This Holding Comes Under Pressure Following Acquisition Report

With our comments and respective price target changes discussed for the shares of Alphabet (GOOGL) and Microsoft (MSFT), let’s go beyond our initial comments about a potential M&A move by Marvell (MRVL) that is dropping its shares on Thursday.

We touched on this potential tie up with Lumentum (LITE) in our opening comments on Thursday morning, but given the market reaction, the selloff in MRVL shares and the possibility that a deal between the two doesn’t come about, we need to delve further into this.

Speculation

In our opening comments on Thursday, item six flagged a Bloomberg report that Marvell is in advanced talks to buy data center optics maker and EPS All-Stars resident Lumentum with a transaction that could be announced “as soon as next week.” The article also noted that a final agreement hasn’t been reached and it is possible the talks between the two companies end without one.

That’s the name of M&A conversations between two companies and while they can make strategic sense, more often than not the final determination tends to come down to price paid, potential synergies and acceptable dilution. We’ve seen that several times this year with potential deals between Netflix (NFLX) and Warner Bros Discover, Estee Lauder (EL) and Puig, Stripe and Advent for PayPal (PYPL), Piper Sandler (PIPR) and Perella Weingberg (PWP) that have not been consummated.

So, let’s answer some questions about this potential Marvell-Lumentum tie up and get ready for any potential announcement from them.

Does it Make Strategic Sense?

From a strategic perspective, top customers at Lumentum include Marvell but also Amazon (AMZN), Meta (META), Ciena (CIEN) and as we discussed on Thursday morning, Google. Google accounts for 15% to 20% of Lumentum’s total net revenue and Lumentum is an acknowledged supplier of optical circuit switches used inside Google’s Tensor Processing Units. For Amazon, it relies on Lumentum’s “picks and shovels” optical components to handle the massive data throughput.

Lumentum is expected to deliver around $6.4 billion in revenue this year, growing to more than $10 billion in next year with operating profit climbing to almost $4.5 billion next year from $2.6 billion this year. Lumentum’s optical component capacity is heavily constrained and reportedly sold out through early 2029.

By comparison, Marvell’s revenue for this year is expected to hit $12 billion, up from $8.2 billion last year and climb to about $19.7 billion next year. Operating income this year is forecasted by Wall Street to hit $4.5 billion this year, up from $2.9 billion last year, and expand to nearly $8 billion next year. Given the potential timing, we’ll focus on calendar 2027 figures and that means Marvell is roughly twice the size of Lumentum.

From a customer fit position, a combination would make sense. Given Lumentum’s sold out capacity, Marvell would secure direct access to its components and technology. And the optical-interconnect market is expected to grow at a faster rate than total data-center spending in the next two to three years.

Does it Make Financial Sense?

When we look at Lumentum’s market cap near $85 billion and Marvell’s near $200 billion with only around $4 billion in cash on its balance sheet, we have to think any acquisition would be funded by stock or a combination of stock and debt.

A multiple of 10-times expected 2027 revenue for Lumentum equates to a figure just north of $100 billion. At Marvell’s current share price that implies around 460 million shares, which compares to the 921 million shares outstanding at the end of July. That’s potentially a lot of dilution, but we have to remember the other part of the equation, which is to layer Lumentum’s revenue, operating profit and net income on top of Marvell’s for next year.

When we do that, assuming no incremental revenue or cost synergies and based on current consensus figures, the Marvell-Lumentum figures for next year become $29.6 billion in revenue with operating profit around $12.4 billion and net income of about $10.5 billion. Again, this is pretty down and dirty, and to doesn’t exclude the amount of revenue Lumentum would book from Marvell, and vice versa, so some hair cutting would be needed. However, that potential post-acquisition share count of 1.38 billion, the combined entity’s EPS would be around $7.60. Factoring in the existing customer relationships between the two companies, we’d need to make some adjustments lower for that pro forma figure.

That compares to the current calendar 2027 consensus EPS of $7.35 for a standalone Marvell.

The thing is, we’ve seen acquisitions in the chip and networking space run between eight-times to 14-times revenue in the last few years, with Marvell paying around 14.6-times trailing revenue for Inphi several years ago. Granted, such a multiple on Lumentum’s trailing 12-month revenue doesn’t reflect its robust revenue ramp or its sold out nature for the next few years.

The bottom line is if a transaction between Marvell and Lumentum were to go through, what is the price Marvell would be willing to pay, what are the expected synergies and potential dilution, and does Marvell have another increase to its multi-year revenue forecast up its sleeve?

Other Considerations

As we noted above, Marvell is a Lumentum customer, but Lumentum is also a major customer for Marvell’s digital signal processing chips, and a merger could risk Marvell’s dominant market share (60% to 65%) if rival module makers look to alternative chip suppliers. That raises questions about U.S. and potentially other regulatory approvals.

Bottom Line

While a coming together of Marvell and Lumentum may make business sense, the question as to whether it makes financial sense will hinge on how much Marvell management is willing to pay measured against the incremental revenue and profit to be had plus any incremental synergies.

The answers to those questions will determine whether Thursday’s pullback in MRVL shares is warranted, too much or not enough. The discussion above at least gives us a framework to measure it by.

But, if a deal does not emerge, for whatever reason, or perhaps the two were thinking more of a strategic partnering instead of an M&A deal and the reporter got it wrong, we would be inclined to use the renewed pressure on MRVL shares to add another slug of shares. The TPU comments from Google and what we’re likely to hear from Amazon about its Trainium chips tonight would prove ample cover for that decision as does the upswing in AI and data center capex and the pull through for Marvell’s networking business.

On the housekeeping front, a big hat tip to the folks at S&P 500 Market Intelligence for helping with the consensus figures used above.

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At the time of publication, TheStreet Pro Portfolio was long AMZN, CIEN, GOOGL, LITE, META, MRVL and MSFT.