Yet Another Value Podcast - Mordechai Yavneh on Silicon Motion $SIMO

Episode Date: December 15, 2022

Mordechai Yavneh, founder and PM at Focus Capital, discusses his investment in Silicon Motion (SIMO) and why he thinks it's "merger arb for people who don't like merger arb."   Focus Capital's research site (with SIMO deck): https://focuscapitaladvisers.com/research   Chapters   0:00 Intro  2:40 Why SIMO is different than normal merger arbitrage  6:00 More SIMO overview  11:25 Is the merger overhang impacting SIMO's price?  15:30 Discussing SIMO's fundamentals  21:30 Why companies are outsourcing to SIMO  25:50 Why SIMO is taking share 31:30 Breaking down SIMO's market share  34:15 Why SIMO's demand dynamics aren't like MU's  40:20 SIMO's proxy projections and fundamentals  45:35 How Mordechai looks at SIMO's fundamental value  52:15 Why MXL wanted to buy SIMO  57:00 Why SIMO saw some customer churn in ~2018  1:00:00 What are the odds the SIMO deal goes through?  1:03:45 Capital allocation in a potential deal break

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That's visible alpha.com slash value. Hello, welcome to the Yadmother Value podcast. I'm your host, Andrew Walker. If you like this podcast, it would mean a lot if you could follow, rate, subscribe, review it wherever you're watching or listening to it. With me today, I'm happy to have Mordecai Yavnet. Mordecai is the founder and portfolio manager

of Focus Capital Advisors. Mordecai, how's it going? Good, thank you. Thank you for having me. Thanks for coming on. I'm really excited to have you on. I wish, having met you, I kind of wish I had had you on in the July time frame because I know what we would have been talking about then, but I think this is a good one too.

But before we get there, let me start this podcast the way I do every podcast. First, the disclaimer to remind everyone that nothing on this podcast is investing advice. That's always true. But we're talking about a company that's foreign domicile. They trade under, they have an ADS, so they trade American, but they are a foreign company. probably adds a little bit extra risk. You know, this is a merger arm situation, so adds a little risk there. Please consult a financial advisor, do your own advice.

This is an investment advice. Second, with the pitch for you, my guess, I mentioned July time frame because you were one of the few people who were riding hard with me on the Twitter train. I know you swung quite hard at Twitter, but look, you run a concentrated, I'm going to call it event and quirky portfolio. I know you run concentrated and you do great. Mostly not event. Mostly not event. That would be a real situation. It comes up, I had to hit it.

But look, you weren't very concentrated. You do deep work. We were having fun chatting before, so I'm really excited to dive into this one. The company we're going to talk about today is Silicon Motion. The ticker there is S-I-M-O. You've got a deck on your website, which I'll link to in the show notes. Anybody can check it out. I believe the tagline for it is merger arbitrage for people who don't like merger

Arbitrash. So I'll just flip it over to you. What is Silicon Motion and why is it so interesting today? Okay. So let's first talk about what's bad about merger arbitrage to explain why this is different. The usual problem with merger Arb is that most merger arbitrages are there are small spreads for companies that the market expects for the merger to close. And you're collecting your little spreads until one of the deals blows up in a totally unexpected way and you lose a lot of money, kind of picking up nickels, vines in front of the steamroller. That's not such an attractive approach, especially for a concentrated portfolio like mine is. Maybe it could work. Some people have done work with that, our specialized merger, merger are shops that have sometimes had success

with that, but that's not more for my investment philosophy. The other type of merger are where you have a very large spread because a lot of people have looked and seen the risk of the merger and not closing. There's a lot of questions usually about regulators, sometimes about finances, whether the shareholders will approve it, et cetera, et cetera. So it's not clear that the merger will close. You have a large spread, but then you have a large risk as well, large reward, large risk. That is important. theory can be attractive, but I'm not so attracted by risk. I like large reward and low risk. So that's what I believe we have here with Silicon Motion. Silicon Motion is a Taiwanese company

with, as we said, an ADR in the U.S. It's being bought out by Max Lanier, an American company. And right now they're trading for about $66, $67, and they're being bought out for about $108. Almost all of it, the vast majority that is cash, $92,000. cents cash and 0.388 of maximum your shares that comes out to about 108 at the present prices. That is, what we have here is a 70% spread on the merger, which is very large, even for large. You know, you have a company where the FTC is suing that Microsoft should not be able to take over Activision and the spread is only about 30%. And here you have a 60% spread. So I would say that the market is very negative on the merger closing.

If I could just, when I was getting ready for this podcast, you know, I was doing my standard. I'm sure you've got it. You've got your, hey, if you've got cash in stock, here's what everything's worth. And as you said, here's the spread. And I did it the first time and I forgot to drag my cells down to include the value of the share component. So I only had the $90 plus in stock. And I was like, oh, 40% spread. That's pretty big.

And then I was like, oh, my gosh, I forgot about this extra $20 and shit. Like, it's big even if you ignore the share. So, you know, just neither here nor there. Just a funny story about me not being super confident in Excel. Exactly. When you forget part of the price, it's still having 40 cents spread. Exactly. The spend here is out of the world.

And the reason is pretty obvious, I think, for most market observers, Silicon Motion is a semiconductor company. We'll get to discuss exactly what they do. But a semiconductor company, a tyranny, a semiconductor company that has been bought by an American company. And among all the approvals in the world, which it already has, the one that has not yet received is Chinese approval.

Given all the, what we'll call it, tension between America and China now about semiconductors, with America banning China from buying many advanced semiconductors, technology, et cetera. I'm sure China is not happy with America's

semiconductor policy at the time. So the question is whether they will allow an American company to purchase is a Taiwanese company in the seven-conductive space when they have the right to deny approval. That seems to be, I mean, the reason why most people are expecting not to close. It's officially, it's supposed to be reviewed

by Chinese Samar, S-A-M-R, which is an antitrust review on antitrust basis was really nothing to pick on in the case because Max linear and Silicon Motion don't have any overlap. They're both 70-doctor companies, but in different reaches. So there's really no overlap, no antitrust risk at all. So if they were following the rules, there's really no way for them to no approval. I don't think there's a reason to believe that China has to follow their own rules.

So will China approve or not approve, have no special insight? Very well, they might not. Probably the simplest thing for them to do is just drag or the feet, not respond and not respond until they run the clock out, which I think is the preferred method of when they want to deny approval, just... Yep. I get back to it. And for anybody who's an event, we're very familiar with this.

