This Stuggling Semiconductor Business Offers Huge Upside

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Technology companies come and go as new innovations create new companies and destroy old ones. As a result, investors in high-tech businesses tend to be quick to flee at the first sign of trouble. While this is sometimes a prudent move, investors have overreacted to Marvell Technology's (NASDAQ: MRVL) recent slowdown.

Good risk/reward

Marvell is a leading semiconductor company that operates in the wireless, storage, and networking markets. Its stock price is a little more than half of what it was in January of 2011; investors have fled the company en masse as operating margins shrink as a result of pressure on gross margin and higher R&D spending.

Marvell is an innovative company that depends on R&D to continue creating value for shareholders. As a result, the company spends close to one-third of its revenue on R&D -- an expenditure level that probably will not be cut back any time soon.

The other pressure on operating margins -- falling gross margin -- will likely be alleviated in 2014. Marvell has strong competitive positions in its niche markets that will enable it to earn higher margins once the HDD market recovers.

In the meantime, the company is aggressively returning capital to shareholders. The company has repurchased nearly 30% of shares outstanding over the last two-and-a-half years, which reflects the shareholder-friendly orientation of management. In fact, Marvell's CEO owns 12% of the company, so buybacks and dividends are likely to continue into the future.

In addition, the company has $2 billion in cash -- or $3.80 per diluted share. So, over one-third of the stock's market price is cash. After backing out the cash, Marvell trades at just 13 times depressed trailing earnings. Its normal earnings is likely closer to $1 per share, so, the stock trades at just 7 times normal earnings, excluding cash.

To top it off, David Einhorn's Greenlight Capital maintains a position in the shares after buying in at $14.35 per share in the second-half of 2011. Einhorn believes the company is severely undervalued.

A better investment than these superior businesses

Marvell is not the best business in the semiconductor industry, yet it represents the most attractive investment in the space.

Texas Instruments (NASDAQ: TXN) is a market leader in several chip segments. The company has an enormous sales staff with deep relationships with key clients, which enable it to earn high and steady profits over the long run.

However, the company is not nearly as shareholder-friendly as Marvell. For instance, Texas Instruments bought National Semiconductor for a large premium to what other companies were going for; it is unlikely that National Semiconductor will ever be profitable enough to justify the acquisition price.

Meanwhile, STMicroelectronics (NYSE: STM) also has strong sales relationships with some of the largest companies in the world. In addition, the company has been selling off low-margin businesses in an attempt to boost profitability.

However, STMicroelectronics is essentially controlled by the French and Italian governments; companies controlled by the two governments own 27.5% of STMicroelectronics and the French government has veto power over all board decisions. Investors who wish to own companies that allocate capital efficiently would be wise to avoid stocks that are controlled by a socialist government.

Bottom line

Texas Instruments and STMicroelectronics are both in better shape than Marvell at the moment, but the risk/reward ratio clearly favors the latter. Marvell is a recovering semiconductor company that is returning massive amounts of capital to shareholders as it continues to innovate -- it is hard to come up with a better investment than that.

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Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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