Focus Capital's Mordechai Yavneh returns to explain how $SIMO / $MXL deal fell apart (podcast #187)

Mordechai Yavneh, Founder and Portfolio Manager at Focus Capital, returns to the podcast to discuss how the Silicon Motion Technology Corporation (NASDAQ: SIMO) / MaxLinear (NASDAQ: MXL) deal fell apart. Note this is a follow up to his first appearance on SIMO, which you can see here.

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Transcript begins below

Andrew Walker: Alright, hello and welcome to Yet Another Value podcast, I'm your host, Andrew Walker. If you like this podcast it would mean a lot. If you could rate, subscribe review wherever you're watching or listening to it. With me today, I'm happy to have on for the second time, my friend Mordechai Yavneh. Mordechai, How's it going?

Mordechai Yavneh: Good. Thank God. Good to be here.

Andrew: It's great to have you back on. I'm really excited for today's podcast. Before I get to it, let me just start with a disclaimer. Nothing we talk about on this podcast is investing advice. Everyone should consult a financial advisor. Always true. The stock we're going to be talking about today is domestic listed but it's foreign exchange. And as we're going to talk about, it has one of the wildest legal situations I've ever seen. So everybody should keep in mind that comes with a little bit of extra risk. That disclaimer out the way...

Mordechai: [inaudible] advise also.

Andrew: Say it again.

Mordechai: Not legal advice also.

Andrew: Not legal advice. You're not a lawyer, are you? I'm certain you're not a lawyer.

Mordechai: Oh, no. I'm no lawyer at all.

Andrew: But that out the way, the stuff we want to talk about is silicon motion. The ticker is SIMO. Longtime listeners of the podcast might say, "Hey, Mordechai is all and talking about SIMO. Am
I having Deja Vu?" And the answer is yes. Mordechai came on in December and did a great pitch for SIMO. The pitch, I was rereading the transcript or re listening to it, it actually holds out especially the fundamental side holds up pretty well today. So I'll include a link to that in the show notes. People should go maybe listen to that for some background. But Mordechai the reason we're having you back on is because SIMO when we were talking about it, they were in a deal to get bought out by Max Lanier. Over the past month the deal with Max Lanier has kind of Fallen apart in epic very bitter fashion and I think there are two things we can talk about. We can talk about fundamentals, do an update on fundamentals but what we really want to talk about is start by talking about the legal case in this evolving really unique, legal case. So I've rambled a lot. I'll turn it all over to you. Why don't you give a little background on what's happened since the December podcast we did?

Mordechai: Okay. So let's just give a background for the legal case for those who aren't necessarily familiar with silicon motion. Back in May of last year, May of '22, MaxLinear agreed to buy the commotion most of it with cash $93.54 of sheer passion, a little bit of MaxLinear shears 0.388 shares, and that comes out to pending on deck where Max Lanier was holding it, day by day, about a $102, $103, $105 a share or whatever. So the big thing that was holding up the deal from being concluded was Chinese government had to approve it from an antitrust perspective. It wasn't really any true antitrust issue that MaxLinear and Silicon Motion didn't really have any crossover in their markets, despite the talk of synergies as you have to talk about every merger, they really... Silicon Motion does NAND Flash controllers, MaxLinear does zero NAND flash controllers, two total separate markets, wasn't really much of an antitrust issue but tensions between the US, Taiwan, and China, Silicon Motion is a Taiwanese company trading and MaxLinear is an American company buying a Taiwanese company in the semiconductor industry when tensions between China, Taiwan, and the US about semi-conductors specifically are at all-time highs.

So there was concern that the Chinese antitrust regulators would not approve the deal. And it dragged on for a while. They have to be filed. Well, the clock would stop, start it over again, and
then out of the blue on July 26, about two weeks ago, we got the news that the Chinese government is willing to prove it with the customary conditions of continuing to serve the Chinese market, fear of reasonable and non-discriminatory manner, but not including any malicious software in chips being sold to China. Okay. Keeping your present Chinese employees in China and keeping the Taiwanese research and development in Taiwan, all regular, normal conditions that are expected in such a deal. No deal breaker of any sort. Stock[?] zoomed, from where I was holding there was a huge gap between the stock prize of about 50[?] and where the merger terms or whatever, 105. Mostly because the market did not expect China to be approving, then they approved, it zoomed up 75% on one day to about 93 down the share. Then a few hours later, MaxLinear announces, "Oh, we're terminating the deal." We're terminating the deal, the stock plunges back down. Actually, doesn't plug back down as far as the starters up for the day. I guess the market felt that the Chinese regulators giving approval was less likely than Silicon Motion winning a lawsuit MaxLinear or maybe, I don't know. What the market thinks is hard to know.

Andrew: We can talk about that. But I do just want to jump in. It was Wonder and I was on a babymoon in Europe with my wife, and it was one of the craziest trading days because, you know, we're over there and we're like, doing dinner or something. I'm like, "Oh my God. I can't believe Cyma MaxLinear is actually getting improved. The stock's up 80%, the spread is collapsing. I'm having people telling me this is the best spread I've ever seen, all the conditions are cleared, this is going to close next week, and then out of nowhere, the deal breaks. So it goes from up 80 and all of a sudden it's down like 40, it's up 20 on the days. It was just, it was absolutely wild. It's one of the wildest things we've ever seen.

Mordechai: Absolutely, absolutely. I feel bad for anyone who came in at 93, [crosstalk] at 12%.

Andrew: I know one person who's going to be listening to this podcast. He did and he'll probably know I'm thinking of him when I say that.

Mordechai: Yeah. And then there are a bunch of people who sold at 93, which probably made sense in terms of you got most of your premium that we're looking for. It didn't really make sense to go around to the last few dollars. I am fortune I was not one of them. I wasn't working that day so I missed it.

Andrew: Anyway, let me get us back on track because we're reminiscing about wild days. So at the end of that day, SIMO has cleared this. This is ready to be done if MaxLinear once said and MaxLinear at like 3:30, they come out with the press release, they come out with their earnings, they say, "We are not closing this. We think..." and they throw the book at SIMO but basically they say we think SIMO who has suffered a material adverse event. People who remember the Twitter deal will be very familiar with material adverse event. They state SIMO has suffered a material adverse event. They have breached some of the closing conditions and because of that, not only are we not closing, but we don't even have to pay them the break fee that we would have owed them if the deal had been blocked by the China regulators or couldn't close for some reason.

So we are walking away scot-free and they have their earnings call and they say... a person even asks them, "Hey, what are you gonna do with the break fee?" And they say, "Well, you know, it's probably going to be a legal situation but we think they suffered a material adverse effect. We're walking away scot-free." So that's MaxLinear's standpoint, maybe we can talk about what SIMO comes out with.

Mordechai: Right. So basically they said that they had four reasons why they were able to back out of the deal. They said, one, certain conditions of closing were not satisfied, not capable being satisfied. Two, material adverse event like you said. Three, that SIMO's in material breach. The presentations weren't oozing confidence etc. And that the original date for closing the merger was supposed to be extended two times, but after the first extension on May 5th, they said that it did not automatically extended because conditions for closing were incapable of being closed. It was outside the last date for... the outside date for closing anyways. The second outside date, which was the final outside date, was August 7th.

