"Mellanox would fit Broadcom like a glove"

Shiri Habib-Valdhorn

Good results and acquisition rumors sent Mellanox's share price soaring 26.3% in two days.

A possible takeover of Israeli technology company Mellanox Technologies Ltd. (Nasdaq:MLNX; TASE:MLNX) last week fired the imaginations of Wall Street investors and sent the company's share price soaring: a 10.3% jump on Thursday following publication of good results by Mellanox was succeeded by a 14.5% leap on Friday.

The CNBC network reported on Thursday that the company had hired an investment bank following queries about an acquisition by more than one company. According to CNBC, the talks are still at an initial stage. Mellanox did not respond to the report.

Only a few months ago, the campaign waged by activist fund Starboard against Mellanox's management came to an end. Starboard complained about Mellanox's low operating profit margin, demanding better performance and replacement of members of Mellanox's board of directors.

Starboard alleged that Marvell Technology Group (Nasdaq: MRVL) had offered to acquire Mellanox, but had immediately been rebuffed. It is believed that Mellanox founder and CEO Eyal Waldman, who is the dominant voice in any possible acquisition, wants to preserve Mellanox's independence, even in the face of the wave of consolidation sweeping the entire industry.

Asked by "Globes" a year ago about attempts to acquire Mellanox, Waldman responded that in Mellanox's industry, "Everyone talks with everyone else."

It is possible that hiring an investment bank, as reported by CNBC, indicates a possible change in this stance. In June, Mellanox and Starboard reached a compromise in which the fund appointed two directors to the Mellanox board.

Mellanox develops and markets communications equipment for high-speed data transmission using Ethernet and InfiniBand technologies.

The cumulative 26.3% two-day rise in Mellanox's share price added $922 million to the company's market cap, making it $4.4 billion. Mellanox's share price is now $83.30, close to its year-long peak in early July at the height of the dispute with Starboard: far below its all-time high of $120 in 2012, but 28.7% higher than at the beginning of 2018.

"Broadcom is ready to make acquisitions"

"An acquisition of Mellanox is a real possibility. Mellanox is a very clear story. The synergy there is obvious to anyone who buys it," Oppenheimer senior analyst Sergey Vastchenok said today. He added that Mellanox was "an inexpensive company that would immediately add to the acquiring company's profit. Mellanox is very profitable, very technological, and there will be no problem in leveraging the acquisition."

Who are the potential buyers? Vastchenok's first suggestion is Broadcom. "To put it simply, Broadcom is ready to make acquisitions. It operates in the same market as Mellanox, it is able to make very smart acquisitions - all of its success is built on acquisitions - and Mellanox would fit it like a glove, much more than other possible buyers," he says.

Several months ago, Broadcom's attempted acquisition of Qualcomm was blocked, and the name of Mellanox (substantially smaller than Qualcomm) was raised as a possible alternative. Broadcom recently announced the acquisition of CA Technologies for $18.9 billion.

Another possibility raised by Vastchenok is Oracle. The software company has held shares in Mellanox for years, and sold shares for $104 million in January, reducing its holding to 4.3%. Vastchenok says, "Oracle is the type of company that is finding growth hard to achieve without making an acquisition every year. It has hardware activity. The sale of shares in January was probably because they gave up on the stock."

Like Oracle, another major company having problems increasing its revenue is IBM, which Vastchenok also mentions as a possible buyer for Mellanox. "The acquisition of Mellanox is synergetic," he says, "because there is a connection in the industry between hardware and software - software companies are increasing their hardware share and vice versa. The major companies need a contribution to their sales line, and here is a natural growth engine."

Yet another name likely to arise in this context is Intel, both a customer and a competitor of Mellanox. Vastchenok is persuaded  that this "is conceivable, but Intel will have less synergy in acquiring Mellanox. Intel doesn't know how to make acquisitions; its previous acquisitions were failures."

Vastchenok also mentions Xilinx as a possible candidate to acquire Mellanox. He says that Xilinx leads the field-programmable gate array (FPGA) market, but that it is not a large company ($19.9 billion market cap on Nasdaq), and lacks acquisition DNA. Nvidia is another company that Vastchenok believes could buy Mellanox. He says that the two companies already collaborate on data centers, and that the combination makes a great deal of sense. Other names mentioned by Vastchenok include VMware and Cisco Networks, although he believes that these are less likely candidates and that Broadcom is the most suitable. 

Vastchenok says that in any case, "Anyone who buys Mellanox for $4 billion will be paying a relatively small sum, and the acquisition will immediately add to its profit. The question is for whom the synergy will be greater." He mentions the acquisition made by Marvell a year ago, when it paid $6 billion for Cavium, Mellanox's competitor. "Marvell wanted to buy but Mellanox refused, so they bought Cavium at double Mellanox's multiple, even though it was a smaller company. This only highlights Mellanox's attractiveness," he declares.

According to Vastchenok, companies have a sweet spot at which they can be sold: a $1-5 billion value, a high gross profit margin, and growth. "For example, if Medtronic buys Mazor Robotics (Nasdaq: MZOR), which has a high gross profit margin, it is easy for it to achieve a high operating profit margin with it; acquiring companies can bring profitability," he says. Mellanox fits those criteria.

"Globes": What interest does Mellanox have in being sold at a time when it is reporting fine growth and expects to continue growing?

Vastchenok: "Mellanox has no ostensible interest in being sold, but in the end, I think it depends on Waldman and his decision. Obviously, there are shareholders, but there has to be a consensus with management. The company is to a great extent built on its management, and they won't want a decision made in opposition to management's opinion. For example, if Waldman gets a senior position in the acquiring company, it might suit him. In my opinion, he's one of the most outstanding CEOs in the Israeli technology industry. If he agrees to a sale, he may get a position in the acquiring company, which is bigger, and this could be an interesting development."

Given all of this, it looks as though,if there is a deal, it should be at a large premium.

"A sale at less than $100 a share will be a big disappointment. The synergy calculation is simple: calculate the profit margin excluding sales and marketing and management and general expenses and compare it with the multiple of the companies that can acquire Mellanox. If a large company takes over Mellanox, it gets rid of all of the expenses other than R&D and brings Mellanox to a 40-50% operating profit margin with no problem. With Mellanox, that's easy, because it's already close to 30%."

Published by Globes, Israel business news - en.globes.co.il - on October 28, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

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