the past five quarters, Marvell has repurchased and retired over 79 million shares (12% of shares outstanding).

6. Improving street perception: consensus forward EPS estimates have increased by 22% since its February 23 earnings report.

Brief Valuation
Current price implies 13x 2012 EPS and 10.5x 2013 EPS (9x ex-Cash), which is at a massive discount to the 5yr median of 14.4x. FCF yield of 10% is the highest among peers at 6.1% and net cash is currently 23% of market cap. Marvell has traded in the range of 9x to 20x forward EPS in the last two years. Marvell is currently trading at EV/S around 2, at 40% discount to its peers. It has traded in the range of 2.2x to 4.7x in the last two years. Average 7 yr EV/S was 2.8x, average P/E NTM: 20.

Target price of $20 implies 16x ‘13PE and 13x ’14 P/E, or 13x FY13 EPS estimate exclusive of cash which is in-line with comps growth multiple (an 8% discount to historic average, given increased competition/ASP pressure in wireless). This target multiple appropriately reflects the company's superior margins, strong cash generation and solid balance sheet offsetting near-term growth challenges. Comps are trading at an average FY1-FY2 P/E of 14x and 12x.