So they terminated the deal about two weeks before that was supposed to close. So, silicon motion came back and said that this is all nonsense. They actually wrote a very strong letter yesterday which I have right here actually. It is written very, very down-to-earth method. MaxLinear supposed grounds for terminating the agreement are baseless and share fiction. Is obvious as manufactured excuses to try to get out of its binding agreement. MaxLinear's wrongful termination is a willful and material breach and we will vigorously pursue all remedies including but not limited to the right to hold MaxLinear liable to substantial damages.

Andrew: And I think one thing, I can't remember if they alued to in the letter or not, but one thing they say is like, "Look. Hey, if we have suffered..." The material adverse change, not so much, but if we've reached the merger, we have 30 days. You have to alert us, right? Again, if you remember the Twitter deal, Elon alerts them. Sent files in 8K or if I wasn't in touch, it was 13D, in early June that says, "Hey, you are in breach of the merger. You have 30 days to cure this breach. If you don't, then I can break the merger. But if you do, then the merger is kind of back on." Right? And one of the things I think SIMO says is, "Hey, MaxLinear You could have filed that we were in breach of the merger a month ago, two weeks ago, whenever and then we would have had 30 days to cure it and then you could break it. You didn't file it." It's clear that you guys kind of were thinking, Oh, I hope China doesn't approve this and then we can break the merger but you never filed that we were in breach so didn't give us a chance to cure. Sorry, go ahead. I was rambling.

Mordechai: It's more than just... you know, even when you file that you're in breach, you can't just a send the letter like what MaxLinear did, "You're in breach." You got to say what is the breach. You're supposed to [crosstalk]. It's even spelled out in the agreement, you have to send the letter that explains the basis for why you say there's a breach. I mean, whatever you think about Twitter's invented... Elon Musks' invented reasons not to have to buy Twitter, but he invented the reasons and he spelled them out. They are mostly nonsensical but there was... it was too many bots, it was foreign intelligence agencies that have infiltrated Twitter. Whatever the reasons were, he spelled them out. And these are the reasons why he felt he could back out.

Here, they're basically just cut and pasting. All reasons given in the merger agreement that allow MaxLinear to back out, they're cutting pasting that terminology without giving any reason for it. You can see that even when they say that, Silicon Motion breached representations, warranties, covenants, and agreements. Well, which one? Did they breach a covenant? Did they breach a representation? They're not the same thing at all. It's not like you just cut and paste it, any of these things would be sufficient, so they breach those. And material adverse event, and we're outside the date, and these conditions weren't satisfied, those are the four reasons given why we're allowed to back out. Well, go for it. What are you talking about? They don't know either, they just cut and pasted the language.

It's unquestionable that it is sheer fictional and baseless. I don't have any private information about what's been going on but there's very little silicon motion could have done to breach the deal, breach the agreement. They basically have to be working towards the closing. They're clearly, we're working towards closing. They got to governmental approval. There wouldn't have been working for governmental approval, that would be reaching the agreement, but they worked to it and we're successful at it. They got all the deals needed, there was nothing left to do. They didn't go out and buy another company. They didn't sell off part of the company. There's clearly nothing obvious to say that they breach any in a material amount of fashion. [crosstalk]

Andrew: They weren't counting all of their box's users. I don't know. Like, at this point. Let's just throw that one in for old-time sake.

Mordechai: They didn't actually claim[?] forward. You know, that's one thing that... they didn't actually say, "Oh, and all your revenues fraudulent." No, they didn't throw that one in. That would also get them out of the agreement. They didn't claim that. And it's ridiculous. Everyone, every third party observer on the hill understands that it's basically bars and moors[?]. Bars and moors[?] because MaxLinear's... because Silicon Motion stock has come down a lot. And you know, the whole industry is suffering through a downturn. Bars and moors probably more importantly, because MaxLinear's suffering. The same way the rest of the semiconductor industry is suffering. They're suffering their last quarter to push them into a loss.

On the upper hand, Silicon Motion is still profitable. MaxLinear is the one that that this downturn has put them to a loss. And that combined with the huge rise in interest rates, they were going to borrow 3 billion dollars from Wells Fargo at all other Banks to close this deal. They're paying, so far, plus 3%. So originally maybe that would be, let's say, 110 million a year and now we're talking about paying 250 million a year of interest. I think that's probably the most important reason why they looking at this 250 million a year during a downturn, can we even afford it?

Andrew: It's not just that. When they announced this deal, if I remember correctly, the deal was announced late 2021, early 2022. [crosstalk].

Mordechai: May 20.

Andrew: MaxLinear 's Enterprise Value is about 6 billion dollars, right? So this is a leveraged buyout. They're paying 3 billion dollars plus a little bit of shares to go buy Silicon Motion. But, you know, there's 6 billion. Obviously, silicon motion has value, but it's a leverage play. Today, as you and I are talking, MaxLinear's Enterprise Value is under 1.8 billion dollars, right? So it's not just that... I agree with you. There are forecasted... And again they'd have Silicone Motion in there, but their forecast is 160 million of
[inaudible] this year, if you think about throwing 250 million of interest expense and they're like, "That's terrible." but it's also, "Hey." They were going to go borrow more than their Enterprise Value to buy silicon motion at this point. Like the mask really changed, I heard Wells Fargo was probably looking at a billion dollar loss on the loan that they were going to do Max.

So I think MaxLinear , they were really praying, if China blocks this, we can pay the break fee and walk away, but when China proved it, you know, it's the worst day they've ever had and they say, "Oh crap. We're going to have to leverage the whole company to buy SIMO at the absolute downturn. This is going to be awful for us. Let's just take a Hail Mary and try and get out of this thing." Again, very similar to Elon signing at 54 and the whole tech industry went [inaudible] down and him saying, "Oh my God, Twitter might not be worth 20 as a standalone." Go ahead.

Mordechai: It seems obvious that push comes to shove. MaxLinear does not really have the right to terminate. So, [inaudible] makes you feel good and moral and the high ground as a Silicon Motion shareholder, but I regret to tell you that I don't think that will get you all that much. So, where is this going? So, people are comparing this to the Twitter saga with Elon Musk and there's a few major major differences. The biggest difference here is that Elon Musk and Twitter went to Delaware Courts. Delaware Courts are famous or infamous, depending on how you look at it, for their super speed. Everyone who was familiar with the topic understood that this was going to take place, six months at the outside the whole Twitter saga will be over one way or the other. Even with appeals etc., in the end it took what? Three months, maybe a little less, and it was done.

This is not going to Delaware Courts, this is going to Singapore Arbitration under the SIAC using Cayman Island laws and using Delaware law to define what a material adverse event is. So that just sounds like some amalgamation of everything there but the basic point is it's going to Singapore arbitration. That's not happening in three months. It's not happening six months. If you look up Singapore's stuffs, I'll tell you that they finish an arbitration within about 15 months when arbitration is fine. I'm here to tell you that number is also underselling it. 15 months from when arbitration is filed that's their average. Most of the cases they're seeing are 15 million dollar cases, 20 million dollar cases, 50 million dollar cases. The biggest case they took in 2022 was a 600 million dollar case. This is a multi-billion dollar case. It's definitely going to be on the higher end of how long things take. We're probably talking a minimum of two years.

