Morgan Stanley Admires Analog Devices' Model, Improved Diversification

"We estimate ADI can drive to pro-forma EPS of $4.45 in CY18, representing 23 percent accretion, leading to a new PT of $78. The businesses are very complementary, although we stress that Linear's unique culture is a driving force of its success. As such, a smooth integration will prove key," analyst Craig Hettenbach wrote in a note.

Despite admiring Analog Devices' model, Hettenbach was concerned over the company's decision to add more exposure to the lower-margin consumer electronics business, which is estimated to account for 17 percent of 2016 sales.

Related Link: BlueFin Research Reviews Analog Devices-Linear Technology Deal

The analyst noted that the Linear Tech deal would bring this exposure down to 13 percent, including roughly 5 percent of sales from Apple Inc.AAPL.

"Improved diversification as well as higher margins (we estimate pro-forma GM and OM of 70.5 percent and 42 percent, up 400bp and 700bp from standalone ADI) should ultimately drive a higher valuation multiple for ADI," Hettenbach highlighted.

The analyst views ADI's cost saving target of $150 million as "conservative" and expects the company to save $160 million in costs.

Analog Devices, Linear Deal

Hettenbach noted that complementary product portfolio should lead to attractive cross-selling opportunities. ADI is the leader in data converters, commanding a 40–50 percent market share, while Linear is the third largest supplier of power management. Thus, this acquisition would add power management business, one of the fastest growing segments within analog, to ADI where it was lacking.

"Given the long design-in nature of these end markets, its conceivable [sic] that the revenue synergies opportunity could lineup well and provide another layer of accretion beyond anticipated cost savings expected through 2018," Hettenbach highlighted.

Hettenbach also noted that with this deal, "ADI now represents a vehicle to play our theme of semi acquirers who have above-average EPS growth potential."

Analog Devices joins NXP Semiconductors NV NXPI, Broadcom Ltd AVGO and Microchip Technology Inc. MCHP as part of this theme.

At time of writing, shares of Analog Devices were seen up 1.24 percent to $63.65, while Linear Tech was down 4 percent to $60.01.

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