You know, just this year there was Rogers Dow, or was it Rogers-Zapunt, one of the two. I'll probably bring that up later. The famous one everyone remembers is NXPI Qualcomm back in 2016 or 2017. So people are very familiar with China using Samir to just drag out, drag out, drag out, until eventually the company say, all right, there's no way this merge is going to go through. Exactly. So, okay, so this is the situation where I said a high risk would not going through and a high spread. And I just described that type of situation as being unattracted.

So why do I say Silicon Motion is a merger R for people who don't like merger R. But the reason is because I haven't believed that Silicon Motion is worth much more alive than that. I believe that if the merger doesn't go through, we will make more money in one term. as shareholders in a standalone Silicon Motion, then we would buy it being purchased. Fun fact, when Silicon Motion announced a merger to be bought out for about $107 a share by Max Linear, I actually reached out for legal advice to see if there was any way I could block the deal because I believe that $107 vastly undervalued Silicon Motion, as a company, it turns out that Hayman Island's domicile, there was no real way to.

there was nothing to sink the teeth into. So we didn't have a way to try to block it. But if this deal doesn't go through, I think that's great for investors. So basically the way I view it is 60% of the deal goes through from the present price and even better if the deal doesn't go through. So really, although I call it a merger arm, it's really a fundamental deep value play on Silicon Motion

as a standalone company, even if we have no opinion about the merger. So let me discuss what Silicon Motion, what's so attracted about Silicon Motion of the company. So I'm basically going to say Silicon Motion has, I would say trifectar, but I want to say four things. Quad-factor, the quad-factor of everything we could want in a company. One, highly preferable. Two, fast-growing. Three, low-risk and diminishing competition. And four, super low valuation.

You do not usually have all four of those at the same time. It's usually, you know, profit, growth, or cheap, pick two or three, or pick one of three sometimes. And this has all them, highly profitable, fast growing, low risk, and cheap valuation. So really, I think this is the, if I can get five companies like this for my fund, I would go for it. You know, as you said, I mentioned that I run a concentrated fund. So I only invest in very high conviction idea.

We invest in four to five companies at a time. There's got to be high conviction to slide into my fund to begin with. And this is the highest conviction idea I've ever had. We're holding about 35% of the fund in Silicon Motion. And the last long letter that we wrote about Silicon Motions, all the moving parts, We actually titled it, hounding the table on Silicon Motion, that the price was around here about 60s, a few months ago, the event 2021 before the merger was announced. It was trading around 60, and we said that it's just not a price.

It's price that does not make sense for the future of this company. Do you, it's, I want to dive into a bunch of things you said, but let's just start with one. You know, it's common in event land where you'll see something that's got a, Rocky arbitrage or even just a normal arbitrage and people will say, look, this thing is trading discounted because no one wants to touch it. There's no natural buyer, right? The classic all the time, like a utility company agrees to sell for 10. Two months, a year later, the utility index has doubled and the stock's trading at 980 because

there's questions over if the deal goes through or not. And people will say, look, this is because no utility funds or any. who indexes to the utilities can buy this because it's under arbitrage. And no arbitrage people want to underwrite the fundamentals because they want to get 10 or get out. And so it's kind of broken that way. Do you think something similar is happening with Simo where it's, hey, if you're a fundamentals guy, it's pretty obvious that the merger arbitrage here is really rocky and you don't want to step in front of a deal break. And then if you're a finance guy, if you're a merger arbog guy, it's pretty obvious the deal's rocky.

So you don't want to like kind of underwrite too much in fundamental value. Do you think that's what's going on? It might be. Listen, people ask me, I've been asked, if the deal breaks, what will the stock drop to? So I'm torn between thinking that the stock has already dropped. That this is the price that the market thinks it deserves the deal breaks. The market isn't pricing and the deal.

That's one way of looking at it. The question is, really, the shareholder base now, is it mostly people who are believers in Silicon Motion and are waiting either for their $107 or for the company, to continue as a standalone. I know there are many shareholders like that in the base. Or has it mostly transferred to merger ARB hand who are hoping to get the deal on the,

maybe they don't think it's likely, but it's enough of a spread to track them anyways. They figure that even if it breaks, it won't go down so much. But then they'll be allowed for selling. If the deal breaks, all the merger are people are going to leave, and then they'll just be dumping,

it even if it doesn't make sense. I don't know. I can't tell you right now what percent of the float is in merger our hands, which will dump it on a break, and what percent of the funds are in index funds or in other long-term shareholders that are just going to keep going on it anyways. So I don't know. I don't know. If the merger breaks and the stock drops more, it'll just get more attractive, so it'll be a reason to buy more. I always feel that, you know, trying to time, some way we can't time the markets as a whole. You can't time a company. You can't say this is a great company. It's worth double, triple the price, but buying four and a half month and three hours. I mean, I can't tell you what to buy. I know that now the price is extremely attractive,

so I think go for it now. That's the way I look at it. You know, I think we mentioned Twitter when I can't remember I said explicitly or implicitly, but when I said we had something to talk about in July, I was referring to Twitter. And one of the things, I mean, I don't think I swung as big as you, but I swung pretty big. But one of the things I regret it is like, if I started from the end and worked backwards, I was like, Twitter is 95% to win this case. And I always thought that every time, you know, and but I never quite, I certainly never swung like I thought it was 95% because I would joke to people. Kelly Criterion said, you know, if you think this is 95%, you should sell your kidney,

sell your house, sell your dog, and put it all in Twitter. And I certainly didn't swing that. But I never swung quite as hard as it wanted to because I was like, I'll wait for the trial to get a little bit bigger. I'll wait for this event. And then, you know, it just, it's settled. all the sudden. Now, nowhere. Elon just said, I throw in the towel, I settle. And I kind of regret, like, if you're that convicted, just start from the end, work backwards and say, take the position now. And that's obviously what you're doing. You're kind of like cutting up there. But there's two things we need to talk about here, right? We need to talk about the merger arbitrage angle, which if it plays out, you might not be happy, but I think a lot of people would be happy walking away with the 100 in the near term. I think it's unlikely. People can see that from the share price, but we should discuss it. And we should talk about the fundamental angle. So we're do you think we should start? I think we should start from the fundamental angle. Okay. The base value of any companies understand what the company does and why it's worth more, if it is. Great. So let's start with the fundamental angle. You mentioned a couple of things in there. You mentioned growth. I think the thing you've mentioned, and I've heard about you

