Integrated circuits on a printed circuit board. The semiconductor industry was in focus during the trade war between the US and China.
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Company: ON Semiconductor Corp (ON)
Business: A leading semiconductor company focused on power and sensor products. ON Semi's segments include (i) Power Solutions Group, which offers a range of discrete, modular, and integrated semiconductor products; (ii) Analog Solutions Group, which designs and develops application-specific integrated circuits and application-specific standard products and power solutions for analog, mixed signals and logic; and (iii) Image Sensor Group, which designs and develops complementary metal-oxide-semiconductor and charge-coupled device image sensors, as well as proximity sensors, image signal processors and actuator drivers for autofocus and image stabilization for various end users in various markets.
Market value: $ 10.7 billion ($ 26.07 per share)
Percentage ownership: n / A
Average cost: n / A
Activist Comment: Starboard is a very successful activist investor and has extensive experience in operational activism to help boards and management teams run businesses more efficiently and improve margins. Starboard has made significant semiconductor achievements with investments in Actel, Microtune, Zoran, DSP Group, MIPS Technologies, Integrated Device Technology, Tessera, TriQuint Semiconductor, Micrel, Integrated Silicon Solution, Marvell and Mellanox Technologies. Starboard has achieved positive ROI in all twelve of these filings, and the average return across the twelve companies is 71.62%, compared to an average of 23.23% for the S&P 500 over the same period.
Starboard believes that it trades at a large discount on its competitors and should take one or more of the following measures: (i) improve gross margin by streamlining the manufacturing site, (ii) reducing cyclicality and increasing FCF conversion through Research into a Fab-Lite model and (iii) continue industry consolidation.
Behind the scenes:
ON Semiconductor is a leading semiconductor company focused on power and sensor products. The company sells products in diversified, attractive end markets, with automotive and industrial markets accounting for nearly 60% of sales. These markets have a long growth path with long product life cycles. About 80% of the company's sales have a product life of more than 3 years and about 50% have a product life of more than 7 years, which makes this business a very stable business. With a primary focus on analog and power components and sensors, the company is able to do business regardless of the characteristics of the final product.
Since 2007, the company has spent approximately $ 6 billion buying companies to strengthen its product portfolio and improve its competitive position. Over the long term, the company has seen slow and steady revenue growth, but has seen declines recently. In 2019, sales fell due to the widespread weakness in the semiconductor industry, which was due to an inventory correction and the trade war with China. In 2020 the company suffered from the Covid-19 crisis. In particular, the company suffered from its fabulous model, which includes a high fixed cost base. Despite the strong end-market exposure and product positioning, results lagged both management’s plan and below comparative medians. The company has an operating profit margin of 9.2%, which is well below management's target plan of 22% and even well below that of its peers (33.7%). As a result, the company is trading at a pro forma EBITDA multiple of 7.3x versus 16.5x for its peers, the biggest difference to peers in years.
Keith Jackson has been CEO of the company for 18 years and has done an excellent job building the company through organic growth and acquisitions. Now is not the time for growth, but for more efficient integration and streamlining of processes. This wasn't management's strength and the company is now at a tipping point where it can get the right CEO for this point in its life cycle – Jackson has already announced that he will be retiring from May 2021.
Starboard sees several opportunities to win in the company. The first option is to streamline the manufacturing footprint and improve usage rates to improve gross margins. The company suffers from additional costs because it has not fully integrated its acquisitions or has realized other synergies from its acquisitions. The company has 12 production facilities around the world and can easily operate with just 3 to 7 plants. The company has already started taking steps in the right direction, moving from smaller and outdated facilities to better equipped facilities with overcapacity. Starboard believes there are even more options here.
Next, Starboard sees an opportunity to move to a Fab-Lite model, which will allow for more stable gross margins, more flexibility in handling surges in demand and downturns, higher free cash flow conversion, and better ROI. Additionally, external foundries are often better to manufacture and more efficient, which can result in even better pricing and quality for the company's customers. Maxim Integrated is an example of a company that switched to a Fab-Lite model and now does 75% of its business externally. As a result, Maxim was able to increase gross margin by nearly 500 basis points, reduce investments from 10.5% of revenue to 2.5%, and now achieve significantly more stable margins in downturns. It's the fabulous model the company currently employs that is probably the largest contributor to its multiple EBITDA rating, which is worse than its peers.
The last chance here is strategic. Starboard sees an opportunity for further industry consolidation and believes the company is uniquely positioned as a scaled asset trading company at a discount. While the company has been an acquirer in the past, it could be an attractive target for a number of strategic buyers. Industry consolidation has increased significantly, and for the past five years it has traded at a median multiple of 17.2x, which is higher than today's trading at 10.6x. Additionally, it's an ideal time to investigate a sale between CEOs, and with an activist involved, the company is brought into play almost automatically.
When the company is at a tipping point, it can benefit from adding Starboard directors to the board at many levels. First, with all the success in the semiconductor industry and one of the largest networks in the industry, there is no one better able to help identify, evaluate, and negotiate the CEO's successor. Second, Starboard has a long history of improving board-level margins, especially in tech companies. Finally, when the opportunity to sell the company does come, it is invaluable to have a hedge fund by your side who can quickly build financial models to see if the transaction is maximizing value – it's like an independent investment bank, who only cares about corporate value.
Ken Squire is the founder and president of 13D Monitor, an institutional shareholder activism research service, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist assets.
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