At that point are we suing for specific performance? The world will look different in two years. I don't know if MaxLinear will be capable of buying them for 102. I don't know of the shareholders. I would be very disappointed if in two years, the shareholders, they'll be looking for MaxLinear to be buying them for 102. I would hope this little commotion would be significantly higher by then.

So I don't think we're actually looking to sue MaxLinear to actually close. I think that's not really in the cards. So what are you talking about? So termination fee, 160 million dollars, that they should be able to sue for. Two or three, whatever it is, years down the road, they very likely will be able to get a judgment for at least 160 million dollars or 260 million dollars, it's $5 a share. Yeah. So it was supposed to go for 102 now it's trading for a little bit over 60, you get $5. Nothing, I'll take $5 but that's just not really compensation. You know watching people online and the little people who texted and emailed me and whatever.

Andrew: Look I feel like you're calling me out because the moment to deal broke I sent you a message that said, "We've got another MAE. Let's go. It's Twitter all over again." I know you're calling me out but that's okay, I appreciate you not [crosstalk] me directly.

Mordechai: Not just you, I talk to other people on WhatsApp. So, the merger agreement does state that in cases of a willful and material breach, damages are not capped at a termination fee. In all cases, damages are capped at termination fee except in situations of a willful material breach, which is specifically, if you're paying attention, Silicon Motion has been underlying that this is a willful material breach and I think it's clear that in basically any Arbitration Court of law that's what they're going to decide. That is a willful material breach. But that doesn't get them as much as you think it will. People are probably expecting this, they'll say, listen, August 7th is when they were supposed to close.

At that point they would have closed, shareholders would have gotten $102.45 a share about. Instead, the shares on August 7th closed at about $61.50 or something. So the differential is about $41 times 33 million shares outstanding. 1.4 billion dollars of damage, uncapped. And that sounds like The Best of Both Worlds. We'll get the 1.4 billion dollars cash, keep the company. I mean, they can't actually get 1.4 million of cash simply because MaxLinear doesn't have that money. So essentially, [crosstalk]. Lots of damages and what would push MaxLinear probably into bankruptcy. They have 400 million dollars of debt, plus 1.4 billion dollars of... a legal word against them, they probably go into bankruptcy, we get something out of it, share with all the creditors or whatever it is, unless there was some massive upturn in Semiconductor industry, like really massive because MaxLinear is probably over-levered for the size of the company. I don't think you'd actually see 1.4 billion. So let's say, we'd walk away with 500 million dollars worth of cash or shares or something from MaxLinear. Sounds like a nice outcome and you're keeping Silicon Motion. Best of Both Worlds.

Unfortunately, it is not so likely that that will happen. And the reason is because we have to keep in our head the difference between a company and the company shareholders. The shareholders suffered 1.4 billion dollars of damages. The shareholders are not parties to the merger agreement. The merger agreement is between Silicon Motion and MaxLinear. Silicon Motion didn't lose 1.4 million dollars because they weren't going to get 1.4 billion. In the merger agreement, Clause 8.8. says that there are no third-party beneficiaries created by anything in this agreement except for the banks for certain forces. But otherwise, no third-party beneficiaries.

This has been litigated not so many times. It's been litigated in New York. 2005, the famous consultant Edison case was supposed to... Cornet[?] was supposed to buy Northwest Utilities, they backed out from the merger. Northwest Utilities sued them for the difference in what they were supposed to get in their trading price. Northwest Utilities shareholders sued Cornet[?] through different suits, went through court, went to the second circuit, the second circuit ended up ruling, no third-party beneficiaries. So in the merger agreement, you have no rights for damages for the difference in price, the damages you can get are the amount of money you spent on trying to get the merger closed, your legal fees, that type of stuff that you spent in working towards a merger and they backed out of you, that's your damages. 25 million dollars.

Andrew: Can I just push back there? It is unquestionable, you and I as SIMO shareholders cannot sue MaxLinear and say, "Hey, we would have gotten 100 or so, it's worth 50. Give us 50." Unquestionable. If I can just pull back there. So I hear you like in this case specific performance which would be the deal, closed the deal is not available to us. I know there's a merger cap, as you said, except for willful breach, which I think this wilfull breach [crosstalk].

Mordechai: Not with us. You could go for specific performance and two years down the road Silicon Motion is trading at 10, they can still be sued for specific performance, and if MaxLinear ... financing is not a condition to the agreement but MaxLinear has to be able to get the financing two years. Two years down the road MaxLinear is doing well and Silicon Motion is doing poorly, you could still be suing for specific performance and you can probably get it. Yeah, I just don't know how likely that... that's may be an option in the background, but I don't know how likely it is that practically specific performances will still be asking for in two years and that MaxLinear will actually be able to do it.

Andrew: Yeah. I mean one thing and we'll talk about this in a second is there are branches of this where Silicon Motion sues M MaxLinear, wins specific performance or 2 billion dollars or whatever comes out. And MaxLinear has to file and Silicon Motion, has to take them out of bankruptcy as the largest on-screen [crosstalk].

Mordechai: Not specific performance. Specific performance can't get them to bankruptcy. If you are suing for specific performance then they can do it, so they can do it. Then you can sue for damages. How much damages do you get?

Andrew: Well, you would get the specific... Yeah, I do hear you.

Mordechai: No, no, no, no, no. You do not get the difference in price. That's not what specific performance means. You can sue that they should do what they said they would do, and you could win that lawsuit. If they can't do it, then they can't do it. Now you can sue for damages.

Andrew: Yes.

Mordechai: And the damages is what we're talking about. And this is called shareholder expectation damages. And the second circuit of the United States has ruled that shareholder expectations damages are not valid in the merger agreement where it says no third-party beneficiaries. Now is that absolutely clear? It's not absolutely clear. That's the second circuit of US. A similar court in Ontario. This was in 2005, the second circuit. In 2021, in Canada, Signworld was supposed to be buying Signplex and they backed out because of covid which was not a valid reason to backing out. Actually, pandemics we're specifically carved out as a reason in the merger agreement even though it was signed in 2019. They luckily carved that out. Signplex sued Signworld. It came to court in Ontario.

The Court ruled that they do not get damages for the premium loss because that is not a damage of the company. They do get the damages for lost energies, which they awarded Signplex 1 billion dollars for it. Signworld now are in bankruptcy, that's being appealed. But they got money for lost energies not for the premium. They specifically ruled that they cannot get the premium because, no third-party beneficiaries. Now they could be going for lost energies. But the lost energies here is not going to be 1 billion dollars. The lost energy in their perspectives, they predicted synergies of 100 million dollars. And part of that probably includes... the SIMO part of it probably includes the Maxlinear, and between me and you, the lamppost are probably all fake. I don't think there's anything synergies really. You know, you get the synergies maybe in your accounting department. I don't think there are 100 million dollars Synergies, certainly not more than that. And it's the type of thing that would be hard to prove a high number for a lawsuit.

Andrew: Let me just back up. So in your scenario, if we go two years down the road and rule specific performance, and MaxLinear says, "We can't close specific performance because we can't raise the financing." Right? You're telling me that SIMO would just have to walk, basically, because MaxLinear can't close anymore?

Mordechai: They'd be able to sue for damages.

Andrew: But the damages would be, you have to close this, right?