talked about before, you kind of started alluding to it, is that they are, I don't want to put words about it, but they're a little moaty and they're getting more moody, right? They're taking a little bit more share. They've got great partnerships. A lot of the competitors are exiting. So if you can expand on that and we can use that as a jumping off point for fundamentals. Let's first tell everybody what Silicon Motion does. They're probably waiting. I don't know how many minutes it was, but that 15 minutes in, we haven't said what they do. They're a semiconductor company. What do they do? So Silicon Motion makes controllers for NAN Flash. Nan Flash is the memory that's ubiquitous in matter computing, iPhones, iPods, smartphones, tablets, your laptop,

your computer, the data center, anywhere that has storage used to the hard drives, has all been transferring to flash memory, SSDs, et cetera, the data center, your automotive in the infotainment center, in the telematic center, in the self-driving, internet of things, your, if your toaster oven has some sort of, you know, SSD, I don't know what they're putting it in nowadays, but, okay, that's a fad, the toaster oven part, but, but, but, but there is a growing internet of things, you know, the home video cameras, the industrial, lots of places with flash memories going everywhere there's flash memory, there's a flash memory that runs the flash memory and it's important for we're leveling, it's important for

garbage collection, for prolonging the life of the memory, hardware level encryption, all the different things that, depending on what the end case use is, what the, you know, what the end market is what type of controller you need, but they all need controllers. Everywhere there's Flash, there's a controller. Silicon Motion is the largest merchant controller, largest merchant provider of Flash control. What do I mean by merchant provider?

So Flash has made our seven companies that make all the Flash in the world. So that's Samsung and S.K. Heinex are South Korean companies. Then we have Kochshia, formerly known as Toshiba. That's a Japanese company. Then we have Micron, Western Digital, and Intel, which was bought by S.K. Heinex. And those are American. And then we have YMTC, which is a new entry, a new entry from China, but has started to catch up.

And now I think they're ready at the commercial level of actually having customers. So those are seven flashmakers in the world. The seven flashmakers, they can make their own controls. That's an in-house controller. And then a merchant controller is when there's a different company making the controller and is being paired with the flash from these seven flashmakers, either by the flashmakers themselves or by a third party called module makers. Module makers buy flash from the flash controller, from the flashmakers,

combine it with a controller from Silicon Motion or someone else, and then put together the package and sell it out with. for market. So Silicon Motion's customers are the flashmakers themselves, these module makers, and also in a large sense, the

customers are their customers, the OEM, the Dell, the HP, the Apple, I don't think Apple the customer, but the OEMs who are making the products, they're highly involved in choosing who they want to be there provided for Flash, who they want to be the provider

for the controller, etc. So those are the pretty overall overview of what the market looks like. Perfect. Historically, the risk, I'm just going to start over with what we're talking about, how the risk is diminishing and competition is agony. The biggest risk that has always faced Silicon Motion, at least the market fair, has always been that the in-house controller teams by the flashmakers, that the flashmakers will take more of the market for the market.

themselves use out Silicon Motion and other merchant, merchant controllers. What's actually been happening has been the opposite. Over the years, more and more, the flashmakers have been outsourcing their controller needs two third parties like Silicon Motion, Silicon Motion being the largest. And the reason for the is actually pretty simple. The flashmakers, their competitive advantage is knowing how to make. flash, building the fabs, bringing down the costs of the fabs and the course of the production, the manufacturing on the flash.

That's their competitive advantage. That's their secret source. And that's where they have to go and compete in the market. Actually making the relatively small percent of the chip of the controller could be as little of 50 cents. It's not the, it's a critical component. It's needed. but it is not the majority of the package

by any shape, size, or form. And they can't amortize the cost of every new generation of controller being more sophisticated and more expensive. They can't sell to their competitors. Samsung's not going to be able to make control and sell to SK Heinz. XTS is not doing business with Samsung.

Their competitors are flash. They can't buy control to each other. So they're limited for amortizing the cost of development of control over their own production only. So Conmotion can amortize the cost of control across the entire ecosystem. So, Mordeca, if I wanted to just like dumb it down, and obviously it's not quite this simple, but if I went back to the 90s and 2000s, could Dell and HP, could each of them have made their own operating system and made their own processing chip?

I mean, technically, yes, there's lots of network effects and everything that I don't think would apply here that would have applied to Microsoft and Intel, obviously. But, you know, especially on the process ship, technically, yes, they could have, but you know what? It was probably better for Intel to do all that R&D, build the giant app and then sell to Dell, Microsoft, Dell HP, Apple, all of them, and amortize that cost over a much bigger base. So here, I mean, I'm not saying it's as Modi as Intel in the 90s, but it does, it's a vivers built and all of them are saying, hey, we're one of six, one of seven. We have 20% market share. If we give 100% to someone elseworts is making this thing that, you know, is a reasonably small cost of the overall

all-in package. It actually makes more sense. They'll be able to amortize the R&D, amortize their scale. They'll be able to produce it basically, bottom line, cheaper than we could if everybody did this in-house. Am I thinking about that correctly? Absolutely, absolutely. The flashmakers have to retain some control of talent in house because as they're developing the next generation of Flash, they have to be able to test it. They have to be able to see how well it's working. So they need some sort of in-house controller talent.

And at the very high end, the controllers are extremely expensive. I just got control about 50 cents a chip. You could get controls for a few thousand dollars in chip at the very high end. So at the very high, pretty high end enterprise, So that's already more attractive, higher margin, relatively for the flashmakers to compete in. That market, they're still competing in as a core competency.

But the lower end and the mainstream, that's a living goal for cell commotion. So let's talk about all the various competitors over the years who have just fallen by the wayside. One of the big competitors was Marvel. Marvell was, let me first take a step back and break down the different divisions of the company. Silicon Motion has basically two main divisions cover most of the company, and then the three main divisions cover the company. The first main division is a client SSD. That's the hard drive place.

