Skynet Deal Flashcards
Skynet Deal Summary
It’s about $400mm deal where we were representing a fabless semiconductor company located in UK manufacturing USB bridging integrated circuits. To give you a little more background on the product – almost every electronic device needs connectivity of some sort so when designer wants to add a connectivity protocol to a device instead of building connectivity protocol into the device itself that requires knowledge of the protocol they would use a third party so called bridging chip that they can just add to the device. USB is a dominating connectivity protocol in the world and USB bridging is about $0.3 bn market growing at accelerating pace with the growth of IoT devices and data center infrastructure.
The target was #1 player in this market with ~18% of the market and historically growing market share, strong brand recognition as premium supplier and ASP twice of the market’s average. High margins and high cash flow generation profile made it ideal candidate for a sponsor.
Founder of the company Fred established the company 30+ years ago in 1992 and wanted to bear fruits of his labor now by selling it.
Skynet Company Overview
Any device needs connectivity these days and one of the most common, cheap, reliable and universally accepted connectivity protocols is Universal Serial Bus (USB). So when a designer of an electronic device needs to add a USB port to the device, he would buy a turn key USB bridging solution from our client. The client is a market leader in USB bridging with 18% market share in a fairly fragmented market of USB bridge ICs. Fabless manufacturer, which means they haven’t owned any manufacturing facilities on their own but rather majority of their business was IP, R&D capabilities and distribution.
Segments: Integrated circuits (bridging ICs) and Non-IC (modules – electronic printed circuit board, cables – different converting cables like USB to TTL and other connectivity standards). ASP per chip is ~$2 (for newer generations can go up to $5).
Skynet Market Overview
- Size. Around $0.3bn market in 2019 worldwide growing at about 6%.
- Growth. Bridging IC market is projected to grow by 12% volume-wise and 6% value-wise. USB bridging is majority of the market. ASP is projected to decline at ~5%. Despite that client’s ASP has been growing in the past 5 years as an evidence of strong value proposition for customers.
- Competition. Top 5 players own about 40% of the market with a long tail of niche players. Client is a market leader owning ~ 15% of Interface Bridging ICs market and ~18% of USB Bridging ICs. Silcom Labs – 9%, Microchip – 6%, TI – 5%. Client’s market share has been growing at 3%, 3x faster than closest competitor.
- Cyclical. Even though the end markets are highly diversified, this market is largely affected by underlying semiconductor market cyclicality. Cyclicality of the market is driven by cyclicality of demand for electronic devices, dependency on GDP growth and buildup of inventory and capacity in the periods of high demand.
- Technological trends. Growing applications within new end markets like IoT, self-driving cars, data centers are expected to drive growth of the market. USB is an established standard for connectivity and expected to continue remain universal protocol due to a ubiquity of the installed base.
Skynet Investment Highlights
- Market leader in growing market with growing market share. Market grows at 6%, while the target has been growing at 9% over the last 3 years.
- Strong brand. Best-in-class offering with 25+ years of history and strong client relations.
- Highly diversified Tier 1 customer base. 60.000+ end customers with Microsoft, Tesla and Siemens. Highly diversified end markets by geography and application.
- Best in class technology & IP. That’s why our target was able to charge 2x ASP compared to the rest of the market
- Mission critical function. Small costs of total product development for a client but mission critical product allows client to charge premium and protects its competitive position.
- Long product life cycle. Over 10k design wins with product life cycle of 15+ years that limits competitor’s ability to displace client’s products.
- Best in class financial profile. >73% gross margins, ~64% EBITDA margins over the 3 year period from 2017-2019. 2x of market ASP. Strong FCF generation 90%+, low NWC needs
- Upside opportunity. Ability to accelerate R&D roadmap with incremental investments; ability to invest in sales & marketing to address Chinese market and drive direct sales
Skynet Investment Risks
- Management team. Need to build out a team as Fred (CEO) is moving away. Will he take R&D capabilities with him? There has been a deliberate effort to build out independent R&D and management in the past few years
- Used as cash cow with a weak R&D roadmap. Last chip was issued 4 years ago so there is a concern that the company was used as a cash cow and underinvested in R&D and development (Truth: they have very active product roadmap; products are evolutionary rather than revolutionary with very long adoption cycles hence R&D spend is lower)
- Size of the target and target market. Will not move a needle for large acquirers
- Commoditization. Risk is minimal. The client achieved a number of break-through design wins over the years, which is evidenced in it’s ability to charge premium prices. Client’s ASP has been growing over the last years
- Trade war and macroeconomic disruptions. Affected by US-China trade war and cyclical drop in semiconductor market in 2019
- Cyclicality of semiconductor industry.
Skynet Financials High Level
2020
Revenue $60mm (drop in 2019 to 57 with the rest of the semiconductor industry due to trade war) growth is constrained by COVID by strong growth resumes from 2021 at ~10%
GM 74% growing with growth in ASP, growth of direct sales and change of suppliers (shift to Greatek and ASE for assembly services)
OM 62% high operating leverage drives improving OM as majority of opex such as R&D is fixed
EBITDA margins ~70% low capex given fabless model
High FCF 90% of EBITDA converts into cash flow
Skynet Financials Drivers
Revenue Drivers
- Due to trade war between US and China in 2019, there was a slight shift in end customer sales from US (i.e. Digi-Key) to EMEA (i.e. Farnell) region to avoid the additional tariffs from US suppliers
- Increasing project registrations from China clients which resulted in increase in revenue contribution from China (driven by increasing preference to buy from Asian suppliers)
- Opportunity to increase China sales as there is upside potential for FTDI in China –e.g. by leveraging on strategic buyer’s well established sales and coverage team in China vs. FTDI’s small sales team / limited coverage effort currently
- Tesla started to buy for infotainment systems
COGS
- Shift towards higher ASP products
- Sales directly to customers increased from 3% in 2017 to 8% in 2019 so margins have been growing due to lower discounts given
- 70% of COGS consist of wafer costs paid to foundries like ON Semi located in US and UMC located Taiwan
- 30% of COGS are Testing & Assembly costs outsourced to Taiwan based ASE Group and Greatek
- 6-month sales forecasts are provided by distributors and developed internally to minimize warehouse and stocking costs (warehouses in UK and US)
Opex
- Majority of opex is fixed costs like R&D
- Majority of opex is R&D
Capex
- Low capex given fabless business model
Skynet Valuation
Standard football field with historical and forward looking multiples including DCF, trading and transaction comps and LBO.
Trading comps include semiconductor universe (Texas Instruments, Analog Devices, NXP, Infineon, Microchip, Realtek, Silicon Labs – EV/Rev 4.5x, ~16x EBITDA)
Transaction comps include recent semi deals: ADI / Maxim, Infineon / Cypress, Microchip / Microsemi, and comparable by size deals Maxlinear / Exar, Integrated Technologies / Gigpeak (EV / Rev 2.4x, 12x EBITDA) Target’s GM was 74% VS other targets of 58%