Mordechai: That's two different things. Specific performance is to do what you said you do. Damages is monetary compensation for the fact that you've breached agreement. Specific performance is not damages. Specific performance is specific performance

Andrew: So specific performance do you have to close? MaxLinear would have to say, "We can't close." And then they would have to file, right? Wouldn't they have to file?

Mordechai: File for what?

Andrew: File for bankruptcy.

Mordechai: They don't owe any money. [crosstalk] They owe [inaudible] they can't close. What do you want me to do?

Andrew: They owe $92 per share.

Mordechai: No they don't. Specific performance says I have to close and I cannot close. So I'm not closing because I cannot. I don't owe you $92 a share. I owe you that you have the right to force me to buy you. You can try to force me to buy you, I cannot do it.

Andrew: But that's why I think they would have to...

Mordechai: I don't owe you money. I do not owe you money. I owe you to buy you. Buy you means give you money and get shares. I cannot give you money to get shares because I don't have the money. Therefore, I'm not doing what the court ordered me to do because I am force majeure, not able to do it. May be my fault but I cannot do it. So I'm not in contempt of court or anything. I cannot do what the court told me to with arbitration tribunal in this situation. At that point, you could sue me for damages. Give me money in place of the fact that you did not do what you agreed to do. That's monetary damages and monetary damages would be unlikely to be 1.4 billion dollars. The second circuit will not give damages for that and the Canadian Court wouldn't. Delaware Courts, interestingly enough, might. It's very much up for grabs. I don't know. How close [inaudible] in the middle of the Twitter Saga...

Is my video...? Do you see my video?

Andrew: Your video is behaving a little strange but I can still hear the audio just fine.

Mordechai: One second. Let me see if stopping the video and restarting it solves that problem.

Andrew: There we go. Yep. Perfect.

Mordechai: Solves that problem, right? Turn off the computer, turn on the computer solves every tech problem. So in Delaware during the Chancellor McCormick actually, there was a side case. I don't how closely you were following The Twitter lawsuits.

Andrew: Oh, I was reading everything with the Twitter lawsuits. Good.

Mordechai: Mingy Crispo, I believe was an individual shareholder of Twitter that also sued Elon Musk. And there was a question why they had standing to because he was a third-party beneficiary. And the agreement said no third-party beneficiaries and Chancellor McCormick wrote an opinion on this topic where she somewhat danced around. But she talked about the second circuit's decision. Talked about other decisions in Delaware that seemed to say that no third-party beneficiaries does not include the shareholders. Because shareholders are obviously, yes beneficiaries of the agreement because they're the ones getting paid. So no third-party beneficiaries means anybody else except shareholders. That shareholders are included.

There were three different cases that she just discussed none of them were actually about getting damages for the premium loss and the cases were not necessarily so precisely... it didn't follow from the cases that you would get the damages lost. They were more like the post-closing conditions that somebody agreed to buy another company and then agreed after buying that not to change their prices or not to do this, not to that. And shareholders stood over that, former shareholders. It was like a family-owned business that wanted certain things to continue and the question was whether they had failed. And the answer was, yes, but who was that line written for?

But that doesn't necessarily translate and she speaks this out, Chancellor McCormick, that it's not so clear whether the Delaware president would allow for damages for the premium gap or not. That needs further briefing. It needs further discussion. It's a question in the are indolent. Second circuit wouldn't give, Canada won't give, Delaware may be or may not be. This is really not so relevant because we really want to know what a Singapore arbitration tribunal will sign on the Cayman Islands law. And we don't have any precedent that I know of about Cayman Island law or Singapore arbitration tribunals on the topic. But to me on the Lamppost, the weight of precedent of the second circuit and the cannon, which is directly on this, and Delaware which is about other things and was hypothesizing what would be about this interesting question.

I think it's more likely to Singapore Arbitration tribunal will say, "We're not awarding 1.4 billion dollars. We'll reward your damages. Your damage is definitely on the 60 million dollar termination fee, the 30 million dollars you spent on, you know, your lawyers and the people you pay to work through the regulations stuff. Maybe or maybe not cost of the arbitration itself. So we get you to 200 million dollars maybe." That's not what [crosstalk] looking for you.

Andrew: So in your mind, the most likely outcome if they pursue this arbitration is SIMO winning and kind of taking in, as you said, 200 million dollars which kind of comes out to, if I remember the math in my head right, a little under $7 per share at the end of two years. You think that's the most likely outcome here?

Mordechai: I think that's the most likely outcome with a [inaudible] option. That if things go terribly for Silicon Motion and things go well for MaxLinear they do have the option to force specific performance and it could very well be that MaxLinear will be able to. It is unclear to me, from reading through the financing commitments from Wells Fargo, whether Wells Fargo's commitments will last through the two years of arbitration or not.

There's no specific ending date in Wells Fargo's commitment. The commitment is to finance whatever's in this agreement. If it's fair that the agreement never terminated, it's possible Wells Fargo's commitment will still be there to lend the 2 billion dollars or it might be another lawsuit on the topic. Lots of fun. And not really clear to me what... I don't know of a clear precedent. That's probably me not knowing more than that there isn't any. There probably is some precedent out there that's relevant. It could be that MaxLinear will be able to close simply because Wells Fargo will have to lend them the money. So I don't know about that, but that's like kind of an option and that's a valuable option. But personally, if in two years time we still want specific performance I'd be disappointed.

Andrew: Let me push back. So, again, how I had been, and I have done work on this but not as much as you and I am certainly not a legal expert, but how I had been kind of shaping around to it was, you have the suit and it's a two-year suit and at the end of it, if SIMO wins and get specific performance, MaxLinear would either need to close or they'll need to file, is how I had been looking at it. I understand what you're saying, that's just how I'd look at it and kind of how what I had been thinking was, so you've got that hammer at the end of it and then where you kind of come out is you have either a settlement between now and... you have a settlement between now and then where the deal gets recut and basically... and this assumes a positive thing, but basically MaxLinear's breaking this was a way to force a huge recut of the deal, right? Where the original deal was something like $90 per share cash and like, $18 per share in equity, you're basically coming to back and say, "Alright. We're going to change this deal to be $10 per share cash and SIMO shareholders get 50% of the combined company or something.

Mordechai: Definitely not happening and I'll tell you why. If they raise the stock's portion of the deal, then MaxLinear shareholders have to vote on it. MaxLinear shareholders are going to vote, no. They don't want this deal. When the deal was announced the stock tanked. When the Chinese approval came in the stock tanked because they don't want the deal to go through. I don't blame them. [crosstalk]

Andrew: I hear you, but if they go to their shareholders and they say, "Look, we're going to lose in our arbitration and if we do that, we're going to have to pay $90 per share to SIMO or file.." Like that [crosstalk]

Mordechai: [inaudible] That probably might be true, as I said. You might be right that they're going to recut. I don't see a massive recut in... mostly shares is very difficult and if they recut it to let's say we recut it to the same amount of shares, but let's say instead of $93 cash, $80 cash, instead of $104 we'll bring it down to $90 a share. Yeah. You need another vote from SIMO shareholders. Don't know if that would or wouldn't go through. I voted no to the first merger so I don't know where that embeds if you listen to me. Now, we've got, you know, confirmed, confirmed $90 a share. There could be people who vote yeah. I don't know. They would need to be another vote etc. It could be that's what Maxlinear's game here is, they're just trying to recut. It's definitely possible. They aren't to know what's going on inside the minds of the Maxlinear management that could be what they're aiming for. A massive cut to $60 share? I don't think SIMO shareholders are interested in it or $70 or $75 a share, I doubt they'll be interested in it. And changing mostly to the stock, which is affordable, is just not happening because MaxLinear shareholders are not going to approve it.

