Description

Cypress Semiconductor (Ticker: CY) – Long, $18.00

Mkt Cap: ~$3.6Bn

EV: ~$4.4Bn (Debt: $820MM | Cash: $190MM)

ADV: ~$111MM (11.5MM shrs)

Shrs o/s | Float: 311.8MM / 297.8MM

Current: ~$11.50/shr

Edge: ~$14.00 – $16.00/shr LBO // ~$17.00 – $22.00/shr Sale to Strategic

Risk: ~$9.50-10.25/shr

Situation Overview / Entry Catalyst:

Cypress Semiconductor provides high performance mixed signal semiconductor solutions and memory products for the automotive, industrial, mobile, consumer, computing, communications, and military verticals. The company has completed numerous deals over the last 10 years, most recently Spansion and Broadcom’s IoT business. Activist investor Three Bays Capital filed a 13-D back in March. Although we are not clear as to what their intentions are, the founder used to work at Highfields Capital Management, which has historically been a successful activist and change agent. In April of this year, long-time CEO and founder T.J. Rodgers finally succumbed to investor pressure and announced his departure from the company, potentially paving the way for a sale.  

Semiconductor M&A activity remains elevated, and there continues to be clear strategic as well as private equity interest (Chinese quasi PE too) within the space. We believe several recent events appear to pave the way for a potential transaction:

• Three Bays Capital disclosure in March and June indicating a significant stake in the company (see link to 13-D filings below) and the potential for Three Bays to advocate for a sale of the company and / or shift to less capital intensive business

• The exit of long-time CEO and Cypress founder T.J. Rodgers in April of this year and the opportunity for fresh management to create value for shareholders

• Change of control severance agreements put in place in June, aligning management incentives with shareholders in the event of a sale of the company (see link to 8-k below)

• Perhaps most importantly, the sale / disposal of the company’s Minnesota fab operations which is expected to close imminently according to commentary on the latest earnings call (see below). This opens the door for potential Chinese takeover interest as a disposal would remove the potential for a long and drawn out CFIUS (Committee on Foreign Investment in the United States) regulatory approval process given the Minnesota fab manufactures chips used in the defense industry

Relevant Management Quotes / Links:

Three Bays Capital 13-D filings:

https://www.sec.gov/Archives/edgar/data/791915/000101143816000483/form_sc13d-cypress.htm

https://www.sec.gov/Archives/edgar/data/791915/000101143816000503/form_sc13da-cypress.htm

Change of Control Severance Agreements:

https://www.sec.gov/Archives/edgar/data/791915/000156459016020201/cy-8k_20160526.htm

Minnesota Fab Sale / Disposal:

“On the Minnesota fab, what we found as we go through this process is the equipment set is in very high demand from our Minnesota fab based on today's tool market. We're in very advanced discussions with interested parties to dispose of the fab, and we expect to make an announcement in the near future” - Joe Rauschmayer, VP of Manufacturing, July 28th Earnings Call

Event Path:

• Three Bays Capital 13-D filing on March 9, 2016

• Long-time CEO / Founder, T.J. Rodgers announced his departure on April 28, 2016

• Change of control severance agreements filed on June 1, 2016

• Three Bays Capital amended 13-D filing on June 21, 2016

• 2Q’16 Earnings Release on July 28, 2016

• Pacific Crest Global Technology Leadership Forum on August 8, 2016

• Oppenheimer Technology Conference on August 10, 2016

• Deutsche Bank Technology Conference on September 13, 2016

Variant View:

The probability of an acquisition by a strategic or financial buyer is currently being under estimated by the street given the company’s imminent sale / disposal of its Minnesota fabrication facility. The Minnesota facility manufactures chips used in the defense industry and as a result, would make a takeover by a Chinese buyer unlikely given CFIUS regulation (could be carved out in the merger agreement as a condition to close). Additionally, the market is underestimating the positive margin impact of disposing of this facility, which makes Cypress a more attractive stand-alone business with a smoother free cash flow profile.

Valuation:

LBO Math: We assume $14-16 per share in the event of a LBO which implies ~22% returns to a sponsor (30% return for investors) assuming a ~20% EBITDA CAGR, 5.0x leverage and a 11.5x exit multiple (in-line with historical peer average)

In the event of a strategic sale, we assume a wider valuation range of $15-22 per share. Given the recent M&A activity in the space, we believe there are several possible strategic buyers in the U.S. and Europe including Intel, Microsemi and Microchip Technology in the U.S. and Infineon in Europe among others. Infineon recently announced the acquisition of Wolfspeed power from Cree and would fit strategically with Cypress. Additionally, the sale of Cypress’ Minnesota Fab operations, we believe opens the door for a Chinese buyer like SummitView Capital. SummitView recently acquired Integrated Silicon Solutions, outbidding none other than Cypress, which implies a strategic fit between the two businesses.

Risks/Potential Hedges:

Cypress risks (order of magnitude):

1.) Takeover offer fails to materialize (however, fundamentals are improving)

2.) Secular headwinds intensify impacting gross margin and leverage profile

3.) Spansion and IoT synergy / integration efforts miss expectations

4.) Company fails to dispose of Minnesota Fab (We believe this is unlikely, as the company would “pay” to dispose of this asset)

Catalyst

Fab sale leads to margin improvement

Broadcomm IoT and Spansion synergy acceleration

New CEO focused on FCF generation

Sale of the company