It goes to computers, laptops, low-end data. centers. There's also enterprise SSD, which they are entering, but have not really entered yet until probably late next year. But client SSD would be in, as I said, computers, laptops, game consoles, and low-end data centers. Then that's about 10% of their revenue. Then there's EMMC and UFS. EMC and UFS. EMC is a legacy smartphone technology. It's still used a lot in low-end smartphones and Internet of Things but the successor technology

is UFS that's being used on the premium end of the smartphone and the mainstream as well nowadays probably will eventually go down to the low end at one point that EFC and UFS business is about 40% of the business and then

the rest of the business is industrial and they have a division Shannon which does Chinese hyperscale data centers basically so basically means they sell to Alibaba basically that one customer Alibaba and Baidu also a little bit that hasn't been doing so well that part of the business is a small little sliver I guess it's optionality that maybe that'll take off one day but basically right now we're

looking at the client SSD and the EMC UFS that's 90% of the years so So on the client SSD side, Marvell, who used to be very big in hard drive controllers, so as SSDs were taking over the market, they started doing SSD controllers as well. Marvel, of course, is a heavyweight, much bigger than Silicon Motion. Marvell was not successful in competing with Silicon Motion. Marvell's and so on their revenues and profits in that division were kept on increasing. they were actually asked on the conference calls you could read, well listen,

the conference calls where they were asked point blank whether competitors say that they're winning share from them. And they were referenced in Silicon Motion, nobody mentioning anybody's names, but Silicon Motion is winning share from you. And then, no, no, that's not really true. We're doing fine.

We're doing great. We're doing great. They kept on saying they're doing great, they're doing great, they're doing great, until they announced in 2018 that they're pivoting away from the client desk. SSD space to focus on enterprise SSD and where they are, which is a major chunk of the business now, Enterprise SSD, but client SSD, they're basically abandoned because they were being unsuccessful. You can see for yourself as SSDs come out, you see whose controllers are in them, and Marvell was having less and less of the market and Silicon Motion, and a load of the fires from getting more and more of the market. Marvel has been squeezed out.

So that was the first, you know, competitor that just exited stage left in 2018. 2019. Kingston is technically a module maker. That is that they don't make any flash. They're buying a flash for the flashmakers and peering it together with controllers from third-party companies and selling on. But Kingston is almost a tier one company in terms of they're almost as big as the module makers. They themselves are selling 10% or more of the world supply of SSD. So Kingston is very big.

Yeah, client and an enterprise. Kingston was actually a shareholder, 7% shareholder in a competitor of Silicon Motion, FISA. Join Venture with FISA and the exclusively used FISA controls. That was until 2019. 2019, they started using Silicon Motion and there been increasing 2020, 2012, they kept on increasing Silicon Motion share by Kingston. And that says quite an endorsement when you're basically the joint venture competitor is coming to you for the controllers and moving away from FISA.

It just shows you that Silicon Motion was succeeding in execution and the R&D and putting out the product at the price point that customers wanted and the winning market just. Then in 2020, 2020, they had one, they had one client, SSD, a customer that was direct flash, one of the flashmaker customers that had one in 2020, 2021, that's two. in 2022, that's seven, which is all of them. Yep. Started working with basically everybody. Naturalist module makers. And their OEM business, which is very important, there's two parts of the business.

The module maker business is a little opportunistic. Depending on the price of flash, they need to get allocation. When there's type of supply of flash in the market, the module makers are last on the list to get. When prices are high, they'll last on the list to want to buy because their margins are being crushed. So they're more opportunity buyers.

They want to buy more when the prices are down, when the supply is high, then the Maljumakers are coming in a buying flash and therefore need controls. When the prices are high, supply tight, mausermakers are not there as much. So Maljur makers in the business, they want it. They start to have about 70% of the Maljumakers'

client SSB business. But the OEM market, meaning the Dells, the HPs, the apples, who are long-term contracts. They need to multi-year roadmaps. They want to lock in their suppliers, know who they're using, and they want to make sure that they have that supply.

And even when prices go up, they still need the supply, they still be selling, buying flash, producing product, and pushing it into the market. So they historically had maybe like 25%. share of the OEM market, 2020, that went up by 30, 2021, they have 40%. And in this year, 2022, they've won 50% of the OEM slides. As you see, a line up to the right of growing that market ship.

Who's got the other 50% at this point? So some of that is going to be the flashmakers themselves. Yep, okay, just making sure. Yep, that's who I thought. Fisen is probably the biggest competitor. It's Fisen is the biggest competitor Fison is somewhat a merchant controller

where they sell it for third parties It's a little bit also a captive producer for Kingston a little bit And for Kokesia, Toshiba Who is also an investor in FISA So So to call them a merchant controller You could look at that a little bit

as a joint venture arm of Toshiba and Kingston. You've talked about how a lot of the potential competitors have come in and given up or lost a lot of share. If I just said, Mornika, of the controllers, of the flash controllers out there, what percent of the outsource market do you think Silicon Motion owns? And what percent of the overall controller market do you think Silicon Motion owns? What would you say? It's hard to give an exact number on that. the module makers SSD they have about 70% share

70, 70. 70. 7.0 on the maljumakers as a client SSD on the OEM SSD they're having around 50. And that's overall. That's not outsource. That's overall. So including the stuff that the flashmakers are making in touch. So they, in all of their divisions, they've got the majority.

I mean, if you've got 70% obviously your multiple is bigger than a possible competitor. So I would say that they have a, yes, quite a decent share of on the EMMC it's a little harder.

Fisen I think is much larger in the EMMC market than the client as a fee market. I believe still that that overall the Silicon Motion has about It's hard to say with the show numbers, I'm sorry.

It's fine. So let me just jump to a question that I think, look, I'm a generalist. I think a lot of people who listen to this podcast are generalists. Not a lot of people are semiconductor experts, right? But I do think a lot of journalists will hear this to say, oh, this is a great story, right? You've got a niche product, you've got a company that has the majority of market share. We've already described how it's a growing market.

We've already described how, I mean, anybody who hears, hey, I think I misspoke before. When I said, when I was referring to, I was referring to the outsource market when I said the loans. Okay. The numbers of the outsource market. Samsung does all the client that says these, almost all the client that says these are in-house by Samsung. And that's about 34% of the market. that's kind of quite close. If Samsung ever decided to outsource their client SSD

that would open another avenue of growth. Tell me if I, they do. The market is probably closer to 40% of the, 30, 40% of the entire market. Even there that's huge. But tell me from right, they do have partnerships with Samsung, right? Like, Samsung has started working with them. And I know in 2023, I think they've got partnerships announced that will ramp up their Samsung work.

