Beaten-Down MaxLinear Starting To Look More Interesting (NASDAQ:MXL)

The last year has been a rough one for MaxLinear (NASDAQ:MXL), with the shares down about 46% (underperforming the broader semiconductor market by almost 20%) despite strong growth in the company’s WiFi connectivity business. Not only have investors become more cautious on chip stocks in general, but there are greater concerns now about potentially slowing cable net-adds in 2023 hurting the Broadband business as well as ongoing concerns about the proposed Silicon Motion (SIMO) deal.

Down more than 40% since my last update on the company, the shares are quite a bit more interesting now even with those fears around cable subscriber growth. I’m not particularly positive on the Silicon Motion deal, and I think the company continues to overstate the opportunity in PAM-4, but I think a lot of bullishness has been beaten out of these shares and I think the longer-term potential in home connectivity and 5G is enough to support the shares from here, with any progress in optical interconnect and the Silicon Motion deal constituting upside beyond that.

Broadband Could Get More Challenging, But Fiber Is A Wild Card

MaxLinear reported disappointing results in its Broadband business in Q3’22, with revenue down 5% year over year and 14% quarter over quarter and management talking about weaker near-term trends on slower cable gateway deployments.

As a reminder, MaxLinear and Broadcom (AVGO) are near enough to a duopoly in DOCSIS gateways, and MaxLinear has been a meaningful beneficiary not only of a desire to diversify away from Broadcom, but also strong cable broadband growth in recent years (over 4M net adds in 2020 followed by 2.6M adds in 2021 and likely close to 250K in 2022).

In the near term, this business is going to see some challenges. I believe the pandemic pulled forward a meaningful number of subs, and I’d expect small decreases in net subscriber adds for cable broadband providers over the next few years. While equipment upgrades could offer some upside, I think the overall end-market will be challenging, and cable companies generate more than half of the company’s revenue.

Offsetting that, at least to some degree, is meaningful potential in fiber. Management expects to see a launch with a major Tier 1 fiber carrier in 2023, and not only is fiber still growing subs at a strong rate (likely around 1.75M in ’22 and accelerating in 2023), MaxLinear content in fiber gateways is in the neighborhood of $20 to $30 versus $10 to $15 for cable gateways.

WiFi Isn’t Done Yet

MaxLinear saw strong growth in its Connectivity business throughout 2022, with the most recent quarter (Q3’22) seeing 118% yoy and 47% qoq growth on the strength of the company’s WiFi 6/6E offerings.

Not only has WiFi 6/6E driven an upgrade cycle (that has also benefited Broadcom), but it has also produced share and content growth opportunities for MaxLinear. Fortunately, the company has executed on these opportunities quite well.

In addition to higher ASPs on new generation products, the company has benefited from improved market share (likely more at the expense of onsemi’s (ON) Quantenna than Broadcom) and higher attach rates (broadband gateways that include the company’s WiFi chips). Gateways with MXL WiFi attached generate about $5/box higher ASPs, and the attach rate is still only around 50% (half of MaxLinear’s gateway SoCs ship with MXL WiFi), so further growth is still possible from here.

The Not-So-Good – Uncertainties About PAM-4 And SIMO

I’ve been skeptical about management’s prior bold predictions for its PAM-4 interconnect business, and I haven’t really seen much reason to regret that stance. The Infrastructure business has been growing (up 22% yoy in Q3, after 22% growth in Q2), but I see no real evidence that the company has made any meaningful progress against Marvell (MRVL) (the market leader) or Broadcom.

I do still expect relatively strong demand for high-speed interconnect in FY’23, and I can understand an argument for some customers wanting an alternative to Marvell (and/or Broadcom), so I’m not writing off this business entirely. Still, I think expecting much from this portfolio is a recipe for disappointment and I regard it more as a source of potential upside than any sort of core driver.

I’m likewise skeptical about management’s ongoing bid for Silicon Motion. Management has done well with deals meant to build up its core home connectivity/broadband business (including the home-run deal for Intel’s (INTC) business), but deals outside of this core space haven’t fared as well, and management has yet to really demonstrate that they can gain traction outside the consumer broadband space.

At present, Silicon Motion is suffering from weak demand for PCs, tablets, phones, and other consumer devices with SSDs, and with already-high attach rates, I think growth will be challenging. Management has talked about opportunities to leverage Silicon Motion’s technology into the enterprise SSD market (and MaxLinear was apparently working on its own solution here before the deal), but I think competing more intensely with the likes of Marvell isn’t a particularly welcome challenge.

I do understand the financial rationale for the deal; although Silicon Motion will be dilutive to gross margin, it should be accretive to operating margin after cost reduction efforts, and I do expect meaningful EPS synergy from the deal. Still, semiconductor M&A motivated by finances (rather than strategic fit) doesn’t have a great track record of success, with Broadcom being one of the relatively few to do it well (and even there, there’s an argument for more strategic fit than commonly appreciated by the market).

At this point, the market is certainly skeptical about the deal going through – SIMO shares trade about 40% below the implied takeout price and it remains to be seen if the Chinese government will sign off on the deal. MaxLinear management remains committed, though, and expects to close the deal in mid-2023. Were the deal to be scuttled due to regulatory issues, MaxLinear would owe a $160M break-up fee.

The Outlook

I can understand why MaxLinear shares have been weak. The company has yet to show the progress in PAM-4 that management has long been promising, the SIMO deal offers few strategic benefits and additional execution risk (including debt to fund the deal), and now the company’s major end-market, cable gateways, appears to be entering what could be a multiyear slowdown. That’s not a great backdrop on top of the overall weaker sentiment for chip stocks.

Still, I see some bright spots. I see further share gains/attach rate increases in WiFi (as onsemi exits that business), and I do think fiber gateways could be a significant growth driver for the company that offsets weaker cable gateway demand. I also expect improved 5G demand (mmWave in India) in 2023, and PAM-4 could yet prove to be a material opportunity.

I do see some risk of a miss and guide-down in Q4, and my 2023 revenue estimate ($1.056B) is below the current reported sell-side low estimate ($1.07B, versus an average estimate of $1.15B). Likewise, my 2024 estimate ($1.17B) is below-Street. Still, I expect around 7% long-term revenue growth from MaxLinear, as I do see meaningful growth opportunities in consumer broadband (fiber in particular) for Broadband and Connectivity, as well as growth opportunities in the Infrastructure business.

Not surprisingly, I’m below-Street for margin estimates in FY’23 and FY’24, but I still expect the company to generate long-term adjusted free cash flow margins in the low 20%’s, driving healthy FCF growth. Discounted back, those cash flows can support a long-term total annualized return in the low double-digits today.

Using my returns-driven EV/revenue and EV/EBITDA approaches, MaxLinear likewise looks undervalued. Provided that non-GAAP operating margin stays above 30% in FY’23, I believe the shares should trade for close to 4x forward revenue, supporting a fair value today that’s a bit above $50 on my FY’23 estimate.

The Bottom Line

As I said before, the weaker outlook for cable broadband subscriber growth is an understandable reason for MaxLinear shares to be trading lower, particularly when added to weaker-than-projected progress with PAM-4 and the risks around the Silicon Motion deal. I do certainly see some larger challenges over the next 12-18 months, but I think the share price more than reflects them, and I think this is a name for more risk-tolerant investors to consider.