Earnings Call - LUMENTUM HOLDINGS INC

A history-making deal in the tech sector is marrying AI semiconductors with optical components for data centers. Custom chipmaker Marvell is acquiring Lumentum at an enterprise value of $115 billion in an all-stock transaction. That values Lumentium at $1,132 per share. That's a 24% premium from the closing price back on October 28th, right before reports of the deal started to emerge. Marvell designs custom AI chips and other tech that connects processors and moves data around data centers at super fast speeds, which is where Lumentum comes in. Buying Lumentm would expand its offerings in technology that uses light to move data super fast between chips and servers. Marvell Technologies CEO Matt Murphy and Lumentom CEO Michael Hurlston join us now live. Matt, clearly investors are not feeling the love here. Both Marvell and Lamentum are selling off. What are they getting wrong about this deal? Yeah. Hey, Liz. Hey. Thanks for having us on. And it's really a historic day for the two companies. We're putting together basically the best-in-class leader in AI connectivity technology for semiconductors with the leader in photonics. And it's something, to get to your question, that hasn't been done before. So we both have a shared vision, Liz, of this convergence of semiconductor and photonic technology together. And that's happening because as you go inside the data center, there's a new category of connectivity called scale-up networking. This is connecting GPUs to each other or XPUs and basically creating a large compute fabric. That trend and what maybe is missed is that that trend is happening now. We're seeing strong ramps for the Marvell business and scale-up optics next year. Michael can talk about it on his side, and that's only going to get stronger in 2028. So the core businesses are doing really well, but what's layering on top, which maybe isn't as understood, is the magnitude of the scale-op optics ramp. And I would point out, finally, that if you take both companies and you just look at from this year in calendar 26 to 2028, and you juste take a look at FATSET and you look at earnings per share projected growth based on street estimates, Marvell is the fastest-growing company in the S&P on a projected basis on EPS growth of all the big tech names, and Momentum is number four. So the earnings growth is in front of us. The trend is happening. And the combination is accretive to earnings, not dilutive to earnings. So I think, look, the markets risk off. There's a lot of shifts going on. It's day one, but the story is incredibly compelling. Our story standalone, Michael's standalone, and together, because of the additional opportunity we see with each other, there's an opportunity to really outperform as a combined company. It's almost as if the market at this moment, you know, you see IPOs stop or pull from the market because they say due to market conditions. Market conditions change every 48 hours lately when it comes to AI. Michael, you and I have spoken. You have unbelievable demand. You're coming out with earnings, I believe, Thursday. So I know you're in a quiet period on that level. But we see what the analysts are expecting, more than a 200% jump in earnings per share for the most recent quarter. So you've got, as Matt puts it, you've got this long runway that you can see. And the fact that it would be accretive is something that usually is what gets people excited. So could this simply be just a weird moment in time where people are nervous on day A and not nervous on day B? Look, let me start, Liz, by thanking you, as usual, for having me on the show. We actually released earnings today. And that's gotten sort of lost in the backwash. No problem. It's got lost inthe backwash of all this thing. The earnings were phenomenal. So we actually hit our number for what our fiscal Q1, the September quarter, and guided to incredible growth in December. We beat, I think, every estimate on both the sell and buy side by posting a guide of $1.6 billion. And the big story was our gross margins. You and I have talked about margins a number of times. Our margins actually now are 53% in the guide. So this is an unbelievable quarter. I think people are saying, hey, is something wrong with the Lamenta business? No. Is something wrong with the Marvell business? No. Both companies, as Matt said, are executing phenomenally well. And what we see, Liz, is a multiplying effect where we're going to do much better together in two years than we would on a standalone basis. And that's really saying something given the trajectory of both companies. Matt, to that point, what can you, what will you be able to do together that you were not able to doing apart? Yeah, thanks for that question. And so just to frame it in terms of economics for a second, then I'll talk about the solution. Marvell is a standalone company, has a $400 billion TAM that we're addressing. We just presented on that last month at our Investor Day. Very well articulated, bottoms-up plan for us to drive outsized growth into that. Lumentum's prior stated total available market was about $90 billion. So that's $490 billion between the two. But as we went through the diligence process and worked out what we could possibly do together and the teams got together, traded notes, looked at the opportunities from both lenses, the opportunity is actually $60 billion higher together. And a lot of the reason for that is that, one, we can address opportunities that maybe we