Photon Control shareholders should take the MKS offer: Paradigm

Optical sensor tech company Photon Control (Photon Control Stock Quote, Chart, News, Analysts, Financials TSX:PHO) has agreed to be acquired by Massachusetts-based MKS Instruments (MKS Instruments Stock Quote, Chart, News, Analysts, Financials NASDAQ:MKSI), a deal which PHO shareholders should support, according to Paradigm Capital analyst Daniel Rosenberg. In an update to clients on Tuesday, Rosenberg reviewed the proposed acquisition and moved his rating on Photon Control from “Buy” to “Tender.”

Vancouver-based Photon Control makes optical sensors for measuring temperature, position and flow, with the bulk of its customer base in the semiconductor equipment manufacturing and its top three customers account for about 90 per cent of total revenue. Other verticals for PHO include oil and gas, medical and power and utilities.

The company on Monday announced it had entered into an arrangement agreement with MKS Instruments, which makes instruments, systems, subsystems and process control solutions, for MKS to acquire PHO for $3.60 per share. The deal would represent an aggregate transaction value of about $387 million and the proposed purchase price represents a premium of 26 per cent to the 30-day volume weighted price of $2.87 and a 15.7-per-cent premium to the last closing price on Friday of $3.11.

Expected to close in the third quarter 2021, the deal comes with a $15.5-million termination fee and is subject to approval of 66.67 per cent of shareholders along with customary closing conditions. Photon Control said a special committee formed by Photon’s board has voted in favour of the transaction.

“We are pleased to announce this Transaction with MKS, which offers our shareholders a compelling opportunity to monetize their investment at an attractive valuation and significant premium to the current and historical trading price of the Company’s shares,” said Neil McDonnell, Chair of Photon Control’s Board of Directors and Special Committee, in a press release.

“The Transaction is also expected to accelerate the execution of our strategic plan, enhance access to additional customers and markets and provide efficiencies from greater scale,” McDonnell said.

Looking at the proposed deal, Rosenberg wrote, “Photon’s business has a very attractive margin profile, deep customer relationships and leading technology with large exposure to the red-hot semiconductor space.”

“While we do see potential for a competing offer given the attractiveness of Photon’s business, we believe the offer is fair and attractive to shareholders. The transaction price represents ~4.5x 2022e sales, which is attractive compared to other component suppliers we track at 3.3x EV/2022e sales. We are moving our recommendation to Tender and changing our target price to $3.60 (was $3.75),” Rosenberg said.

Along with the deal announcement, Photon Control delivered on Monday its first quarter 2021 financials, which featured revenue of $18.0 million compared to $17.3 million a year earlier and $14.9 million for Q4 2020. Adjusted EBITDA came in at $5.0 million compared to $7.0 million a year earlier and $3.7 million for the previous quarter.

PHO said its revenues are strongly influenced by capex in the semiconductor space, where there has been strong market demand due to chip shortages and demand for technological advancements.

The company explained the adjusted EBITDA drop to be primarily caused by “an increase in contingent consideration as a result of higher forecasted revenues, investment in product development and sales and marketing costs for servicing our customers to maintain and leverage the revenue momentum gained from a successful 2020 year.”

Photon Control ended the first quarter 2021 with $44.2 million in cash and equivalents compared to $48.4 million a quarter earlier, with the cash outflow caused by cash used in operating activities as well as $5.0 million for an income tax settlement.

PHO had a strong 2020, finishing the year up 46 per cent, and had continued that trend in the new year, with the stock up 54 per cent prior to the MKS acquisition announcement.

On Photon Control, Rosenberg wrote, “PHO has a long track record and a strong reputation in its core end markets. Recent M&A activity and a new strategic licensing agreement are helping to diversify revenue, which has historically been volatile. Higher memory content for 5G devices, high-performance gaming, electric vehicles and cloud capex spending are tailwinds for continued demand into 2021.”

“PHO has deep industry experience and long-standing relationships with key customers to drive accelerated growth, particularly within the semiconductor capital equipment market, as it undergoes a massive investment cycle,” Rosenberg said.

Looking ahead, Rosenberg is forecasting PHO to deliver 2021 revenue and adjusted EBITDA of $74.5 million and $22.3 million, respectively, and 2022 revenue and adjusted EBITDA of $78.0 million and $24.2 million, respectively.

On valuation, Rosenberg’s comps on PHO have the average 2022 EV/Sales multiples among semiconductor capital equipment companies at 6.5x and among semiconductor component suppliers at 3.3x, whereas the analyst estimates PHO’s multiple at 3.2x. On 2022 EV/EBITDA, Rosenberg has semi capital equipment companies averaging 18.4x, semi component suppliers at 15.6x and PHO at 9.8x.