Yes, Samsung and also on EMMC that partners. And we'll come back to it. But I guess, you know, If you're a journalist and you're hearing, like, you're hearing a lot of good stories here. But I think any journalist is going to hear, oh, they serve the flash drive market. And every generalist has seen Micron at one point, you know, and the stock is just, for people who aren't on the YouTube, the stock is a wave, right? You know, you're hitting a cycle and there's a bad flash cycle and prices go to hell.

And, you know, it's oversupplied and micron stock is down 80% in a year. And then two years later, tight supply prices are going through the roof. Micron stocks a 5X inside a year, you know, like everybody's. seen the micron stock and i think people are going to bullwhip effect all this sort of stuff people are going to say oh these guys are supplier flash we've seen what happens to micron stock why are these guys not going to be super cyclical and yes we're going to talk about the low p in a second we're talking about the growth story but you know everybody knows semis are getting crushed right now why when people look at these and they're thinking the fundamental story are we not saying oh next year is

going to next year is going to be bad as oversupply flash pulls back all that and i would add to I guess I'll add stuff from the proxies that in a second, but I'll just, I'll pause there on that question. That's a great question. And it's a great question to bring out why this has absolutely no, no similarity to Micron at all. Micron, when flash prices go down, hurts Micron. Micron sells flash, and they end up selling at negative margins and lose money.

When flash prices go down, that does not hurt a Silicon Motion business at all. It actually helps the Silicon Motion business. As Flash's prices go down, it's more attractive than the remaining hard drives, you know, the main part of the computers that are still using hard drives, flash drives become more attractive. They get used more. They are tied not to the price of Flash, but to the volume of Flash. If the price of Flash goes down and the value goes up, that helps Silicon Motion story. Silicon Motion is selling the controllers.

The controllers are a different business. The more Vash is sold, the more controls are. If Flash is used less, that would hurt solar commotion. But in terms of the overall usage of Flash in the market, both on a percentage of what's using hard drives, what's using Flash, I mean, by now, I mean, it's already almost not 100%, but it's getting pretty close to maybe maybe 20% of the computers still using hard drives. I don't know exactly what the sensors are in data centers.

It might be even less. It depends on type of data center, actually. The ones that need high performance like Google and Alabama are basically all these necessary for now. So the, but the value of all this is just growing everywhere. Flash memory, besides the percentage, the market share the flash memory has of the memory of the storage space, the storage space is just exploding. Data centers need more and more, more memory, as the automotive,

to internet things everywhere flash memory is being inserted. Flash memory could crater that helps the business. Now, I want to do one caveat on that. If you go back to the 2018-2019 cycle where flash memory cratered, that actually hurt their business. Now, I just said when flash memory goes down, that helps the business. You're cutting off my next question. Go ahead.

The answer is that in 2018 and 2019, most, Most of their business was still module makers. Module makers, although they benefit from a lower cost, like I said before, they don't benefit from a volatile market. Then, not only was flashed low, it was cratery. And the module makers were nervous of being stuck with inventory that was at their own price. So they didn't want to make large purchases. And then the price would go down and they wouldn't be stuck with inventory than they couldn't sell. So the module makers pulled back for the voluminating.

multiple module. And since a lot of the business module makers, that hurt their top line. And secondly, they had their other division, which the 10% part, at the time, it was structured that they were buying flash, packaging it and selling it to Alibaba. So that was fine and all, but then they got stuff with inventory risk, and they had to take somewhat of write down on that. Now, all that said and done, they were highly profitable during the bad years. 2018, 2019. Their gross margins were close to 50%, just like they always are. Their skill went down a little bit, so the operating margin got hurt, but their operating margin. They were profitable throughout,

always building up cash. Know that on the balance sheet, by the way. Constantly profitable, even at the time that they were struggling because the margin makers were pulling back and they themselves had to suffer right down, and they were still profitable, everything's done them. But with the OEM market,

the OEM market is multi-year, sticky contracts, and by now, about 50, 60 percent of the business is very OEM market. A lower, even a volatile price won't really affect the OEM market. They're buying at high prices, low prices. They're going straight. A recession, which hurts the end market, obviously, you know, would filter down to Silicon Ocean as well. They have no more visibility into the world economy than anybody else.

But they're gaining, they're kind of a double growth story. they're gaining share in a growing market. It's a secular growing market. Flash, a memory is a growing market. Flash is gaining share in the memory market, and they're gaining share in the flash, which is gaining share. So it's like, I don't know, triple growth if you want. Gaming share in a growing market and a growing market.

So let me just, I hear you. So this is a, I think we're just saying this long-term growth story, it's price attractively, whether, you know, as you said, when the merger got announced, you thought it was worth more than the merger price. And it sounds like you still do, but I do just, I hate to dig into the next year is going to suck angle, but I do just want to dig into that a little bit more. You know, I look at, so as part of the merger, and we'll come back to the merger arbitrage in a second, they publish a proxy, right? And I believe the proxy projections were made in late Q1, 2002, right?

So they published proxy. 2002, they say we're going to, we're projecting 1.15 billion in revenue with EBITDA of 366 million. for the first they are they're not going to do a billion of revenue this year right and uh i i don't have the ebidah number but they're going to come far far short of that ebidah number and you know you see that you see gross margins in q322 have cut i think gross margins are coming down below to 47 percent for the first time you know well below 50 percent for the first time in a while operating margins have come down to 25 percent which is kind of where they were at the nadir in 2019 if i remember exactly. They were even lower in 2019? Yes. They actually in 2000, they entered 2021 with 20%

operating margins. 2021 brought them up to 27%. That dropped a bit down now 25%. I think over the next few years, I'll read 30. Okay. Yeah, because I'm looking at 2000. I was looking at 2019 overall. I was looking at Q4 accidentally, but that was 24%. For 2019, they did 21%. But still, they're starting to get pretty low. So I guess just, you know, I'm rambling here, but it's easy to say, hey, look long term. This is growing, all this sort of stuff. But I think people are saying, ooh, the cycle seems like it's turning and it seems like it's turning pretty quickly when you're talking about in five months going from 1.15 billion projection to under a billion. Like it seems like it's starting quickly. It seems like it could get ugly. It was 1.15 for 2020. That's not,

that's not that's not such a huge difference you said 1.5 so 1.15 to under a billion is what they're going to do in 2020 to project in march that you're going to do 1.15 so you've already got three four you've already got three months in and you've got you've got some projection to come under as i said before they have no more visibility to world economy than anybody else they can project the next quarter maybe but not more than that the rest is just what their customers are telling them and the customers don't really know either. So, right, what the role of the kind will do,

the semiconductor space, you know, goes up and down, up and down, that's fine. But, you know, if you look at the big picture here, in 2018 and 2019, 2020, they were doing about $500 million revenue. 2021, 2002, they saw the step change. The step change is because of all the competitors exiting the market. We spoke about clients as a team.

