As shares of Apple Inc. (NASDAQ:AAPL) have collapsed over the past few months due to concerns over loss of market share in the smartphone space, shares of one of its suppliers, Cirrus Logic, Inc. (NASDAQ:CRUS), have been decimated.
Eighteenth century British nobleman Baron Rothschild, of the famed Rothschild banking family, once famously said: “The time to buy is when there is blood in the streets.” The view that this statement communicates; to take long-term advantage of opportunities created by emotionally driven actions that were based on short-term situations is one I share. That approach appears to apply today for investors interested in initiating positions in Apple or Cirrus Logic.
Taking a bite out of Apple
While there has been an enormous amount of handwringing related to the death of Steve Jobs and the impact that will have on Apple Inc. (NASDAQ:AAPL)’s future performance, I believe the angst is vastly overblown as there is only so much impact one individual can have on a $400 billion business. The teams that conceive, design, build, and market Apple Inc. (NASDAQ:AAPL)’s products remain in place and, while Steve Jobs will be missed, his legacy will remain intact.
Right now, there is blood in the streets of one of the most recognized brands in the world as the market has taken a 37% bite out of Apple Inc. (NASDAQ:AAPL)’s market capitalization in an absolute panic over a slowing rate of growth, and cut the valuation of the business to a P/E multiple of only 10 times 2014 consensus earnings. Considering that the five-year annual earnings growth is projected at 15%, this business is just too cheap to last at this level.
Add in the 2.76% dividend yield and the recently announced plans to distribute an additional $100 billion to shareholders between increased dividends and share repurchases, coupled with the pervasive negative sentiment, and we have the makings of a stock that is poised for potentially explosive gains over an expanded time horizon of at least five years.
Taking more than a bite out of a supplier
As investors took a bite out of Apple Inc. (NASDAQ:AAPL), they made applesauce out of its supplier, Cirrus Logic, Inc. (NASDAQ:CRUS), that derives approximately 85% of its revenue from sales of mobile device components to Apple. From its high of $45.49 reached in September last year to its 52-week low of $17.33 seen just last month, investors decimated the share price of Cirrus by 62%, an astonishing fall for a business with no debt and substantial year over year growth.
The shares were showing signs of recovery when, on May 23, in a Barclays Investor Presentation, Cirrus Logic, Inc. (NASDAQ:CRUS)’s CEO, Jason Rhode, announced some changes in the forward guidance of the company related primarily to the gross margins projected by the company, reducing the outlook from the previous level of 50% to 52% to a new projection of “mid-40’s” on projected revenue for this quarter of $150 million to $170 million.
Shareholders rushed to sell in a panic and the share price plummeted 19.5% to close at $17.76. The blood was certainly in the streets; the question was whether or not the news actually justified the reaction of investors. In this case, probably not.
Over the last five years, Cirrus Logic, Inc. (NASDAQ:CRUS) has produced gross margins and net margins of 52.1% and 23.5%, respectively. The March quarter and the June quarter also tend to be the weakest for the company. If we assume that sales will only come in at $600 million (4 times the low end projection for the current quarter) for the current year and net margins will decline by the same 7% fall projected for the gross margins, both very conservative projections, then Cirrus should generate a net operating profit of $99 million, or $1.54/share for the year ending March 31, 2014.
The consensus five-year projected earnings growth rate for Cirrus Logic, Inc. (NASDAQ:CRUS) is 15% per year and if a price to earnings growth rate of 1 is assigned, the current fair value of the business is conservatively calculated at $23.10/share; an increase of 28% from the current level of about $18. I think it is worth much, much more.
Looking for a cheap snack?
Large, slow growing businesses, that carry high market valuations related to their growth rates, tend to like to look to smaller, faster growing businesses, priced at low valuations compared to their forward growth as potential acquisitions as it allows the acquiring business to receive an immediate return on the investment when the low valuation of the acquired business increases to reflect the higher valuation of the acquirer. When the products and services are similar, or complementary, that just adds to the incentive.
Texas Instruments Incorporated (NASDAQ:TXN) is such a business and could well have an appetite for a profitable snack made up of an acquisition that would produce a lot of synergies through the product overlaps and extended offerings to existing customers of both businesses. Texas Instruments’ shares currently change hands at a valuation of 18.95 times 2013 earnings and 15.29 times 2014 earnings, but the forward earnings five-year growth rate is projected at only 8.3%/year. This is a business that should be hungry for growth.
An interesting aspect of the two businesses is that at 49.34% and 14.74%, respectively, the current gross and net margins of Texas Instruments are very similar to the just revised estimates for Cirrus Logic, yet Texas Instruments is valued 50% to 80% higher using standard measures.
Sitting on almost $3.9 billion in cash and short-term investments, Texas Instruments, after including the $171.6 million in cash held by Cirrus, could write a check to acquire Cirrus Logic, Inc. (NASDAQ:CRUS) and only consume about 26% of its liquid cash holdings. Better yet, since Cirrus is trading at around 10 times free cash flow, Texas Instruments could probably issue bonds at around 4% to 5% interest to finance the transaction and pocket an annual return of 5% of the transaction price without making any capital investment.
Final thoughts
Apple Inc. (NASDAQ:AAPL) and Cirrus Logic, Inc. (NASDAQ:CRUS) are two “blood in the streets” opportunities but it will not be long before the cleanup crews sweep in and correct these grossly mis-priced situations. Investors who buy both companies today will reap the benefits of a return to more realistic valuations whether they are reached by individual purchases or corporate acquisition.
The article Buying Great Businesses When There Is Mayhem on the Street originally appeared on Fool.com and is written by Ken McGaha.
Ken is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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