Divestiture Of Unit Will Make 'A More Focused Microsemi,' Needham Analyst Says

Quinn Bolton of Needham says the divestiture of Microsemi Corporation

's certain businesses to Mercury Systems Inc

will result in a "more focused Microsemi with higher margins." Last week, Microsemi agreed to divest its Embedded Security, RF and Microwave and Custom Microelectronics businesses to Mercury Systems for $300 million. The divested businesses are primarily board level systems and packaging businesses focused on the defense industry. The divested businesses generated about $100 million of revenue in FY15, the analyst said. The transaction is expected to close in the company's third quarter and is subject to regulatory approvals and customary closing conditions. "We believe the transaction will allow Microsemi to focus on more proprietary, higher value IC solutions for its targeted markets. We expect the remaining business will have a higher NG GM and NG OM and will be positioned for higher organic growth rates," Bolton noted. "Importantly, we believe the continuing business will approach a 65% NG GM by the end of CY17. As this level is well above management's NG GM target of 60%, we believe it positions the company to more aggressively pursue revenue growth opportunities to drive gross profit dollars and NG EPS." The analyst, who has a Buy rating on Microsemi, cut his FY16 non-GAAP EPS and revenue estimates to $3.03/$1.70 billion from $3.05/$1.72 billion. Wall Street analysts, on average, expect earnings of $3.08 on revenue of $1.72 billion. Microsemi will use the proceeds from the divestiture along with $100 million of cash flow from operations to retire debt raised to finance the acquisition of PMC-Sierra. The analyst believes the lower debt level will reduce annual interest expense by about $13 million – 14 million per year and offset just over half of the pre-tax income divested to Mercury. "We see MSCC's Net Debt/LTM EBITDA declining to 2.1X by F1Q18 (Dec 17)," added Bolton, who raised MSCC price target by $6 to $46 to reflect a higher margin, higher growth business with less balance sheet risk. Shares of Microsemi were almost flat at $38.53, while Mercury Systems shares were up about 2 percent at $19.15.