2023-07-06 04:25:57 ET
Summary
- Marvell Technology has experienced poor margins due to high R&D expenses and increasing D&A and SG&A expenses, largely due to its acquisition strategy. However, MRVL expects to see improved net margins in the future as it aims to reduce operating costs.
- The company's revenue is projected to grow at an average annual rate of 18.5% over the next five years, with a forecasted net margin of 8.58%. Its valuation, based on a DCF valuation approach, yields a price target of $78.88, indicating a 35% upside.
- A potential risk for Marvell is the US-China trade war, as China is the largest source of revenue for the company. The restrictions on semiconductor exports to China could dampen demand for Marvell's products.
In our previous coverage of Marvell Technology, Inc. ( MRVL ), we conducted a comprehensive comparison between Marvell and Broadcom ( AVGO ), focusing on their logic and analog semiconductor segments. Additionally, we analyzed their M&A strategies by assessing factors such as revenue contribution, cash flows, and financial position. Regarding logic semiconductors, our findings indicated that Marvell had a competitive edge due to its advancement in ASICs and Embedded Processors. However, Broadcom had the advantage in Analog products. Furthermore, despite Marvell's stronger financial position in terms of net debt, cash-to-debt ratio, and EBITDA interest coverage, Broadcom demonstrated a superior M&A strategy, driven by higher M&A revenue contribution and 5-year FCF margins.
In this analysis of Marvell, we explore the reasons behind the company's lack of profitability, despite its strong revenue growth of 32.66% in 2022. Firstly, we will conduct an in-depth expense analysis, considering factors such as COGS (excluding D&A), D&A, R&D, SG&A, and tax, to determine the causes of the poor margins. Secondly, we assess whether these margins are likely to remain stagnant or improve in the future. Lastly, based on all the information gathered, we will provide an outlook on the company's profitability, considering forecasted revenue and margin growth rates.
Weak Margins Due to High R&D and Rising D&A and SG&A
Marvell Expense Analysis ($ mln) | 2018 | 2019 | 2020 | 2021 | 2022 | 5-Year Average |
Revenue | 2,866 | 2,699 | 2,969 | 4,462 | 5,920 | |
Growth % (YoY) | 19.0% | -5.8% | 10.0% | 50.3% | 32.7% | 21.2% |
Gross Profit | 1,682 | 1,413 | 1,515 | 2,258 | 3,026 | |
Gross Margin (%) | 58.7% | 52.3% | 51.0% | 50.6% | 51.1% | 52.8% |
Operating Profit | 397 | -121 | -25 | -59 | 398 | |
Operating Margin (%) | 13.9% | -4.5% | -0.8% | -1.3% | 6.7% | 2.8% |
Net Income | -179 | 1584 | -277 | -421 | -164 | |
Net Margin (%) | -6.2% | 58.7% | -9.3% | -9.4% | -2.8% | 6.2% |
Source: Marvell , Khaveen Investments
The table above shows the company’s revenue growth and the change in margins over the past five years. Additionally, the chart shows the change in the various expenses as a percentage of revenue over the past decade. For our expense analysis, we first looked at the chart to determine the periods in which a particular expense has had an increase or has remained exceptionally high. Then for those periods, we analyzed management’s reasons for the increase as stated in Marvell’s annual report .
The company’s COGS decreased steadily right from 2015 (around 45% of revenue) to 2022 (25% of revenue). D&A expenses had a rapid increase from 2017 (around 4% of revenue) to 2022 (around 25% of revenue). R&D expense has remained between 30% and 40% of revenue over the past decade and has been the highest expense as a percentage of revenue since 2018. SG&A expense had a slight increase from 2014 to 2017 but then grew rapidly going from around 10% of revenue in 2017 to around 20% of revenue in 2021, before dropping to 15% of revenue in 2022.
The company’s gross margin has declined over the past five years from 58.7% in 2018 to 51.1% in 2022, despite revenue growing steadily at a 5-year average growth rate of 21.2%. COGS (excluding D&A) as a % of revenue has constantly declined, however, D&A has increased steadily right from 2017 (around 4% of revenue) to 2022 (around 25% of revenue). We identified that the primary attribute (4 out of 5 years) that caused the increase in D&A during that period was the “higher amortization of acquired intangible assets” that is related to the acquisitions it has made over that period (Cavium, Aquantia, Avera, Innovium, Inphi). The acquisitions were part of the company’s M&A strategy, which we identified in our previous coverage . The intangible assets amortized primarily include the “developed technologies”, “customer contracts and related relationships” and “trade names” of the acquired companies.
