Marvell and Cavium Join Forces as Industry M&A Heats Up

We view the deal favorably as it allows Marvell to pivot away from its legacy storage business into the more attractive data center arena. The combined entity would boast an extensive product portfolio with 37% of revenue from networking and processing versus 46% from storage, based on the most recent completed quarter.

The exchange ratio is based on a purchase price of $80 per share for Cavium, using Marvell’s price prior to Nov. 3, when reports of a possible tie-up surfaced. This represents a 23% premium to our $65 stand-alone fair value estimate for Cavium. Given the premiums in recent semiconductor deals, we think this is a favorable premium for Marvell, though Cavium shareholders will also be able to partake in potential upside.

While we don’t think either company boasts an economic moat, we think the consistent growth across Cavium’s product lines supports our positive moat trend outlook as the company continues to expand its silicon solutions in the service provider and data center markets, which we think increases switching costs for customers.

We have raised our Marvell fair value estimate to $18.50 per share from $10, as we think Cavium was one of the few remaining high-growth takeout candidates in the semiconductor space. We think the combined company has a highly complementary set of products and end-market exposures and considerable scale to continue providing competitive solutions. We have raised our Cavium fair value estimate to $80 per share, as we don’t foresee any significant hurdles to closing the deal by mid-2018.

Marvell will fund the cash portion of the deal with cash on its balance sheet and $1.75 billion in debt financing. At the close, the company will move from a net cash to a net debt position of roughly $1.15 billion, or 1 times its pro forma EBITDA, including synergies. Management foresees at least $150 million-$175 million in combined annual run-rate cost synergies within 18 months after the deal closes. About 25% of the total synergies will come from cost of goods sold while operating expense savings will be derived from the elimination of duplicate property and consolidation of overlapping support functions in both selling, general, and administrative expense and research and development. While there aren’t any explicit revenue synergies outlined, management’s long-term revenue growth targets for the combined entity is 6%-8%. We believe this is a reasonable goal, as we forecast Cavium maintaining a double-digit growth rate, with stand-alone Marvell in the midsingle digits. The inclusion of Cavium would be modestly accretive to margins, with gross and operating margin targets of 65% and 35%, respectively. As indicated by management, these would be industry-leading margins. Given the amount of competition in many key end markets from large peers such as Broadcom AVGO and Intel INTC, we think these levels could be difficult to achieve and sustain.

We are most enthusiastic about the joint company’s opportunity in the enterprise, cloud data center, and service provider markets. The current upgrade cycle to multigig Ethernet, ongoing multiyear growth in cloud with demand for high-bandwidth networking storage and heterogeneous processing, and shift to 5G should all drive forward growth. During Marvell’s presentation to justify the rationale of the deal, CEO Matt Murphy (who will run the new combination) cited an addressable market of $16 billion, of which Marvell and Cavium currently capture $3.4 billion. Consequently, we think the duo has favorable prospects for future growth. We were concerned about stand-alone Marvell’s exposure to the storage space, as hard-disk drives are in secular decline and we foresee solid-state drive controllers being more competitive. Ultimately, with Marvell’s backing, we believe Cavium can realize accelerated growth and operating leverage that make this deal worthwhile for the acquirer.