Andrew: Let me just back up real quick too. And I don't want to harp too much on it, but it's really different view than what I've had. In your specific performance case, right? Let's drop SIMO and MaxLinear for a minute. Let's just go to a normal company, buying a normal company, right? I'm buying Mordechai Inc. market turns on me, I get really cold feet. I say, " Hey, Mordechai. I'm breaking the deal." And you say, "What? I followed everything. We've got a contract." You sue me for specific performance. You win. You say, "Great. I win. Pay me." and like to me...

Mordechai: Not pay me, buy me.

Andrew: Buy me. You say, "Great. Buy me." To me, what you've created if I don't have to... if MaxLinear could walk in this situation, if I do... what you've created is I could just say, "Mordechai, I'm not buying you." And you say, "Okay, great. I'm suing you for expectation damages now." But because I was just buying for you for cash...

Mordechai: And then go to court, they'll start putting in contempt of court for not following the court order. Oh, here's an arbitration order, which has to take the arbitration award or specific performance, take that to court, the court would mandate performance, and then... it doesn't... MaxLinear is not going to ignore a court-mandated order. That's not happening. So just like [crosstalk] [inaudible] wasn't going to ignore a court-mandated order, MaxLinear is not looking to be in contempt of court and ignore an order that they can fulfill.

Andrew: That's why I think they need to file for bankruptcy. That's why I think they would need to file for bankruptcy.

Mordechai: That doesn't make you go into bankruptcy. If you can't do something, you can't do something. To file for bankruptcy you have to have a monetary award. Specific performance is an award to do an action. It's not an award of money. Money is Damages and that's expectation damages. But expectation damages are for the shareholders not for the company. And as I said, the second circuit, Canadian circuit, and probably, not for sure, very not for sure, arbitration tribunal could go either way but likely but it's definitely a strong likelihood that the arbitration tribunal would say, "We're not going to award expectation damages for the shareholders that they're third-party beneficence."

Andrew: I'm gonna have to do more work on this. And I'll follow up with you offline. Our listeners can either hit one of us offline [crosstalk] and follow up.

Mordechai: I know there's a [inaudible] for all the [inaudible] multi-shareholders out there, including myself, but that's what I expect.[crosstalk]

Andrew: I just feel like you've created a precedent...

Mordechai: I believe that most of the talk here going forward, should be on either the possibility that there will be a recut and another shareholder vote. And then just we're talking recutting from 105 to 90 as just, you know, a negotiating ploy or I think really focus on the fundamental case, which I think is very bullish.

Andrew: I just feel like that scenario has created a precedent where any company that cannot bot.. That is an merger contract that they cannot fund kind of off their balance sheet, has a free out by breaking, getting sued for specific performance, and then saying, "Hey, sorry..."

Mordechai: Not true. If you sue in Delaware, so you took my three-month process at the end of which they already have the financing commitments, and you [inaudible] because you have to. [crosstalk] malpractice, it's a two-three year process at the point... so yeah, maybe at the end you could get specific performance and maybe the financial commitment is still valid, which it might be yeah. The question is in three years will you still want the specific performance? If you do they could get it maybe. And that option is valuable but... again, that option is really valuable. You have the option.

You could sue specific performance and there's a strong likelihood that the wealth argument will still be valid in 2,3 years from now. Because it's valid as long as the merger agreement is valid. Well, Fargo might start claiming that the termination was... it was terminated, even though invalidly, so they don't have the commitment anymore. It's not really clear in the finance commitment. I read through with a fine-tooth comb, it still wasn't clear. I don't know enough about pressing on that. It could be in three years Wells Fargo won't mind financing it. It depends on what the financials that I like and what the interest rates that I like, and could be they'll be okay with it.

Andrew: I mean, this is a very cyclical industry. You know, boom, time generally, followed bus times, we're in bus times right now. MaxLinear had a 6 billion market cap two years ago, like,[crosstalk] it's very possible...

Mordechai: That option of specific performance is actually very variable. Right now the stock exchange is [inaudible], there's an option to sue for specific performance 104. That's really viable. I personally believe by the time that option becomes in play the stock will be past 104. That's where I'll be on the fundamental view. Let me just take out a moment we didn't really discuss. We discussed why... I mean, they didn't really give any explanation of what the supposed breaches of warranty...

Andrew: [crosstalk]That will transition us nicely to fundamentals. Because that's where I wanted to go.

Mordechai: What about the material adverse event? Let's talk about the material adverse event for just a moment because there it seems obvious what they're referring to is that Silicon Motions business fell apart. You know, the first two courses here, wherever it's been down 40 to 45 percent. Net income has been down 80%. Yeah. So there you go. Here's our material adverse event. That seems to be what they're referring to. So I just want to speak out just for our listeners that that's not going to fly. There's really no Material Adverse Events here for two major reasons. First of all... again, the material Adverse Events here is on the Delaware law. Delaware law is very clear and very specific. And Delaware law they used to say that Delaware has never found a Material Adverse Events in history.

A few years ago they change to a material that they've only once found material adverse event in history. Basically, the law is like this, Delaware says, to be material adverse event, you have to have the business collapse on a permanent basis. So the one time they found a material adverse event was the company that was being bought had defrauded the FDA and made up all the clinical trials and their revenue disappeared. With no foreseeable reason to think that that would change.

Andrew: It was Acorn Franksiers. And if you remember, Acorn made sterile eye drops and they literally had... they present their suit. It came out that Acorn literally had cockroaches running around their sterile eye drop facilities. And like cockroaches running around your sterile facilities, it's not in a merger contract but I use it to say like how bad the business was that they were buying and they...

Mordechai: I believe they actually made up clinical trials in their made up of data and the clinical trials have been submitted to FDA. It was a terrible situation. The revenue fell off the cliff and it wasn't coming back. That was a permanent MAE. What's not a permanent MAE? Example, I forgot the name but one of the private equity firms, contracted the cake business. Then came Covid. Cake business, wedding cake that was.[crosstalk] Yeah, totally fell apart. Yeah, and Delaware said that's not a material adverse event. Yes, Covid. It's not gonna last forever. 2, 3 years Covid will end the wedding business will be back. No Revenue for two years is not a material adverse event. So, there's actually no way for silicon motions to clearly [inaudible] downturn to be material adverse event. That's reason, number one.

The second reason, just as important, is that the material adverse event clauses will have carve-outs and the carve-outs generally do, and in this case do, exclude general economic conditions and let me quote the exact term that used. Changes in general economic business labor or regulatory conditions, changes in Securities credit or other financial markets, interest rates or exchange rates, and changes generally affecting companies in the industry or industries in which a company or its subsidiaries operate in Taiwan, US or globally. None of those changes will count as a material adverse event. The only such changes that affect industry as a whole [inaudible] reverse events if in fact, Silicon Motion disproportionately more in a sense that makes a material adverse event, but it's not. You look at Micron, [inaudible], Western Digital, Samsung, they're all suffering. Their revenues are down, 50%, 60% of their flash. Let's look at Fraise controllers.

