Intel (INTC) and Altera (ALTR): the numbers

Let’s look at ALTR before word leaked to Wall Street that INTC was considering buying the firm.

the basics

ALTR was trading at about $35 a share, with earnings of, say, $1.75 a share in prospect for 2015   …in other words at about a 20x multiple.  The long-term growth rate of eps is probably in the low teens.   The market cap was $10.5 billion or so.

ALTR is one of two firms that together dominate the highly specialized market for programmable logic devices–a relatively stable, by technology standards at any rate, area.

20x for 10%-12% earnings growth doesn’t sent me running to the computer to place a buy order.

where the value is

small stuff

ALTR had $1.6 billion in net cash on the balance sheet at the end of 2014–that after spending $655 million buying back stock last year.

Yearly SG&A is running at about $300 million.  Let’s say INTC could eliminate half of this by substituting its own corporate infrastructure.  That would be enough to boost eps by 25%, so we’re looking at a 16 multiple on current earnings, which would be more reasonable.

the big attraction–intellectual property

The main source of value for INTC is the company’s accumulated knowledge, experience and computer code for creating and operating PLDs. How do we measure that?

The simplest, and only straightforward, thing to do is to add up R&D expenditures over, say, the past decade and see what that totals.  This will be an understatement, of the value of ALTR’s intellectual property because:

–there will always be some R&D related expenditure elsewhere on the income statement,

–duplicating the firm’s accumulated knowledge means spending in today’s and tomorrow’s dollars–not yesterday’s.  The former is always more expensive, and

–we won’t capture stock based compensation.

measuring

1. For ALTR, the 10-year total R&D  is $3 billion.  Arbitrarily add $500 million for stock based compensation.  Add in the net cash.  We get a total of $5 billion in “asset value.”  That doesn’t stack up well with ALTR’s pre-leak market cap.

2. Another approach.  Current R&D expenditure is running over $400 million a year.  Let’s say it would take ten years of spending at the current rate to duplicate ALTR’s intellectual property.  That gets us to $6 billion in “asset value.”

3. Let’s consider the future earnings stream (this is arguably just dart throwing).  Ignoring SG&A synergies, and with 300 million shares outstanding, $1.75 a share in eps translates into net income of $525 million.  Let’s say earnings in eight years are double that, or $1.05 billion.  If earnings progress in a linear fashion (another incredible simplification–but, hey, this is what securities analysts do), then the total earnings over the next eight years will be just over $6 billion.  (Why eight years?  My experience in analyzing corporate behavior in takeovers is that eight years is the outer limit of future earnings that companies are willing to pay for in an acquisition.)

 

Okay, we’ve got one figure, #1, that’s too low and another, #3, that’s too high- (and a giant leap of faith).  Let’s add them together!

They total $11 billion.

Ta da!

That gets us to around the market cap of ALTR before the leak.  To be clear, I’m not willing to defend to the death anything I’ve written so far.  But Wall Street had to be tacitly thinking something like this for the price of ALTR to be at $35.

the leak   …and a dilemma

Look back at #2 above.  For INTC, the alternative to acquiring ALTR is doing #2.  This would be expensive.  More important, it would be time-consuming–time that INTC probably doesn’t have.  And there’s the risk that its effort wouldn’t be successful.

Therefore, the value of ALTR is higher to INTC than to you or me.  INTC is probably also figuring that it can expand the ALTR business dramatically over the coming years by stuffing every one of its servers full of ALTR chips.  Therefore, $10 billion price leaves room for the acquisition to be accretive to earnings in a few years.  Also, SG&A synergies.

On the other hand, any of us with a loose $10+ billion will probably find a lot of things we’d rather do than plunk it all down to buy ALTR.  For us, $35 a share is a pretty rich price.

this brings us to the leak…

Both sides can make up numbers as well as I can.

Both know there are no other suitors.

Both know that INTC really wants ALTR.

Hence, the leak, which I would bet came from bankers representing ALTR.  The idea is–let the market bid up the price/decide what the price should be.

I’m not sure whether the leak makes the situation better or worse.  My guess is that a deal gets done somewhere between $35 and $40.

 

 

 

 

 

2 responses

  1. Isn’t a bit of double counting to included future earnings, and the intellectual property which underlie the future earnings? Also, if R&D were capitalized as asset investment is, then there would be depreciation subtracted from earnings and that is reasonable.

  2. Thanks for your comments. Both are good points. The only thing I’d say is that no matter what liberties I take, I can’t find a reason for me (or anyone other than INTC) to pay more than $35 a share for ALTR.

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