The company’s operating margin has declined from 13.9% in 2018 to 6.7% in 2022, however, it is an improvement to the -1.3% operating margin in 2021. SG&A had a slight increase from 2014 to 2017 but then increased rapidly from around 10% of revenue in 2017 to around 20% of revenue in 2021, before dropping to around 15% of revenue in 2022. We identified that the primary attribute (4 out of 4 years) that caused the increase in SG&A from 2017 to 2021 was the “higher employee personnel-related costs” and “higher amortization of acquired intangible assets” related to the acquisitions the company has made over that period (Cavium, Aquantia, Avera, Innovium, Inphi), and we believe these SG&A intangible assets include the “customer contracts and related relationships” and “order backlog” stated in the company’s annual report.
However, the biggest factor affecting operating expenses is R&D, which is the highest expense making up around 30% of revenue in 2022. The company’s R&D expense has constantly fluctuated between 30% and 40% of revenue over the past decade and has been the highest expense incurred by the company since 2018. We identified that the primary attribute (5 out of 9 years) that caused R&D expense to remain so high over the past decade was “higher employee personnel-related costs”.
When comparing Marvell with its competitors in terms of R&D expense as a percentage of revenue (table below), Marvell is by far the largest spender which is reflected in its 5-year average of 34%, much higher than the second highest of 18.4% which is Broadcom. Moreover, when comparing product capabilities between Broadcom and Marvell in terms of logic and analog semiconductors in our previous coverage , we concluded Broadcom had an advantage in 4 out of the 6 products. Therefore, we believe Marvell does not have an effective R&D strategy.
R&D as a % of Revenue | 2018 | 2019 | 2020 | 2021 | 2022 | 5-Year Average |
Marvell | 32% | 40% | 36% | 32% | 30% | 34.0% |
Broadcom | 18% | 20.8% | 20.8% | 17.7% | 14.8% | 18.4% |
Microchip ( MCHP ) | 15% | 16.6% | 15.4% | 14.5% | 13.2% | 15.0% |
Analog Devices ( ADI ) | 19% | 18.9% | 18.8% | 17.7% | 14.2% | 17.6% |
Infineon ( IFNNY ) | 11% | 11.7% | 12.8% | 13.0% | 12.6% | 12.2% |
Source: Seeking Alpha, Company Data, Khaveen Investments
Lastly, the net margin has been negative in 4 out of the last 5 years, with an exception in 2019 as the company had a $1.1 bln increase in Other Income “due to the gain on sale of the Wi-Fi Connectivity business”. Apart from that one year, the biggest expense affecting net margins has been tax. Although it is not displayed in the expense analysis chart, the table below shows the tax rate as a percentage of EBT for the past decade. The negative tax indicates a tax benefit paid to the company. Overall, the taxes paid by the company have massive fluctuations over the years, however, the $786 mln tax benefit in 2019 and $249 mln tax paid in 2022 is related to the “intra-entity transfer of the majority of our intellectual property to a subsidiary in Singapore” and the “remeasurement of Singapore deferred taxes” respectively, which are not regular payments. We identified that there were various reasons for the rest of the tax payment/benefit fluctuations, which include “restructuring actions” (3 out of 8 years) and “current income tax liability” (3 out of 8 years).
Marvell Tax Expense | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 |
EBT ($ mln) | 306.3 | 479.7 | -727.7 | 147.4 | 451.2 | -4.6 | 798.4 | -322.2 | -483.5 | 85.1 |
Tax Expenses ($ mln) | -9 | 44 | 84 | 126 | -70 | 175 | -786 | -45 | -63 | 249 |
Tax as a % of EBT | -3% | 9% | -12% | 86% | -15% | -3793% | -98% | 14% | 13% | 292% |
Source: Marvell, Khaveen Investments
In conclusion, the biggest contributor to Marvell’s poor margins has been its consistently high R&D expenses coupled with increasing SG&A and D&A expenses. The company’s 5-year average R&D expense as a percentage of revenue is way higher compared to its competitors at 34%, with the next highest being Broadcom at 18.4%. Both D&A and SG&A expenses have risen significantly since 2017 due to the “amortization of acquired intangible assets” because of the company’s growth strategy being driven by M&A. Below, we further examine if Marvell’s margins could improve or remain poor going forward.