Fraise is probably the closest comparison to Silicon Motion business. They sell modules of combined Flash and controllers. They sell controllers. Let's see, their business for the first quarter this year was down 41%, second quarter down 39%. And that's the business as a whole. The control business for itself was actually down 33% which is more than MaxLinear's business was down. I guess, Silicon Motion business was down. So Silicon Motion has actually gained chair in the downturn. So one is cyclical, two it's industry-wide. It's temporary, it's industry-wide. There's no way anyone would consider this under Delaware law. There's no way in Delaware Court will consider materials adverse event by any sense of imagination and even though they're not going Delaware Court, it's going to Singapore arbitration, under Delaware law. I don't think there's anyone in the world that would see this as a material adverse event based on the contract as written.

Andrew: My favorite tweet was, somebody said, "Hey, if you look at MaxLinear's results and Silicon Motions' result, MaxLinears' performing worse. So there's a chance that the MA happened. It was just on the MaxLinear side. [crosstalk] I think we've actually pretty well covered the legal case. Obviously, you've done more work so I'll defer to you. But you and I have a slight difference of opinion on the outcomes of a specific performance potential but I think we pretty much covered it.

Let's quickly talk about... and there is even... again, I'll defer to you but even you're right, I'm wrong. There is definitely a lot of option value to being able to sue for specific performance. [crosstalk] I love what you said. Cyclical business. MaxLinear could be worth 7 billion dollars in two years and you might have Wells Fargo saying. "Hey, we'd love to fund it. We'd love to fund this [crosstalk. This is the best that we'll ever fund." Right?

Mordechai: It's quite possible that Wells Fargo will finance it if the arbitration rules it must. It's quite likely that Wells Fargo... definitely not out of the realm of possibility that Wells Fargo will as you say want to fund it and even if they don't, it could be that they'll have to anyways. So it's definitely an option of value to that. That's important. Yes.

Andrew: And as you said there, there also is, if the damages are, let's say an arbitration is going to roll 200 million, like there is also optionality to hey, you know, six months from now, everybody might say, okay, let's... MaxLinear says Yes, we have some [inaudible] from this performance. Silicon Motion will give you 300 million dollars right now, walk away. You know, so there's going to be some pot of gold at the end of the rainbow. It might be the $100 per share. Let's quickly turn to the fundamentals. And again, I'm going to refer people to the December podcast. We actually did quite a bit on the fundamentals and what makes Silicon Motion so unique and why again cyclical business. So, we're in a bad cycle right now, but why over time, they should be a sure taker. Why they should. But I just want to quickly get your thoughts on how the business is performing and kind of how you see the cycle evolving.

Mordechai: Right. Okay, so, anybody who's been paying attention. So the semiconductor industry is experiencing downturn. Memory in particular is experiencing a massive downturn. If you look at the flash makers that's Micron, SK Hynix, Western Digital Samsung's Memory Division, Kioxia which used to be Toshiba, and also YMTC which is Chinese flash maker. You put them together over the first half of this year they must have lost 20, 25 billion dollars plus just in the memory division. It's huge amounts of money there. What's the basic chords behind it? So let's start with taking a little bit of a flawed review back.

Andrew: What's the basic cut? They're not pumping AI hard enough. They're not pumping AI hard enough Mordechai. That's the cause.

Mordechai: Yeah, a little bit. An AI server uses probably three times amount of NAND memory than a regular server does. So there's truth to that, but. What happens is like this, if you go back two years, 2021, everybody was talking about the chip shortage. There was a chip shortage. Autos weren't being made because they couldn't get chips that they would sell. Because of that chip shortage, all these customers were nervous about not getting allocations everybody doubled ordered or tripled ordered. It happens all the time in the cyclical semiconductor industry, especially my ministry. People are nervous, they order, double order, triple order, quadruple order, I don't know.

The inventory starts building. 2022 inventory stock continues to build and then the demand explosion of 2021 starts falling off. So the demand evaporates. We're now looking at... 2022 had probably double digits down on the PC market, the smartphone market's been down, it's going to be down this year. PC market, smartphone market, the server market, all the end markets on the memory products are all down here over here.
They were thinking the good times will continue and they was a chip shortage so they extra ordered, double ordered the memory they need. Now all the end-users and the channel markets have way more memory than they need. So they said, "Okay. You know what? We don't need. Let's hold off." None of these are long-term contracts, everybody's ordering in the quarter for the quarter.

So the commotion and all the flash makers have very little visibility into their business. They're building out capacity because they're hoping and expecting for, you know, their memory to be needed more and more but they don't actually have any long-term contracts to the memory and they have very little visibility. Their customers could tell them, "Oh, we think we're going to need 20% or 40% more this year." And then two months later they say, "You know what? Changed our mind. We don't need anything." They operated on a day-to-day basis. They have no visibility. Their forecast for the year, they really have no clue. The forecasts are based. They know what their plan to build capacity and what they're hoping the market will buy. But they don't really know what the market will buy any more than any other analysts trying to predict with the PC market will look like in a year's time.

Yeah. So they've been building over capacity, the flash makers, and then there was overordering, so there's too much inventory. And the month fell. Between that you had this massive disconnect between the amount of supply that the flash makers want to provide and the amount of the demand that the customers and the middle market want to buy for the customers and this is massive disconnect. With that massive disconnect, what happens is that people stop by memory, memory prices it cut massively and they start bleeding money, the flash makers. They're bleeding money. They're underutilized. Underutilized that they're
fabs which makes them take massive underutilization charges. So they're selling less product, at a lower amount of money, and it's costing them money for these part of the fabs, vital part of it.

So how does it correct itself? So naturally someone self-correct. They were going to increase capacity this year instead of increasing capacity, they're slowing the increases and eventually cutting production. It takes time but all the flash makers have announced cuts in the first quarter, more cuts in the second quarter, and possibly even an ounce more cuts in the third quarter. But they're going to cut cut, cut until they are confident that inventory starts to bleed dry. Inventory by the flash makers are still pretty elevated. Example, I'd say Micron said they need about 6 billion dollars of inventory to match what would be a normal progression, forward sales, and have 8 billion dollars of inventory. So that's still pretty high. You can see the inventory building the pouch and it hasn't really come down yet. But the end customers themselves and channel market inventory is starting to dry up, there are some indications that.

It's really hard to know. Part of what it was hard to know is, we can still enter recession we haven't actually done that yet. Yeah. We enter recession, the end markets of PCs, smartphones, and servers, which right now are weak, can get weaker. There's nothing we can offer that it can't get weaker. They could totally get weaker. The demand could continue to go down and let's cut production more. This could end up with a flash maker or two with bankruptcy. Some are like Samsung that has other divisions to cover the losses of the memory is going to be stronger, some like Micron and SK Hynix which maybe are more memory focused are going to suffer more.

