Why Does Billionaire Kenneth Griffin like ON Semiconductor?

CITADEL INVESTMENT GROUPBillionaire hedge fund manager Ken Griffin disclosed a 5.1 percent stake in ON Semiconductor (NASDAQ:ONNN) on Tuesday. Citadel Investment Group now owns 23.2 million shares of the company, up from 5.9 million at the end of March.  During the first quarter of this year, Ken Griffin’s Citadel reduced its stake in the stock by nearly 60 percent (you can view Citadel’s portfolio here). The stock posted a 23 percent loss since the end of the first quarter, so Griffin doubled down on the stock with good reason.

On the other hand, Steven Cohen’s $14 billion hedge fund SAC Capital Advisors upped its ON Semiconductor holdings in the first quarter, posting triple digit increases in their exposure (Cohen’s fund also disclosed its increased stake in Aeropostale (NYSE:ARO) earlier this month). So Griffin won that bet.

Cohen might have saved a bundle of cash had he mirrored some key insider sales by senior VPs at ON during March, April, and May (you can see all of them here). All of these insiders sold in the $8.50 to $9.00 area. Additionally, Eric Bannasch, manager of Cadian Capital, reduced his ON Semiconductor position by 18 percent in the first quarter. He also sold off 56 percent of his call options. Billionaire George Soros was also among the fund managers who cut his stake significantly (see George Soros’ portfolio).

In January 2011, the company acquired SANYO Semiconductor (SANYO). In February 2011, the company acquired the “complementary metal-oxide semiconductor image sensor” unit from Cypress Semiconductor (NASDAQ:CY). These are ON’s sixth and seventh acquisitions since the fourth quarter 2007.

In the fourth quarter, the company committed to closing a plant in Japan to increase operational efficiency and facilitate investment in advanced wafer technology.   Two plants in Thailand were slated to close over the period spanning from the fourth quarter 2011 through the first quarter 2012 due to regional flooding.

With all of this activity, how does ON Semiconductor measure up to its peers? Why buy it over them? In general, I think that the recent price drop in the company’s share price to under $7 has led to an undervaluation in respect to its peers, and an attractive entry point. Note that ON Semiconductor is trading at 7.1 times forward earnings and presently operates at about 13 percent net margin.

One of its peers, Analog Devices (NASDAQ:ADI) sells higher margin products than those sold by ONNN—ADI’s net margin is around 25.2 percent.  This partially explains ADI’s high forward P/E multiple of 14.9x.  The market may also be bullish on its new product introductions: a series of quad 16- and 12-bit 3V/5V D/A converters and the AD5316R and AD5317R quad 10-bit nanoDACs®.

Another peer, International Rectifier (NYSE:IRF) has a forward P/E of 24x. IRF’s net margin was also lower than ON’s at 4.8 percent. Large funds added 1.8 million shares to their 27.5 million shares in the prior quarter. Maxim Integrated Products (NASDAQ:MXIM) provides various high-frequency process technologies and capabilities to the same end-markets as ON.  Maxim’s recently increased earnings guidance, modest growth, and wide net margin (16.1 percent) make the stock attractive.  Maxim’s forward P/E is 13.

Linear Technology (NASDAQ:LLTC) power management, data conversion, signal conditioning, RF and interface ICs, and µModule subsystems.  The company hits ON’s end markets too.  Its margins are impressive; net margin for the trailing twelve months was 31.4 percent.  While its forward P/E multiple is 14x, there is still market concern about key end markets.

Given strong hedge fund interest in ON Semiconductor and basic valuation metrics, we believe the stock is cheap. Additionally, the full potential of the synergies brought to the table by ON’s recent acquisitions have yet to be realized.  This, combined with ON’s leverage position, suggests to us that earnings will accelerate at a faster rate than the company’s peers.

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