Reduction in Operating Expenses to Boost Margins
In this point, we examine and forecast the future trends for each of the expenses analyzed in the point above, to identify if the company could achieve profitability.
In terms of gross margin outlook, we believe D&A expense will decrease from its current position of around 25% of total revenue as we do not think the company will be pursuing an aggressive M&A strategy as it has high net debt (picture below), leading to lower “amortization of acquired intangible assets”. However, in the company’s previous earnings briefing in Q4 FY2023, management highlighted its gross margins to be challenged.
We are forecasting very strong sequential growth in revenue from 5G and a number of custom ASICs, but these have gross margins well below Marvell's corporate average. As a result, we expect a challenging gross margin outlook for the next few quarters. – Matt Murphy, Marvell CEO
Based on the statement, we believe COGS will continue to go higher from its slight increase in 2022 as the company forays into segments that have gross margins that are below the company’s average. However, management did highlight plans to improve its gross in its latest earnings briefing in Q1 FY2024 going forward by “optimizing headcount and further streamlining operations”. Also, the company highlighted that it was continuing to work with its “strategic suppliers to drive more efficiency in the supply chain”. That said, we will continue to monitor its gross margins and determine whether management’s plan to increase its gross margins comes to fruition.
In terms of operating expenses, we believe SG&A expenses will not continue to increase for the same reasons we do not expect D&A to increase. For our R&D expense forecasts, we believe it will continue its downward trend (as a percentage of revenue) since 2019 as the company has laid off all of its R&D workers in China (44% of revenue) as of March 2023. Moreover, in its previous Q1 2023 earnings briefing , management stated that…
We plan to continue to invest in R&D, given the tremendous opportunities we have in front of us, while keeping opex growth well below top line revenue growth to drive to our long-term target model. – Jean Hu, Chief Financial Officer
Although the company will continue to invest in R&D, it is cognisant of ensuring operating expenses growth does not surpass revenue growth. Moreover, we expect the company’s R&D expense to decrease to be more in line with the R&D expense of its competitors who manufacture some of the same products Marvell does. Therefore, we believe operating margins will improve given that we expect both SG&A and R&D expenses to decrease.
Lastly, in terms of taxation, we still believe there will be fluctuations given the company has foreign subsidiaries, whose tax rates “differ from the U.S. statutory tax rate”. However, we do not expect the company to have any major anomalies such as the tax benefit ($786 mln) and payment ($249 mln) in 2019 and 2022 respectively, as they were one-off payments. As a result, we believe net margins will improve due to improved operating margins and usual tax payments.
In conclusion, we expect gross margins to remain relatively the same and operating margins to improve. We expect an unchanged gross margin as the predicted decrease in D&A would be offset by an increase in COGS. We expect operating margins to improve due to the predicted decrease in both SG&A and R&D. Lastly, we expect net margins will generally improve due to improved operating margins. Below, we will forecast revenue growth and margins to determine if the predicted increase in net margins would lead to the overall profitability of the company.
Marvell Expected to be Profitable Going Forward
At this point, we will be providing our numerical forecasts for revenue as well as margins over the next five years, based on information collected from the points above. In terms of revenue forecasts, we use the same method as in our previous coverage. We forecasted total revenues by forecasting the growth rates of each reportable segment. Our segment growth rate forecasts are as follows:
- Data Center : Based on our forecasts of total cloud market capital expenditure growth. Starts with 18% forecasted growth in 2023 and increases to 22% for the next four years.
- Enterprise Networking : Based on Research Nester's forecast of 15% CAGR in the global enterprise communication infrastructure market.
- Carrier infrastructure : Tapered down Markets and Markets' forecast of 25.3% CAGR in the 5G Services Market by one percent every year.
- Consumer : Based on Reports Insights' forecast of 4.62% CAGR in the global consumer electronics market.
- Automotive/Industrial : Tapered down Report Linker’s forecast of 20.88% CAGR in the Global Automotive Ethernet Market by one percent every year.
From the table below, we expect company revenues to grow at an average of 18.5% over the next five years based on our segment forecasts.
