Magnachip Merger Arb

Third time's a charm

Magnachip is an interesting potential merger arb situation with only modest downside. A Chinese firm has previously tried to acquire this for $29. But that was shot down by US regulators. Currently stock trades just over $15.

I have been in and out of this stock twice already, and I think a lot of people are just fed up waiting for the company to sell itself so far.

Magnachip basically designs semiconductors, is in a growth market and is constrained by a lack of semi fab capacity. revenue could be 25-50% higher if it wasn’t for that. So superficially not a cheap stock, but next year earnings are expected to double, and continue to grow after that (from latest cc):

“So it's creating very hard to pinpoint out how the rest will pan out. And so we are now back to guiding one core at a time. And once we get the better visibility, we will provide more color. But in [ Tom job ] talking more long term, despite these macro issues, on the OLED side, we are winning new customers and expanding into new applications. So we are very optimistic about the growth on the LED business. And once these new projects, whether it's Korea, new customer projects or the outside Korea, when we go production, we're going to ramp up with the new capacity that I just mentioned to Suji.  

And in terms of power, we have continued to execute our power plan through the Fab 3 productivity as well as our external foundry. And we are rolling out new generation products as we speak. And so we are very optimistic about the growth. So let me put it that way.”

Net cash is about $6 per share. And this does not look like a Covid winner. More of a Covid loser. Gross margins for their chip design business has been steadily increasing over the past 5-6 years. Earnings in 2023 are expected to be about $1.6 per share. If you want to know more, there are 6 write-ups on VIC. 

As for the merger arb part, LX semiconductor, a large Korean firm, has been rumoured to make a bid this week (source). 

And they are not the only bidder (source). And LX has new management with some empire building appetite, so the incentive is there (source).

The Chairman of LX even has some sentimental reasons to buy Magnachip (source):

“At that time, the Kim Dae-jung government promoted a ‘big deal’ for the five major groups. In the semiconductor industry, the integration of Hyundai Electronics, the world’s fourth largest and LG Semiconductor, the sixth largest, was discussed in earnest. Both groups objected, but consulting firm Arthur D Little came up with the result that “Hyundai Electronics is suitable as an integrated entity.” Koo and his father, Koo Cha-kyung, were fiercely opposed, but they were unable to withstand the pressure of the government and wept and eaten mustard, so LG closed the semiconductor business. It is said that Chairman Koo was deeply heartbroken because he handed over the company to his will, not voluntarily.

If LX Group finally acquires MagnaChip, the company will return to the former chairman’s possession after 20 years. MagnaChip was founded in 2004 by Hynix Semiconductor (currently SK hynix) is a company that was spun off while cleaning up the non-memory division to focus on memory semiconductors, so if you go back, it is because it was a member of the LG Semiconductor family.”

And (from same badly translated article):

“An industry official said, “I know that Chairman Koo’s will to acquire MagnaChip is great.” “If LX Group embraces MagnaChip, there is a prospect that it will complete the semiconductor lineup that has gone one step further and develop it into a stable system that is not shaken by drafts,” he said.”

So what is the downside? Stock drops to $12-13 if it is not sold? Company could do another buyback with their large cash position in that case. At $12, and if they really earn $1.6 per share in 2023, stock would trade at under 4x EV/earnings. 

Also it was trading at $13-14/share in 2020 before Wiseroad had made their bid, with less cash and a worse long term earnings outlook.. 

If Chairman Koo really wants Magnachip so badly, he will probably have to bid above $20 to get it. We might even see a $25 bid here, which implies 30-60% upside on a short time frame. I doubt regulators will shoot down the acquisition of a Korean firm to a Korean buyer with a tiny % of revenue in the US. 

I like the odds here, so I am long with a sizable position at just over $15/share. Of Course I may sell at any time and do your own Due Diligence.