What's Wrong with Maxim's Inventory?
A short-sell update from the Pirate Investor’s Porter Stansberry. And for those still in the mood, a potentially immense opportunity to the long side, too…
In this space a little over two weeks ago, I warned that Maxim Integrated Products’ stock would soon suffer as investors realized how outrageous options grants impact future earnings per share.
In fact, if you were to expense Maxim’s options grants from 2001, the company wouldn’t have earned the $1.27 it reported, but merely $0.56 – an enormous difference, especially for a stock trading at $37, or 77 times earnings.
Fortunately, the market seems to agree with my analysis. Maxim’s shares have plummeted, falling to $27. And today the company may be forced to write down the value of its Dallas Semiconductor acquisition. You see, not only has Maxim shown questionable corporate governance in regard to its stock options, but its 2001, $2.1 billion acquisition of Dallas Semiconductor also raises eyebrows upon closer inspection.
Here are the facts. In 1999 Dallas Semi recorded its best operating results in its entire history. Much so many other high tech firms, it was running in high gear. Net profits totaled $68 million.
After the boom, in November 2000 Dallas’ CEO Vin Prothro died unexpectedly of a heart attack. Dallas shared many product lines with Maxim and the two CEOs had very close personal ties. Nothing wrong with that…
But did Prothro’s personal relationship with Gifford and his tragic death cloud Gifford’s ability to make an objective business decision? He printed up $2.1 billion in new Maxim stock to finance the acquisition. He paid 30 times all-time high peak earnings! That’s a heck of a lot of money for a company (Dallas) that had overlapping products, lower gross margins and less talented engineers.
Gifford’s handpicked board (which includes the "noted" integrated-circuit expert Eric Karros, who also just happens to also play third base for the Los Angeles Dodgers) has shown itself to lack any ability to stand up to Gifford’s demands, even allowing him to name his own cash bonus each year. Nobody was looking for the shareholders.
What’s the big deal, you ask? Well, as you’ll see, millions of dollars are at risk.
Gifford promised at the time of the deal, that, as a part of Maxim, Dallas could deliver $800 million in revenues. This isn’t likely to happen in the next ten years.
In fact, in the last 39 weeks the entire company only sold $795 worth of chips. Although the Dallas contribution to sales isn’t broken out in the company’s reporting, you can figure that Dallas’ chips aren’t selling by looking closely at Maxim’s inventory numbers.
Prior to buying Dallas, Maxim typically held $45 million in inventory. But in the winter quarter of 2001 as its sales began to slow, Maxim’s inventory ballooned to $67 million. Then, following the acquisition, in the spring quarter of 2001, Maxim’s inventory had grown to $171 million…nearly four times the normal amount. You can guesstimate around $100 million of that inventory belonged to Dallas.
And today, five quarters after the merger, Dallas’ inventory still sits on Maxim’s balance sheet. Total inventory: $137 million, still three times more than normal and more than twice as much inventory as the quarter prior to the acquisition.
Sooner or later, Gifford and company will have to write off this $100 million or so of inventory and take a non-cash goodwill charge against the ridiculously inflated value of the Dallas acquisition.
My bet is that the combination – erasing $100 million in shareholder equity and writing down $1.5 billion in goodwill might cause the institutions, which own 60% of Maxim’s stock to finally doubt the value of CEO John Gifford…and perhaps even the lofty valuation of his company’s stock.
So…what’s Maxim’s stock really worth? Let’s be generous and price the company at 15 times real earnings (accounting for all options). You get $8.40 per share, assuming Maxim can make as much money as last year, despite a 47% reduction in sales.
Below $5.00 isn’t far fetched given the collapse in capital spending and the recent shenanigans here.
for The Daily Reckoning
August 6, 2002
p.s. In Maxim, I found enough things that didn’t add up to warrant shorting the stock…and since running the story in the Daily Reckoning a few weeks ago, we’ve made nearly 30%.
But, these short selling profits are small change compared to the kind of profits you can make when you’re right about a small stock that’s set to shoot skyward. Despite the bear market select opportunities for growth related stocks are still available… one of those sectors is "big pharma."
For example, a block buster drug – which I expect could produce up to $15 billion in profits over the next 15 years – wasn’t recently returned by a major pharmaceutical company to a tiny drug development firm on fears that it didn’t work. Now, however, it seems that the drug works – and can treat a chronic disease, potentially fatal for 500,000 Americans and for which there’s no other safe effective treatment.
You know what you call an investment banker these days?" asked an old friend over drinks at the Maryland Club last night.
"Hey…waiter!" came the punchline.
My friend works for one of the largest investment banking houses in the world. I asked how was business…
"It’s brutal…" began his reply. "Day after day…we’re getting crushed. Thank God, I’m in sales. At least I have something to show for what I do. The guys over in banking are getting laid off; they just aren’t making any loans.
"The company cut back on all expenses. Even top executives are flying coach…"
The Financial Times reports that $47 billion was pulled out of equity funds last month – the largest outflow ever. No wonder. Large cap growth funds are down nearly 25% so far this year. People can lose that kind of money on their own; they don’t need help from a mutual fund.
