Emulex Sale Seen Restoring Lost Stock Value: Real M&A

Emulex Corp., the chipmaker whose shares have slumped by more than a quarter since shunning a takeover offer four years ago, is reconsidering a sale to help recoup some of investors’ losses.

Emulex hired Goldman Sachs Group Inc. to seek potential buyers, according to two people with knowledge of the situation who asked not to be identified because the process is private. Emulex could fetch as much as $9 a share by taking investor Altai Capital Management LP’s advice to sell itself, according to Craig-Hallum Capital Group LLC. The Costa Mesa, California-based company’s shares had declined 31 percent to $6.66 yesterday since it rejected an $11-a-share bid from Broadcom Corp. in 2009.

Emulex, whose biggest shareholder is Elliott Management Corp., now trades at a cheaper multiple of projected profit than 82 percent of peers, according to data compiled by Bloomberg. Shareholder Penn Capital Management Co. said Brocade Communications Systems Inc. could be drawn to the $605 million company, while Credit Suisse Group AG said the cash flow from its fibre channel business and the chance to cut costs may be attractive to private-equity firms.

“Given how the stock has performed since the Broadcom offer, I would be surprised if Emulex’s shareholder base has not grown extremely frustrated by this point,” Youlia Miteva, a New York-based money manager at Proxima Capital Management LLC, which owns Emulex shares, said in a telephone interview. A sale “should be the most obvious route for them to explore to create value.”

Adviser Hired

Today, after Bloomberg News reported that Goldman Sachs was hired, Emulex shares rose 14 percent, the most in 17 months, to $7.62.

Representatives for Emulex and Goldman Sachs declined to comment.

Emulex, which sells chips that help computer servers and storage networks transfer data, traded as high as $109.61 in 2001 before dropping to $4.53 in March 2009 as the recession and weakened demand crimped profit.

In July 2009, Emulex said Broadcom’s sweetened $11-a-share takeover bid undervalued its clean balance sheet and long-term expansion prospects.

Emulex Chief Executive Officer James McCluney said at the time that new orders would help boost revenue to more than $600 million by 2012. Actual sales for fiscal 2012 were $502 million as the company reported its second straight year of losses.

Purchase Criticized

“It will take many years for management to regain credibility in the public markets,” Rishi Bajaj, chief investment officer at New York-based Altai, wrote in a May 7 letter to McCluney. “We contend that the best course of action is for Emulex to initiate a sale process.”

Altai, Emulex’s third-largest shareholder, also criticized the company’s acquisition earlier this year of Endace Ltd., a provider of network performance management tools. Emulex defended the purchase of Endace in a May 8 response, saying the deal would double its addressable market over time.

Jennifer Baumgartner, a spokeswoman for Irvine, California-based Broadcom, declined to comment on whether the company would consider bidding again for Emulex. Broadcom’s market value is $19 billion.

Elliott, the hedge-fund firm founded by billionaire Paul Singer that pushed Novell Inc. to sell itself in 2010, is the largest shareholder with about 10 percent of the stock.

Standstill Agreement

Elliott entered into a standstill agreement with Emulex in March after the company expanded its board. The activist is limited from pursuing a sale of Emulex during the one-year accord, although it can take certain actions, including waging proxy battles, as early as Aug. 12 under specific conditions, including prior communication with the CEO.

A representative for New York-based Elliott declined to comment.

For interested suitors, Emulex is now one of the cheapest takeover candidates in the industry. The company trades at 9.6 times its projected profit for the year ended June 2013, for which it hasn’t yet reported results. That compares with the median price-earnings ratio of about 14 among computer-storage companies valued at more than $300 million, according to data compiled by Bloomberg.

“It potentially could be an attractive target,” Rajesh Ghai, a Dallas-based analyst at Craig-Hallum, said in a phone interview. “Just from the cash flow perspective and looking at the valuation, I would think that the company could be bought by a private-equity player.”

Private Equity

Ghai estimates that Emulex could fetch as much as $9 a share in a takeover, 35 percent more than its closing share price yesterday.

Private-equity firms may see an opportunity to reduce spending on research and development, while utilizing the free cash flow from the fibre channel business, according to Vlad Rom, a New York-based analyst at Credit Suisse.

Emulex earned 4.8 cents in operating income for every dollar of sales in the latest 12 months. That’s less than half the 12 cents earned by similar-sized competitor QLogic Corp.

“A lot of people are thinking their R&D expense is too high,” Rom said in a phone interview. “Why not just cut R&D costs, take it private, milk it for cash and you’ve made a pretty good return that way.”

While buyers may prefer to hold off on bidding for Emulex until it has resolved a patent infringement lawsuit filed by Broadcom, the company would be an attractive target for an industry competitor, according to Steven Civera, a money manager at Philadelphia-based Penn Capital Management. He said $10 a share would be a fair takeover valuation.

Intel Interest?

“It would be valuable to a larger player in the space,” Civera, whose firm oversees about $7.2 billion, including Emulex shares, said in a phone interview. He also owns Emulex shares personally. “There’s room for consolidation.”

Brocade, whose newly appointed CEO Lloyd Carney ruled out a sale of his $2.5 billion company in January, could be interested in acquiring Emulex, Civera said. Emulex’s purchase of Endace gives it technology that would appeal to Brocade, he said.

Intel Corp., the world’s largest computer-chip maker, could also be attracted to Emulex, although a deal would likely face regulatory scrutiny, Civera said.

John Noh, a spokesman for San Jose, California-based Brocade, said the company doesn’t comment on speculation when asked whether it would be interested in buying Emulex. Chris Kraeuter, a spokesman for Santa Clara, California-based Intel, with a market value of $118 billion, declined to comment.

Emulex’s results have been pressured as technology demands shifted and companies reduced spending, potentially making it less attractive to buyers than four years earlier, said Rom of Credit Suisse. Still, with the shares languishing, investors’ best option may be a sale, he said.

Shareholders “view it as an undervalued asset and I think they definitely would want to explore alternatives,” he said. “There are some secular challenges to it so any way to realize shareholder value I think would be a positive.”

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