Maybe we'll speak about EMC also. They had competitors exiting the market. They got much more in the market. year of 2021, 2021, and they basically step change from 500 million revenue to one billion revenue. I want to emphasize that that step change was a permanent step change. It wasn't, you know, pandemic, uh, drawing in revenue. That wasn't a lot of people probably do look at the growth in 22 and 21, or in 20 and 21 and say, oh, COVID beneficiary and what you're saying. It was market chigings. It was market chriggings. The market as a whole didn't grow that much,

certainly not 2022. It's market chriggings. They grew a lot of, the market share. They grew from 500 million revenue to a billion revenue that took their operating margins from 20% to 25, 26, where they're holding me out. And for 2023, this year already has been a year of a lot of suffering. 2021 had 2020 to do 20%, 2021 that you're 70% 21% on that point. 2022 has been a hard year for the time of the industry. They're only going to grow about 8%. That's on the bad years, yeah? So, yeah, so they're a proxy that they put out of March. Don't use that practice.

We'll get it for yourself, yeah? Instead of growing, you know, 71% that they did in 2021, which was a one-time step change, they grew up 8% this year. But they have future growth built in. They're exiting in the year with more OEM slats than they entered. So 2023 will probably have a higher market share overall than 2022. And they're starting to enter the,

the enterprise market as well. They're sampling now and they're entering probably full-scale production toward the end of next year. And that's the greenfield market for them. They haven't competed in the enterprise market as well, but they out-competed in the client, and I can very well see them doing well in the enterprise market as well, which would be just adding growth on top of everything else.

But even if they just stay at the $1 billion and then continue to grow as the market grows, you still expect 510% growth, you know, for a while just in the markets that they're right now investing in besides enterprise market. So I know you said don't look at the proxy. I can't help but look at the proxy, but I do just want to ask, you know, you said when this deal was announced, I think the all in, at the time with the MXL prices and everything, I think the price was around 110, 115 was the all in value. Like, how do you kind of look at the? they announced it as, but as soon as they announced it, maximum you drop, but they're taking on a lot of debt for it. So really, we've got 1007 from the beginning.

How do you look at the value? Because you did not want that price. How easily you think it's worth more? Because when my, my dumb model of it, again, I looked at the proxy, even if you told me not to, I was kind of looking like 2025 unlevered free cash flow in the proxy is 363 million, slap a 10x multiple on that. Maybe that's too low. I'm not sure. That gets you to 3.6. then I assume they get the break fee, the cash on the balance sheet. That could you do about a $4 billion enterprise value. That would be about $120 per share price. And then I guess I'll just call the cash they generate until then versus the time, value, money, fair value.

So that would get me to about 120. Do you kind of, where would you disagree with those numbers? So, well, first of all, the numbers on 2025 on the practice are definitely made up. That's for sure. Yeah, I hear you. I know you told me not to, but a management puts that projection out there. And I can't help but just kind of speak about it. They have no idea of the downside.

That's just pulled out of some of the stomach. But so like this, the way I look at it is we're dealing with $1 billion revenue, about 25% operating margin. They're running about $200 million income, net income, which all flows down to cash, $200 million of cash a year. And they're a company that, I don't know whether they'll They grew 8% in 2022, approximately. I don't know how much they'll grow in 2023.

Maybe it'll be down. It's already been a year of tough semi-conductor market. A lot of people are thinking that's going to start turning back in 2023, first half, second half. A lot of it has been inventory reduction. So it could start turning around. Maybe we'll hit a recession. I don't know.

By the end of 2023, I think we'll probably most likely be ready to turning back up. But whether yes or no, I don't know. expect 2020. We're now looking at a 20% cut in any way, shape, or imagine. The most I can imagine, maybe a 10% cut. I can easily hear a 10% or even 20% increase as well. On the long term, I see it growing at 10% a year, even if the enterprise is not successful. If the enterprise is successful, I can see the enterprise being another 50% on top of the business that we have now. EMMC and client DenseC are both growing very rapidly in the end markets. It's a recession, so that might pause them for a little bit.

But in the end of the day, it's a second growth market. And they're not going away anywhere. Flash is still going to use. So I see it as a $200 million net income. I believe the operating margins are going to go up over time to 30% as they get more, leverage on the operating expenses as the revenue increases. So long term, I see them that we'll be making two years down the line. I see them making probably closer to about 300 million, $500 million, $2,000,000,000, let's

say, in 2024, that's the way I see it. And I think that a highly profitable fast-growth company should be used a P of 15. I mean, I think that's low, but let's give it. a P of 15, you know, maybe the Tijuana needs discount, but, you know, CSMC is also a Tijuana company and they don't have a P of 9. Right now, Silicon Motion is trading at a P of about 11 and a half. And a quarter of the price is in cash, is in, it's basically cash, current assets, highly liquid assets.

So if you X that out, we're looking at a P of that in a half. I think they can they easily deserve double that just to be maybe fairly valued yeah that's the price about 130 and honestly even at that point you'd be getting a good company

it would be a fear price for a great company companies continuing to grow continuing to be profitable as I said before even in downturns they've been very profitable and their margins have been pretty steady the gross margins they've gone down in the past sometimes they've had years where they were down

back when they had the module maker and other issues, they were down 25% revenue and their gross margins were almost rock-stable. Yeah, the gross margins go between 47-49, basically with the margin to grow, depending on exactly which section of the business is selling what, is basically what it was anto. I just want to point out, you made fun of me for using the proxy number, and then your end game, the earnings number you threw out was 350 million-ish, which is what I got from the proxy as well.

