I’ve been engaged in constant debate with readers and other investors about my position in Vitesse Semiconductor since disclosing it. Based on reader email, it was one of my more unpopular opinions. I thought it would be appropriate to share my investment thesis from early August with a wider audience.
This post is not a recomendation to buy or sell Vitesse. It is the reasoning behind why I personally purchased it. Please draw your own conclusions.
Vitesse Semiconductor Investment Thesis
The breakup value of Vitesse Semiconductor (VTSS) is $2.50/share, net $170M debt and $20M cash this yields a valuation of $1.75/share. This is based on valuation of each of the three Vitesse business units.
There are three future outcomes for Vitesse:
Scenario One – Breakup and Sale of all Business units
Total break up value – $505M-$565M, or $1.75-$2.00/share
Scenario Two – Sale of One Business Unit
The Ethernet division is most likely to be sold to generate cash. Further operation and growth of this unit requires substantial cash investment that Vitesse cannot afford (current credit terms are LIBOR +9-11%).
Results from such a transaction at $110M valuation:
This leaves a near break-even company with substantial invested R&D and future prospects in the storage and optical markets, $160M in annual revenue with 65% ($100M) gross margins. Peer company valuations (AMCC) (PMCS) are 3x-4x EV/Gross Margins, which would value the new Vitesse at $1.25 to $1.75/share, which should considered low given future prospects.
Scenario Three – Continued Operation
It is possible, but not likely, that near term growth in the Storage and Ethernet markets leads the company to cash flow break even. The threat of customer migration away from Vitesse has been overstated by conventional sell-side analysts, and analyst cash accounting metrics trend toward pessimistic. Better management of distribution inventory will result in near term margin expansion (1-2%). Regardless, in the absence of near term operational improvements the company has options to resolve cash flow issues through the sale of business units.
Removal of duplicative R&D and SG&A in the specialty component space through M&A is an unrecognized method of generating shareholder value. Vitesse is either an excellent target for consolidation, or an undervalued head and torso that can be fitted out with the appendages of other companies, such as Intel’s Telecom business unit. The current Vitesse valuation leave investors with a lot of room for error.
At the time of posting, of companies mentioned, I am long VTSS and INTC.
This is not investment advice and reflects my personal opinions. Read the disclaimer.