After dropping hints in an earlier conference call (see Vitesse Q207 Conference Call Notes) Vitesse announced the sale of a portion of their storage products to Maxim (MXIM). The $63M transaction has a provision for an additional $12M if certain milestones are hit. The company will use the proceeds from Maxim and $30M in new convertible debt to repay the junk debt to Tennenbaum Capital. (see Tennenbaum and Vitesse).
Three months ago I expected the sale of the entire storage unit to fetch 3.5x revenue. Subsequent research and discussions led me to believe this estimate was inaccurate, something reflected in comments I made (see here).
In the end, the outcome was far less than what was originally anticipated. Instead of 3.5x overall storage revenue ($200M+), the company received 2.5x-3.0x (depending if the additional $12M is met) on $20M of it’s $73M in TTM storage revenue. But this $20M represented the vanguard of the product line growth. The 2G Fiber Channel products are an annuity, and Vitesse’s position in ROC without a full complement of storage products is tenable.
A Concentrated Focus
With this divestiture, Vitesse is essentially out of the storage business. Not that that’s a bad thing, but something that needs to be taken into account when valuing the company. One gets a clearer picture of the situation when you look at storage revenue ex-SAS/SATA.
|Consumption||$ 53||$ 59||$ 61||$ 58||$ 61|
|Storage – Legacy||16.4||15.1||16.4||12.3||9.5|
|Storage – Divested||5.0||5.0||5.0||5.0|
Flat SAS/SATA revenue is assumed. If you assume growth then the falloff in legacy storage is steeper.
This transaction puts Vitesse in a position in which it can concentrate R&D and SG&A in it’s core networking businesses. This is where the operational DNA for the company exists and makes sense. The future of Vitesse now depends on it’s ability to grow replacement revenue in this area.
The company is almost certainly generating significant earnings at this point but my concerns about revenue inflation and Opex deflation temper my enthusiasm for this metric.
In the short term the company is generating cash flow on investments made in the past. Adjusted opex is now at $20M on $56M (36%) in revenue, far below it’s competitors (PMC opex is 63% of revenue, AMCC is around 55%). It is unlikely that Vitesse has suddenly reached a pinnacle in fixed cost efficiency. This leaves investors with a decision – can the company make more efficient investments than it (and it’s competitors) have made in the past, or will operational expenditures rise in order to grow the top line?
Another effect to consider – the number one priority at Vitesse from dawn till dusk was to generate cash in the short term, particularly by monetizing existing inventory. This has the side effect of driving revenue forward. This is not a criticism of management as this is exactly what should have been done to ensure liquidity. The problem may be when investors assume top line growth is organic, rather than aggressive cash management. Some metrics from the company in this area would be helpful.
Unlike PMC-Sierra (PMCS), Mindspeed (MSPD), or AMCC (AMCC) which have broad product lines, Vitesse is now a pure-play optical networking component company. They must reach a level of R&D efficiency that can drive replacement revenue at existing Opex levels. No one else in the industry has managed to achieve this and I would argue some consolidation is needed before anyone, including Vitesse, can make it happen. The singular focus of Vitesse in optical networking makes it a virtual certainty they will play some sort of role.
Update 30 Aug 2007: The purchase agreement is now on Edgar. The earn out looks very achievable, it is simply a 1:1 payment by Maxim to Vitesse for every dollar of revenue they ship. I.e. if Maxim ships $5M in ex-Vitesse product in CQ407, they pay Vitesse $5M towards the earn-out. This should result in Vitesse realizing the full earn-out by July of ’08. As long as Maxim ships $12M in product by September ’08, Vitesse should recognize 100% of the earn out. It isn’t clear to me why this was made so complex.
Author is long Vitesse