Raxie was in 2025, I believe. That is true. I have that a little earlier. Look, this is great. I'm a little worried about time and people always laugh when I say, oh, hour long podcast. I'm like, we could go two hours on a lot of these names. But I want to turn over to the merger R by starting with what I think is like kind of important thing, both for the fundamental and the merger R case.

And that is, why did MXL decide to buy Silicon Motion, right? Because I think when you see that, it helps you think through both the merger arbitrage case, and it helps you think through the fundamental case. So I'll kind of flip it over to you on that. Well, honestly, I think the reason is because MXL CEO was bored and wanted to increase his feefdom. They're serial acquirer.

They've inquired other companies. They take on a lot of debt for it. I don't know whether it will turn out well for max linear shareholders, honestly. Maxillian shareholders didn't get to vote on it. If they voted on it, they probably would have declined because of the extra debt. You didn't get to vote on it because they weren't

giving away enough shares. It was mostly cash. transaction, which is probably why they structured it that way. They're going to take on a lot of debt. That's going to be more expensive with the higher interest rates now. I wouldn't be a holder, Max Lanier, personally. They're loading into the load it to the, to the help with debt, and they're adding more. But they're just trying to become a bigger semiconductor business.

The way they say it is they want to have, a larger kinds of scale with TSM and with their other semiconductor suppliers and manufacturers to be able to get better prices and better allocations, et cetera. And maybe there's a greater truth to that, but if you meet you in the landposts, and the end of the day, I think the CEO wants to be CEO of a larger company. So look, I think you're probably right. MXL stock drops 20% the day that they announced this deal. It is a big premium deal when they announce it.

A lot of debt gets taken on, not a lot of shares big debt. but so I think you're right there that does speak some concerns though right like they say hey we're buying this company with a lot of debt for let's call it 110 per share whatever the number was like if the market thought this stock was worth 150 per share even if they were questionable they'd be like oh you rhyme that with all debt there are synergies here the market you know goes to the root I don't know how much of synergies are real honestly I don't think that I think synergies are usually overblown there probably aren't that many synergies being that they're not in the same niches of the market, they can't find, what's the main expense of Silicon Motion? The main expense of Silicon Motion is the 1,200 engineers that they, say, 1,400 employees, 1,200 engineers, 1,200 of them engineers. They can't have to keep all those engineers. All those engineers are doing engineering work. They're not going anywhere.

And then the next expense is the payout and the, and the paying TSM, there's not going to be too many signatures on that. TNSMC is not going to go to MaxLineering and say, oh, so now you're bringing me Max Max Linear and Silicon Motion business, we're going to give you 20% discount. I doubt it. that they're going to get much of a, that's still going to be tiny TSM and there's still going to be price takers on whatever TSM, you know, charges that the customers. I don't think the synergies are that real. I think that that is concerning. But as you say, even before

the merger was announced, the price was trading in the market for $70 and I think it was worth more. So, yeah. So I think the market had a different view of the fundamentals. I think the market mostly is, A, comparing it too much to micro, like I said before, not recognizing that they're not cyclical like the flashmakers themselves are. Two are not attuned to how much of the competition exits the market. We spoke on the client to SSD side with Marvell exiting, Kingston is starting to use them instead of their joint venture. And the OEMs gave me more and more shear going for 25, 30, 40, 50 percent of OEMs. and more and more of the flashmakers outsourcing their client SSDs to silicon motion. If you talk about the EMMC side of the equation,

the EMMC is supposedly a legacy technology. Low-end smartphones, the higher-end smartphones are now using UFS. But on the EMMC might be legacy, but it's growing very quickly. The low-end smartphone market is still growing, and Internet of things is being used in, and it's growing very much there as well. And the EMMC market in 2021, Samsung decided with the Texas, their fab in Austin, there were to freeze there, and the fab closed down. It took a while to start.

Samsung decided that the EMMC market would no longer for them. They don't need to make those controllers. They're still making the flash, but the controllers are not going to make. They're going to outsource the controllers to Silicon Motion, among other. Silicon Motion is basically the largest EMMC merchant controller out there. they're doing a lot, a lot, a lot of volume on the EMNC market. Let's look at the difference. In the first half of 2021, before Samsung exit the market,

they were growing the EMMC division by about 50%. Third quarter of 2021, they quadrupled. Their growth went to quadruple. Just that's the difference when you're having to get better and not having to get better. So EMC is highly grown. And then the UFS, which is the SQL, you know, the high end and the mainstream of smartphones and tablets, they went from originally, they were the exclusive supplier to S.K. Heinz's EMMC. One of the things that went wrong for them in 2018, 2019, we spoke a little bit about what went wrong.

Everything went wrong at the same time. SK. Hynix, in their transition from EMC, 2FS, decided not to use Silicon Motion was doing. it in-house, yeah. So they lost, over a few years, they lost a lot, a large chunk of that business as S.K. Heinz's EMMC business turned to SK Heinz's UFS business, which wasn't using them. So they lost a good 23% of their revenue or so. So that was a large chunk. They made it up with EMMC to other customers. They made it up with UFS to other customers. They were the exclusive, our exclusive supplier to Micron's UFS. And they went from one UFS. customer to two UFS customers in 2021, to seven UFS customers in 2022.

Can you just real quick, the customer who decided to in-house, look, you're more familiar with them. When I do these podcasts, I generally look at the most recent 12 months and stuff. Could you just talk more about that? Because it does strike me, like, we've pitched this, hey, they're taking share, all these competitive, but you have one customer who decides for, at the time, it sounds like they were 20% of the business. And I do remember you mentioned this in the video you did now that I kind of think back on it.

But can you just mention why that customer made the decision and why this isn't as big a risk as people might see? Because I do think anybody who's listened to it, probably heard that and said, oh, somebody took 20% of the business way in-house in 2018. Like, there's a risk we haven't thought about so far. Yes, right. So I can't tell you, Jack, it will go through S.K. Honeyx's minds. You know, they decide to take a business from sell.

