ADI's management team is out flogging the benefits of the Linear Tech (LLTC) merger to the investment community. Earlier this week, on CNBC's Mad Money with Jim Cramer, Cramer interviewed David Zinsner, chief financial officer of Analog Devices. On July 26, ADI announced it would acquire Linear Technology to create the premier analog semiconductor company in the world.
The merger will create an analog powerhouse and expand the company's total addressable market from $8 billion to $14 billion. The merged company will dominate the data converter and RF/microwave space. In power management, amplifiers and interface semiconductors, Analog Devices will be the second-largest provider in the world.
The best part of the deal is the financials. The combined company will have a gross margin of 69% and a 38% operating margin vs. 62% and 23% for Intel, respectively. The combined company will have free-cash flow of $1.7 billion and a free-cash flow margin of 31%. Management projects a free-cash flow margin of 34% over 12 months, which means Analog/Linear would surpass at least eight other semiconductor makers.
The gigantic cash flow would allow the company to rapidly tackle the $9 billion of debt on the balance sheet it took on to do the deal. In fact, Zinsner told Cramer the company would have so much free-cash flow, it could probably pay down as much a $1 billion of debt a year.
ADI reported fiscal fourth-quarter 2016 results on Nov. 22. The company reported earnings of $1.05 per share, $0.15 better than the consensus estimate. Revenue rose 2.5% to $1 billion vs. the $940 million estimate. Gross margin was 66.6% and operating margin was 38.1%.
Industrial revenue (40% of sales) climbed 8% to $396 million. Automotive revenue (14% of sales) rose 7% to $142 million. Automotive sales were driven by "infotainment" and powertrain applications. Consumer (29% of sales) was down 7% year over year but up 58% sequentially. Consumer sales were driven by shipments to Apple for the iPhone 7 build. And finally, communication (17% of sales) was up 6% led by 100G optical applications.
While management gave guidance on the first quarter, investors are more interested in the guidance on the merger. The combined company will have $5.5 billion in revenue and $3.8 billion in gross profit. Gross margins could be as high as 70% and operating margins would hover around 40%. Holy Cow!
Linear Tech has much higher gross margins (76%) and operating margins (46%) than Analog Devices, 66% and 36%, respectively. The deal would pull up ADI's profitability.
On a pro forma basis, the combined company would earn over $4.60 per share by fiscal 2018. The shares are trading around $73, or around 15.8x estimates, which is pretty low for such a high-quality semiconductor maker. Historically, semiconductor companies trade between 15x and 21x forward estimates. As the analyst community updates its earnings models, I think investors will give the company a higher multiple (18x to 19x) and drive the stock into the mid-$80s.