All over the world, investors are reeling from big losses. The Wilshire 5000 – the broadest measure of U.S. stock market performance – has lost nearly half its value. The story is the same in France, Britain, Germany… almost everywhere.
The pacesetter, though, is Japan. Stocks began falling in Japan in January of 1990… and they’re still down 75%.
Oh la la… if the U.S. follows the Japanese example… the Dow will only be about 2700 in the year 2012!
And why shouldn’t it?
All over the western world…and Japan…people are getting older. Is it really any wonder that economies are slowing down too? Day after day, all the earth ages…drooping unto death.
As you may know, Eric Fry is taking a couple days off…so Addison’s bringing us the Wall Street update from, er, Paris…
Addison Wiggin in Paris…
– Another bad day on Wall Street yesterday. The Dow dropped 269 points. What will today bring? Panic, maybe?
– "A surge in investor fear and such levels of apprehension" Strategic Investment contributor David Tice said in a debate with perma-bull John Buckingham hosted by CBSMarketWatch, "could appear in a bear market and lead to ‘fierce market rallies’ [like the one we saw early last week] – but only for the short term."
– "Such rallies don’t mean the bear market is over," Tice continued. Tice suggested that we’ve entered a secular, not a cyclical, bear market. A secular bear market could span two decades, rather than just a few short years. Following the ’29 Crash, there was a 17- year bear market, followed by a 20-year bull, then a 17- year bear… then our most recent 18 year bull run.
– Markets around the world follow New York’s lead… down, down, down. The Taiwan, Korea, Holland, Switzerland, Belgium and Russia markets all fell 3% or better.
– Curiously, however, a report released in the UK yesterday shows that the housing market is still red hot… even heating up. Halifax, the UK’s largest mortgage lender, suggested by way of a proprietary survey that houses in the UK shot up 20.8% in the year ending in July.
– The economic news in the US, meanwhile, is just… well, miserable. Of the 426 S&P companies reporting profits in the 2nd quarter revenues rose only a 1% annual rate, says a Wall Street Journal article. Domestic sales in the U.S. actually fell by 0.1% in the second quarter.
– And prices are falling too. Over the 12 months ending June 31, 2002, the prices of goods and structures fell 0.7% and 0.9% respectively. Only the prices of services are still rising… barely.
– A Bloomberg headline tells us that even service industries are slowing down. "America is now back on the brink of recessionary collapse," writes Stephen Roach, who predicted a ‘double-dip’ recession at least 6 months ago."Recession, Round Two?" asks MONEY magazine.
– Even the IMF is warning that America may sink into another slump.
– "This business cycle has little in common with those of the recent past," Roach explains. "Unfortunately, it does have a lot in common with the pre-World War II boom-bust cycles triggered by speculative bubbles in financial markets. History tells us that the 19 peacetime cycles from 1854 to 1945 had recessions with an average duration of 21 months – essentially double the 11-month duration of post-1945 recessions. Post- bubble shakeouts are long and painful. Why should this one, following on the heels of the mother of all bubbles, be any different?"
– And more bad news. As Bill is wont to say America "relies upon the kindness of strangers" to finance the lifestyle to which it has become accustomed. Dr. Richebacher estimates that it takes nearly $1 trillion in imported capital to balance the books and keep the U.S. dollar stable. But the IHT says the strangers are growing short of kindness and/or stupidity – the foreigners are pulling back from the U.S.
– Foreign direct investment in the U.S. peaked at $301 billion in 2000, says the IHT. Last year, the total fell to $124 billion. This year…the number could be negative. (As the Mogambo Guru would say: bummer.)
– In the meantime, despite her own woeful economic picture, a decaying stock market, fleeing foreigners and an open- ended promise to rid the world of terror… the US is offering to play guarantor to an entire continent’s banks.
– The Bush administration offered $1.5 billion to Uruguay to assist in reopening that countries banks and pledged to support economic aid to Brazil. The Brazilian currency – the real – has dropped 27% against the dollar in the last year… mostly in July. Neighbors, Peru, Ecuador and Colombia couldn’t be reached for comment… but are thought to be releived that economic crisis would not be heading their way – yet.
Back in Baltimore…
*** From the Rockies a DR reader sends news of what could be the end of the housing bubble (Denver Post): "Denver’s housing market has defied the gravity of a plunging stock market, but it can’t keep rising forever, and some experts see lofty home prices falling back to earth soon.
"Homebuyers may have inflated the market during the past two years, lured by a relatively strong local economy and the lowest interest rates in 25 years. But rising unemployment sets the stage for a decline.
"Consumers are stretched beyond their means, many can’t make payments they once thought affordable, and stock market declines are eroding their savings.
"They are dumping depressed stocks, smarting from losses, vowing to never buy stocks again, and cutting their spending. Some have been laid off for months and will soon run through their severance checks, leading to more foreclosures and fewer buyers on the market.
"[Economist Gary] Shilling says those trends could drag the entire U.S. economy into the second serving of a double-dip recession, creating another drag on the housing market.
"Already, foreclosures are up 57 percent during the first six months of the year in the Denver metro area."