Marvell Revenue Projections ($ mln) ('CY') | 2023F | 2024F | 2025F | 2026F | 2027F | 5-year Forecast Average |
Data Center | 2,834 | 3,458 | 4,218 | 5,147 | 6,279 | |
Growth % (YoY) | 18% | 22% | 22% | 22% | 22% | 21.1% |
Enterprise Networking | 1,575 | 1,811 | 2,082 | 2,395 | 2,754 | |
Growth % (YoY) | 15.0% | 15.0% | 15.0% | 15.0% | 15.0% | 15.0% |
Carrier Infrastructure | 1,358 | 1,688 | 2,082 | 2,546 | 3,088 | |
Growth % (YoY) | 25.3% | 24.3% | 23.3% | 22.3% | 21.3% | 23.3% |
Consumer | 733 | 767 | 803 | 840 | 879 | |
Growth % (YoY) | 4.62% | 4.62% | 4.62% | 4.62% | 4.62% | 4.6% |
Automotive/Industrial | 431 | 517 | 614 | 724 | 846 | |
Growth % (YoY) | 20.88% | 19.9% | 18.9% | 17.9% | 16.9% | 18.9% |
Total | 6,975 | 8,344 | 9,981 | 11,935 | 14,260 | |
Growth % (YoY) | 17.8% | 19.6% | 19.6% | 19.6% | 19.5% | 18.5% |
Source: Marvell, Khaveen Investments
For the margin outlook, we will be forecasting the five expenses over the next five years based on our reasonings in the point above. The numerical forecasts for the expenses as a percentage of revenue are as follows:
- COGS (excluding D&A) : We forecasted it to increase by 1% for the next three years (25.81% in 2023 to 27.81% in 2025) and then remain at 27.81% for the remaining two years.
- D&A: We forecasted D&A as a percentage of PPE to reduce by 0.2% every year from 7.06% in 2023 to 6.26% in 2027, which results in a reduction from 19.6% to 7.2% as a percentage of revenue over the next five years.
- R&D : We forecasted it to reduce by 1% every year for the next five years, going from 29.1% to 25.1%
- SG&A: We forecasted it to reduce by 0.5% every year for the next five years, going from 13.8% to 11.8%
- Tax : We used the average tax rate as a % of EBT for eight out of the past ten years excluding the anomalies in 2019 and 2022.
As a result of our expense forecasts, we believe Marvell could achieve profitability in 2023 with a net margin of 8.58% (graph below). We expect net margins to continue increasing over the next five years, reaching a net margin of 23.64% in 2027. We also forecasted gross margins (54.58% to 65.01%) and operating margins (11.69% to 28.11%) to continue increasing through 2027.
Risk: US-China Trade War
Based on the chart, China was the largest source of revenue in terms of shipment destination for Marvell. However, Marvell being a US-based semiconductor company is subject to the restrictions placed on the exports of semiconductors to China by the Department of Commerce. According to Marvell , these sanctions have “dampened demand” for its products and in its previous Q4 2023 earnings briefing , management stated, “revenue from OEM customers in China has declined to less than 10% of total company revenue”. Therefore, we believe it is a risk for the company as it needs to find a way to shift a substantial amount of Chinese revenue to other countries, given that 42% of revenue is derived from China but less than 10% is derived from OEMs within the country.
Verdict
Khaveen Investments Seeking Alpha, Khaveen Investments
In summary, Marvell has experienced poor margins over the years due to consistently high R&D expenses, coupled with increasing D&A and SG&A expenses. These increased costs are a result of the company's acquisition strategy, leading to the "amortization of acquired intangible assets." However, we anticipate improved net margins in the coming years as the company aims to reduce its operating expenses (R&D and SG&A).
Regarding our revenue growth forecast, we have considered market growth and projected that Marvell will achieve an average annual growth rate of 18.5% over the next five years. As for our margin forecast, we have utilized all the information gathered previously to forecast the company with a net margin of 8.58%.
To value Marvell Technology, we employed a DCF (Discounted Cash Flow) valuation approach. For the terminal value, we based it on the average EV/EBITDA ratio of US chipmakers, which amounted to 20.6x. This figure is higher than the EV/EBITDA ratio derived from our previous analysis , which was 18.44x. We excluded Nvidia from the calculation, as we view its EV/EBITDA ratio of 165.24x as an anomaly. In conclusion, our analysis has yielded a price target of $78.88 , indicating a 35% upside. This target is slightly higher than our previous estimate of $74.59, leading us to upgrade our rating to a Strong Buy.
For further details see:
Marvell Technology: Huge Potential Margin Expansion Opportunity