What I want to underline here in all this is Silicon Motion is suffering, you know, as a consequence of that less memory being bought, bought equals demands downs and market and of course, people have to work through the inventory. So the Bargain, let's get two controllers. So their revenue dropped, dropped a lot. Dropped in the first two quarters about 40, 45 percent. They're still profitable. Is one of the things I love about Silicon Motion, you out the cycle they are profitable. They continue to add cash to the barrel cheap. No debt. They're still taking money and less money. During the downturn, it's less money because they're selling less goods. Gross margin come down a little bit. The gross margins have been used to are about 52 percent because they're, you know, operating expenses, and the employee base is similar. But on less revenues so their gross margin narrows down. The gross margin narrow down because their expenses are up, the CSMC charges are up, and the assembly charges are up, the packing charges are up but they're advertising out over less Revenue. So the gross margins about now 40, 42 percent down.

Andrew: Can I jump in here real quick Mordechai? I think you've done a great job of explaining where the cycle is and kind of what's happened over the past six months that the cycle has gotten even worse. When I read the Silicon Motion and part of, I think, the reason Silicon Motion's stock hasn't gone back to where it was before it seems it[?] came out, and then all this... part of it is the auction, but I think part of it is also people saw MaxLinear say, "Hey, MAE break, we're leaving." And then SIMO put out their earnings that night or the next morning. I can't remember exactly. And I'm just reading. And here's some quotes. "First half was challenging. We're optimistic the industry is well poised. Growth in the second half of the year. We expect Q3 sales will be up 15 to 20 percent quarter-over-quarter."

So, I want you to comment on that, but I will just say, from our perspective, from a trader perspective, from an investor's perspective, I think when MaxLinear files. "Hey, we're finding MAE." And Silicon Motion hasn't said anything because they're getting hit with it about the same time we are. Everybody says, oh my God, this business must be on fire, things are a disaster and then they report Q2 results that, as you said, are profitable and they say, hey, things are actually getting better in the back half here. So I just was hoping maybe we could transition to you commenting on what's Silicon Motion seen in the second half and how their business will perform going forward.

Mordechai: Okay. You started from investors' point of view and from traders' point of view. I want to split that into two groups because they're two separate things. The traders' point of view is probably very interested in what's going to be quarter 3, and what's going o be quarter 4, you know, near-term results. And the answer is I don't know and I want to underline that Silicon Motion does not really know. They predict 15 to 20% up. They predict a strong second half of the year. They don't really add that [crosstalk]

Andrew: It could get a lot worse, though. They reported at the end of July they do have what's their very near turn, they have one [crosstalk].

Mordechai: One month worth of information where they say things are starting to firm up a little bit but at the end of the day. It depends on the end markets. They have meager visibility to their customers' customers. By the way, end Market are not their customers, it's most of the customers' customers. Yeah. They don't have real visibility into that. They don't know that the second half will better. They hope and think they see beginning of shoots of some, you know, budding of some grass coming out of the ground that it's starting to come a little better. And that can all be true. All right, do not want to be in a position to tell you what the next six months can be, I don't know.

Andrew: Great Point. Yep.

Mordechai: I'm not a trader. As an investor, I'm going to tell you what the next three years going to be. And the answer is, I don't know when the cycle will end. So far it looks like quarter one was the trough of the cycle and it's been getting better since. Quarter Two is better than quarter one throughout the industry. And everybody's saying that they're seeing inventory levels coming down by then market. Indoor levels coming down a little. If there's a recession, it could be another, you know, a double-dip kind of and the end market demand, who knows? I don't know. But I know that in three years we'll be out of the cycle. The cycle it's always been a down. This is the worst downturn. Like Micron said, is the worst downturn we've seen in 13 years? 13 years is not such a long time. This happens every 10-15 years. And one of the nice things about it is, last time we had a downturn, of something not really as bad was, I think, around 2018. Then Silicon Motion had to take some write-downs on the inventory. The main reason for that is a little bit of their business model had a little bit different.

They have three divisions. They have their SSD division, that 50% of the company. They have their EMMC and USS business embedded that's like more than smartphones tablets and, you know, Internet of Things type of applications that's about 40% of the business. And then there's SSD Solutions with a package lashed together with highly customized very high-end controllers and they sell at the hyper scalars like Facebook or Alabama etc. that's about 10% of the business. So, 50 is SSD, 42 the embedded, and 10% for SS divisions. Back in 2018, when they have to take write-downs, their SSD solution was they were boring memory and they were stuck with...

There goes the video again. There we go. Not sure what's happening today, but the... What happened was that when NAND flash started crushing on price, they were stuck with old inventory of NAND flash that they couldn't sell at the old price anymore. Two things have changed since that. First of all, is it Solutions didn't live up to expectations. It's a much smaller part of the business and it was like that. Second of all, they reach, they change a contract where they no longer are buying Flash and selling it on. They are basically just taking on consignment for their end customers. End customers are ordering the Flash and they're doing the packaging. So they are on most of the customers, on the large majority of SSD solution customers, they are no longer taking the flash memory risk. They only have to take a write-down if their controller inventory goes down in value and that is much more stable pricing, much more long-term usage. Yeah, so they so far in the cycle I'm going to have to take a write-down. Their inventory has been getting higher a little bit, but it seems to be coming back down.

Andrew: [crosstalk] I was going to make that exact comment.

Mordechai: The peak of the inventory compared to their seals was in quarter one where they had, like two and a half quarters worth of inventory, which is far more than they want to have. They want to have like one or a little less than one-quarter worth of inventory. Has historically been what? They raised the inventory levels a little bit last year when there was a chip shortage. They wanted to be able to provide. So they'll also raised them through like everybody else. Yeah. But two in a court, is way more than they need, but started coming down right now. There are about 1.8 quarters worth of inventory. And as if the next two quarters continue to raise their, they were there claiming 15-20 percent in sales, and then inventory comes down, they'll be back pretty soon. By the end of the year to normalize inventory levels, and we won't have to even be talking about the possibility right now, which I don't think it's in the cards of the cycle.

Andrew: I was just going to add, that was one of the things. Again, when you get the merger break and Silicon Motion, they're a company that's been under contract for a year, right? They are not doing analyst calls during it, they're not doing anything. And you know before they report Q2 you saw, oh my gosh inventory ramped up quite a bit in Q1 and there you've got MaxLinear claiming an MAE, like one of the things that to me again as a simple tad who's studying this company from the outside, I was worried inventory to gone from 320 million to 400 and you had a situation where sales are slowing, inventories ballooning, they're going to have to take a huge write-down on this. And to me, one of the things I saw that I liked was, hey, inventory actually went from 320 to 250. As you said, yes, it's a little higher than we would like, but we don't have a company that's over here choking on inventory that they can't move. And that's just building up and like the cycle needs to turn tomorrow or else they're going to just have to take huge write-down. So that was one of the things that just jumped out to me.

Let's move away from the current cycle. Again, I'm a dumb Outsider, 250 million in EB in 2021, 250 million in EB in 2022, if we kind of fast forward. And let's say, 2025 we're at... and this industry is famous for whoop sign from absolute Peaks to Absolute troughs, right? But 2025, we are at the mid-cycle, what do you think the earnings for Silicon Motion kind of looks like in a mid-cycle, normalized environment?

Mordechai: Honestly, I'd be surprised if there are over 6 dollars per share by that time. They didn't want to sit down to share last year and that one... So the last two years, it did a little bit about 2,000 a share. Maybe last year was pulling in demand from future years as inventory built. But 2021 was much more realistic. They were doing about a billion dollars in revenue. That market share has been building. Even now, I believe the market share's been building. Phison control revenue is down more than Silicon Motions. We haven't gotten so much commentary from them because...

