Wednesday, 14 November 2012

Margin of Safety in a real life example - Marvell Technology

Many of us have heard the stories that Buffet can reach an investment decision after a 5 minute look at a company's business and financials. After trying to replicate this exercise tonight and spending an awful lot more time than 5 minutes I've learned a) why Buffet doesn't invest in technology companies b) I'm no Buffet.

Marvell Technologies has been a hot pick for many investors and fund managers of late and despite it's incredibly cheap valuation, it continues to get cheaper. David Einhorn, Joel Greenbalt, and David Dreman (one of the first investment books I read was by Mr. Dreman) are some of the investment managers disclosing new/additional positions in Q3 and the stock is down more than 20% from the lowest possible price they could have bought it for in Q3 - it's not a shabby place to be in when you can buy a stock for more than 20% (most likely 30%-40%) discount than some of the best investors of our time.

So what is the case for Marvell - luckily many others have done a great job of covering the opportunity on and

Will David Einhorn Buy Marvell Again As Price Drops Further?

Stocks Trading For Less Than David Einhorn Paid For Them

Let me summarize their analysis for you - 
MRVL Price: $7.38
Net Current Assets: $3.50 (using 50% inventory value, which is a small part of NCA anyways)
Price - Cash: $3.88
2011 Earnings - $0.99
Projected 2012 Earnings - $1.15-$1.25
Without getting too far ahead of ourselves with 2013 earnings estimates (which are higher than 2012). You are paying under 4x earnings. This should provide you with plenty of safety margin, right?
Cash is cash!
The management has been extremely aggressive in preserving SH value and returning cash to shareholders - share repurchases of 16% last year and a newly instilled dividend of roughly 25% of earnings. If even after these efforts the market doesn't want to treat cash as cash, well then you shouldn't have any problem sitting there and watching your EPS and dividends grow.

My Concern
Sadly, that is where the margin of safety ends, at least for me (someone that doesn't understand the semiconductor market).

Marvell is in the business of designing semiconductors and is not a manufacturer. Their future earnings are dependent on whether their intellectual property is still relevant in the market place. They have a pretty broad product line and their chips are used in devices for data storage, enterprise-class Ethernet data switching, Ethernet physical-layer transceivers, handheld cellular, Ethernet-based wireless networking, personal area networking, Ethernet-based PC connectivity, control plane communications controllers, video-image processing and power management solutions. HDD memory is one of their biggest end-use products and the industry is cyclical and has undergone significant consolidation in the manufacturer space. Western Digital and Toshiba are their two largest customers representing 23% and 10% of revenue respectively.

At this point, I have no knowledge of the HDD memory market - I don't have the answer to what differentiates Marvell's product from it's competitors, what threat substitute products pose to HDD memory, how the business cycle affects designers and manufacturers, how the supply chain of the industry interacts, what the long-run trend is for HDD memory, and endless other relevant questions.

And unfortunately my perceived margin of safety from a bargain valuation has disappeared. I could go with the layman's reasoning that Mr. Einhorn, Greenbalt, or Dreman must have done their homework, or the company has been consistently increasing revenues over the last decade and will continue to do so, or some rhetoric about the fact that even if the company's earnings fall by 50%, well you still have a stock trading at around 8x earnings. But the point of a margin of safety is so that you can sleep worry-free at night and until you fully understand a business, you will not (or should not) be able to do so!

So until I have the time to revisit and understand this industry, I will have to pass up on attractive valuations such as Marvell at $7.36.

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