They thought they do well with it. Honestly, I think it ended up. being doing poorly for them. S.K. Hynix is not so large in the UFS business, and a major part of that is because Micron with Silicon Motion's controller took more of the business, of the UFS business market, away from SK. Hinesk. Hinesk had not a lock, but had a very large position in the EMC market. And when they transitioned to UFS and use their own controller, they lost a large part of their position in the market, two competitors who use the Silicon Motion.

controls. I don't think they actually worked that well for them. They replaced their UFS, their non-existent UFS sales, SK-onics. They replaced it with Micron, with other customers, Intel, other customers that are using their UFS. And they basically replaced all that, you know, usually you find a company to move 20% of the revenue. That's not something that you're easy to recover from. But if you look at their, at their revenue over the years, it's not so easy to pick out where that 20% loss is, because other parts of the business growing in such a way to cover that up. They had that and the

marginal maker, the price value to use the module makers and their right-offs. So it was kind of everything going wrong at the same time. And still they were doing quite powerful. And not growing, but 2018, 2019, 2020, 2020, they were basically treading water as they turned over

the SK-Henitz business to their other customers. But UFS has been grown for them, close to 30% year over year nowadays. So that's continuing to grow and basically all parts of their business right now are on growth mode. That's perfect.

I just want to come back, we're reading pretty long, I just want to come back to a few things. We mentioned why is MXL doing it? I do just want to, they say 100 million in synergies, the whole, the two combined companies

would have like 570 million in pre-s synergies operating income. I'm with you. I think that's a really high center. number. These two businesses don't don't exactly fit hand in glove. But at the same time, if you go through the filings, Max Linear does kind of have a history, or at least they say they've got a history of way exceeding synergy targets and mergers. So, I mean, 100 million on again, $570 million in pre-Senergies EBIT. That's a big number. And maybe you think they can exceed it.

So maybe you give them some credit there. I want to just quickly, look, the merger are, It sounds to me, and I think you would agree, you're playing this for the fundamental value. If the Arab happens, I mean, you obviously think this is worth more long term, but if the harp happens, great, you'll take the 60% pop in a day, I guess. I personally think, and you can tell me if you feel differently, I think it's a very, not zero, but I think it's a very unlikely chance, you know, just China has not approved my, has not approved semi-MNA in a long time. And after what the Biden

administration did to China semi-industry a couple months ago, I don't think they're improving anymore going forward. You know, I do worry about for people who listen, Rogers, and it was either Dow or Jupon, I can never remember the two. They had a merger. It was trading very tight. Samir kind of

walked it out and then in early November, Dow looked at Rogers and said, oh, this stock would have been worth 60% less than what we're paying for it. We're just going to walk because Samir didn't approve and Roger stock went from like 250 to 100 in three days. I do somewhat worry about that with Simo, but the nice thing here is everybody knows that China's going to block it so it's not unexpected.

If the PE drops from 11.5 to 3, then I'm going to start my 11th by a take over the company. I do just want to ask you then. So let's say this most likely, I see most likely not a guarantee, but most likely this scenario. Samir blocks this in August or so, or they just don't approve it, and Max Linear walks. So Simo at that point is going to be a standalone company. They're going to get $160 million in break fee for Max Linear. That's about $120 tax adjusted. That's about $4 per share.

They've got $250 million in cash on their balance sheet. You have to think they'll probably generate a little bit more, even if sales turn down in the near term, they'll generate more cash over the year. Yep. So I just want to end capital allocation. I know what they've done historically. You know what they've done a story. But what do you think they do? They emerge. The thing breaks. What do you think they're looking at capital allocation going forward kind of 2030? That's a pause for the merger. The dividend dollar 40 a share definitely come back. Maybe have a larger, large amount. They've been pretty good at increasing dividends over time. They've generally been conservative in terms of holding a amounts of cash. At a certain point, even they felt it was ridiculous. And unlike most companies who buyback shares only when they're expensive, and then when the markets crash and things get a little nervous, they pull back on buyback. Surprisingly, they've actually been above average in capital allocation, and they have been buying back shares at loans, at large buybacks that they've done opportunistically in 2019. And earlier this year, earlier

before the merger was announced at low amounts and if the deal broke and the stock was still holding at 606, I would expect them to do a large share buyback simply because there would be a lot of cash would be close to 450, 500, 600 million

of cash on the balance sheet, I would expect them to announce a buyback immediately and either do it or not, depending on whether stockers, because they seem to be pretty good But at buying back stock, if the stock is low and buying back less stock when the stock goes up. So that's good. So just a couple points on that. So dividend, they used to pay, I think it was 50 cents per share per quarter, is that right?

About $2 per year. So you think that's coming back if the deal breaks? For sure. I'll come back at a higher man. And that's about $50 million in cash per year. And then as you said, they've historically been pretty good about buying back shares. Like, look, I don't know many semiconductor companies. It's not like they went haul hog on it, but they bought back shares in 2020.

They bought back shares when they were having the customer issues we talked about earlier in 2019 and 2018. Like, these guys do return cash to shareholders. So I would not be surprised if the deal breaks. They get tax adjusted, $120, $130 million coming in. They've already got the cash on that. I would be surprised if they did a tender for 10% of the shares. I wouldn't be surprised if they got pretty aggressive at taking shares out. And obviously that speaks to a management team that sees value in their shares,

reward shareholders, both that and the dividend, all that sort of stuff. Anything else on the capital allocation we should be talking about? Nothing that comes to mine straight. That's what kind of sums it up. Perfect. Hey, Mordecai, last question I always asked. We covered a lot here. I do think we glossed over the M&A angle, both for time reasons and because I think

both of us think unlikely it would be a bulk case. but anything you think we kind of gloss over, or you wish we had hit harder or anything we didn't even touch on that you think people should be thinking about here? Let me give you minutes to think about it. No, I think we cover all the bases. High growth, profitable,

lower risk, reduced competition, and cheap valuation. That's what I have. If I have five companies like this, I'd be set. I'd be able to take a vacation. Well, hey, Mordeca, I really appreciate you coming on for people. Mordecai's, I'm going to include a link to Mordecai's deck on Simo in the show notes. So go check that out.

It's a 15-page deck that nicely goes through everything we just spent an hour and talking about. And here's the thing. You run five stocks. You and I had Twitter in common earlier this year, and I won't disclose them. But I know you and I have two other stocks in common right now. So we might have to have you back on the podcast. One of them would be very spicy in terms of the online Twitter outrage. If we did it, we won't mention it here.

But, Mordecai, I really appreciate you coming on. I think this is great. And we'll have to do it again in the near future. Thank you for having me. Good speaking, too. Thanks to you, man. A quick disclaimer. Nothing on this podcast should be considered an investment advice.

Guests or the hosts may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advice. advisor. Thanks.