We were having conference calls over the last year, they have a little bit of, you know, commentary inside their earnings release, but not much. But it does appear that they are bullish on their strong desire and momentum. They've been increasing from under half... used to be their SSB business with less than half of that and that was OEM. Now, it's two-thirds. OEM business is long-term sticky business. Once you win the slot, you're very likely to win the next slot when it's replaced at the [inaudible] will point out. So, it's a good business to be in.

How much OEMs need will depend on their end market, but it's good business to be in. Long-term they've been increasing their market share, winning market share. So, I would just say, what are the risks? Let's talk risk for a second. Yeah. They have two major big customers. I mean, the major classes are the flash makers, and the module names and the reacts. In the flash makers, Micron has 24% customer and SK Hynix is 25% customer. So Micron is at 25% customer, it's been a long-term relationship. Micron has recently got banned from selling in to China, which is about 12 and a half percent of their business. Is been bad. They do 25% of business in China and 12 and a half percent, half of that business Micron has said is subject to the ban of infrastructure, the buying from them. So Micron which is a major customer is going to be under some pressure. There problem plays with us another customer, but they're on the pressure.

SK Hynix is 25% customer. A lot of that 25% customer is because SK Hynix recently had ended 2021 what entails memory division. They're actually the presses of wine at the border. They have some control, not full control, it's a multi-year deal, whatever, it is complicated but they have entails forming and division. SK Hynix famously used to use Silicon Motion for the EMFC division. They still do. But when they transit to FS, they decided to end sorts. I'm sure there's some risk that... they were not successful there in sourcing.

SK Hynix is not a major player in UFS business, Silicon Motion is through their Micron deal and others as well. So SK Hynix do not do well with their interests on the controller. I don't know if they read or don't, but there's some risk, of course. SK Hynix down the road will take the television business and sourcing that as well. That's a risk. They always have to be.
The major competitors here are finding a Marvel or virtual controller makers and Silicon Motion and the in-sourcing from The Flash control.

Over time, it appears that the push to insource have been going away. I believe now, during the downturn, The Flash makers are even more looking to Outsource. They want to cut their expenses they don't need. They want to Outsource as much as they can. So the control division, one thing. There's been discussion, rumors, already rumors somewhat, but the last year or two there's been rumors that Samsung might be finally looking to Outsource some of their controllers and that's a major chunk of the market. That's 40% of The Flash market right there. So that would be very important. That would be a major growth story. So this, both
reward possible from further outsourcing and this risk possibly especially from SK Hynix's person until of insourcing.

Last time, SK Hynix insourced, there was a good chunk of Silicon Motion's revenue at the time. I think there were 33 percent customer. Silicon Motion grew through it and came after on the other side. If it happens again, I believe they'll grow through it as well. I'm not so concerned about it. I think more Outsourcing is more likely than more insourcing. That's one major risk. The second thing I would highlight on a long-term basis is that Silicon Motion is yet to crack into the enterprise market. They've been working on it for a few years. I believe this year is the first year where their enterprise controller is, maybe able to be a player. And they want to start breaking in 2024, 2025 and stock all the way up. If they're able to do that, that's a greenfield opportunity for them where they head-on start competing more with Marvel who's mostly Enterprise controllers.

In the consumer space, they want all that business from Marvel and I think that they have a good chance of winning the enterprise business from Marvel over time as well, and that would be tremendous growth for them as well. So I think there's a lot of good things to look forward here. When the cycle turns, I think we're looking at $5, $6 a share on a normalized basis, with the possibility of major further growth if they make it to enterprise space. So I think that's pretty good.

Andrew: I was going to say halfway through that...[crosstalk]

Mordechai: And let's not forget the amount of cash they have on the balance sheet. They're trading $60, about $17 of that is cash and easily convertible receivables, etc. minus their liabilities. They have no debt. Take out one of the liabilities, they have $17 left of cash and convertible to cash assets. So we're looking really at a share price of a little bit more than 40 on something that down the road.

I believe not too long from now, maybe even next year or the end of next year we'll be looking at $5 a share earnings on what's essentially X cash, $40 a share. And the cash just continues to grow. You know, a lot of companies that claim to be profitable and the cash doesn't seem to ever show up and then there's comments like this. They keep on adding cash on the balance sheet hand over fist. In good times, hand over fist. In bad times, I'll hand over first but the [inaudible] in cash. And that's something I like about Silicon Motion. I just want to unwind that again.

Andrew: And I was going to say halfway through. We actually discussed the Samsung outsourcing and the insourcing risk a lot on the first podcast. So, again, I would just refer people to that. And just last thing because we're running long and I've actually got to get ready to get some dinner plans and get some after dinner worked on. But just last thing, you know, one thing that does strike me is Silicon Motion just tried to sell themselves to MaxLinear, right? Or this is a company now, that has tried to kill themselves before. Do you think two years down the line the option on the specific performance phase out and the cycle can normalize, do you think there are seller again or do you think MaxLinear just kind of bowled them over with such a big premium that they have to take it?

Mordechai: I have no idea. MaxLinear approached them not the other way around. I don't know. It could be that the CEO is now ready to retire. So, I don't know. Hard to know. I just [crosstalk] want to add one statement. One thing, going back to arbitration for just one second, people are understandably... you'll be very interested in knowing and you have the arbitration gone and what do you and you want to follow it closely. Like they did with the Twitter saga and I unfortunately will have to tell you that other Singapore rules, arbitrations are confidential.

Confidential means that not the arbitrators and not the parties are allowed to reveal. The hearings are private. Nothing can be read about what happened. The briefings are private, you're not gonna be able to see the claims of the counterclaims. And in fact, even the very existence of arbitration itself is confidential. There are exceptions and one of the exceptions is if they must reveal it on the wall or regulation. And that they will have to reveal... there is an arbitration undergoing. Both sides will have to reveal that as being material to the businesses. We might be able to get some information like what the size of them just claimed is. Maybe we'll be able to see some of the briefings, but much of what's happening is going to happen underneath the water line and we'll not see what's happening. Until the word comes out, which will be public again because it will be material one way or the other.

Andrew: Actually, as a New York based person, it's actually nice to hear that because, you know, in Twitter, we would... I know you and I were both listening to like every Hearing and the hearings would start at like 10 a.m. and end at 1 p.m. So if you take that over to Singapore that means the Singapore time it would start at midnight New York Time and end at 3 a.m. and we're about to have a kid. I'm not sure if I really want to be listening to an arbitrary. I would do it, but I'm not sure if I'd really be thrilled to listen to arbitration. Well, Mordechai, look, this has been absolutely fascinating. I really appreciate it.

I'll include a link to our first episode again, so people can go listen. We talked a nice bit about fundamental value there, but we really talked a lot about fundamental value there. So people can go listen to that. I'm going to follow up on the specific firms angles and you and I will obviously keep the conversation going offline and listeners will just have to wait for the third podcast to hear about the results. [crosstalk] I really appreciate all the great work you've done on this. And I really appreciate you coming back on for the second time. So, looking forward to the third one.

Mordechai: Great. Always good to speak with you Andrew. Have a nice day.

[END]