weren't in before that momentum can pull us into. And there's TAM that gets created when we pull those solutions together and vice versa. And by the way, this TAMing that's increasing is really in the scale-up networking in terms of NPO and CPO solutions where there's just more value we can add. For example, we might be selling an individual component, but combined with Lumentum, we could sell an entire module as an example. So things like that increase our TAM, which, by the way, with our market share that we probably can drive, would drive significant revenue synergies over time. So I think it just was an example now. And another example would be today, when you look at what you need to go to do to actually connect all of these different accelerator and processor units together, you need a few things. You need the processor itself. That could be a standalone GPU, or it could be an custom accelerator, which Marvell builds. On the other side of it, you needs a switch. You need either a packet switch or what's called a UAL switch, which is another independent standard, that is going to connect all of the processor units together. And then you need optical communications between them. And so in that system, what we're being asked to do right now, which isn't what the old business model was in optics when it was scale out, going to scale up, we've got to provide the entire solution. Customers are pushing on Michael to provide that solution. He's got one piece. I've got the other pieces. And so what happens in the chip business is the faster you can get to market, Liz, the higher the revenue and the higher the market share and the profitability. We think we can pull in significantly customer designs we're working on independently for our customers to go to market and go to production much sooner. So when you add all that up, it's really going to be a home run for our consumers. And I've got to tell you, all the feedback we've gotten has been tremendous. I've talked to all the big hyperscalers, our ecosystem partner, Mike, did his checks, and we're receiving tremendous support. Well, the total addressable market point could be more than half a trillion dollars. I think the market likes that because, OK, these are minuscule moves, but Marvell is coming up off its low right now, as you guys are talking, and Lumentum slightly up off its low as well. NVIDIA is a strategic partner in both of you. Have you talked to him? How, Michael, has he received this news, this merger? Yeah, Matt talked to Jensen really early on in the process and explained what we were thinking about. And I think the reaction from NVIDIA has been super positive. In fact, we're going to come off this call and have another discussion with them, really trying to explain the merits of this combination. And, you know, as you correctly said in your comments, NVIDDIA is invested in Marvell. NVIDRIA is invested Inlumentum. We think we can actually bring a lot more product to bear to NVIDIA a lot more quickly in this combination. Matt, at any point, especially Friday, did you think about holding off on announcing this because we had such a big sell-off on Friday and nobody liked that Alphabet and Amazon are cash flow negative. You guys are not, but I mean, this was a bad day for the NASDAQ certainly. Right. Yeah. Things weren't great until Thursday. And then you have things happen in the market. A couple of things on that. First, absolutely no wavering whatsoever. I mean, there are moments in time, and as we've seen, Liz, over the last three years in the AI cycle, you've had risk on and risk off and markets moving around. But ultimately, what gets proven out in the investment community is delivering sustainable, predictable results with a business model where you've got long-term, sustainable competitive advantage. Marvell has that, and Lamentum has that. So you saw their business is off to the races. I'm guiding in a month, and so we'll update our results at that time. But if you look at the trajectory of both businesses, very strong, best-in-class growth. So you've got to just go and get these things done. And what I would say is, one, it's an all-stock transaction. Okay. So this is really about the relative ownership, Liz, and whether we're trading at $180 or $280, the relative ownership, which was already negotiated as part of the transaction, which was Michael and I haggling it out until we finally got to a point where it was too high for me and too low for him. And we hit the sweet spot. That relative ownership is very compelling for Lamentum shareholders. So that would be agnostic of whatever the market conditions are. The one I'll finally leave you with is this is a once-in-a-generation opportunity. It's very rare that you can find two companies of the caliber of Lumentum and Marvell that are number one in their respective areas that find a moment in time where you can combine and create a category leader in a new category. This AI connectivity is going to be as consequential as, say, the compute category or the memory category or the fab category or IP licensing category. These are big categories and you need category leaders in each of them. And if you just take the pro forma company and you look at the revenue scale of it today, by the way, if you take Michael's guide plus my consensus for Q4, which I'm going to report in about a month, The company would be on a $21 billion annualized run rate with operating margins today of over 40 percent, growing at a massive rate. And as you said, Michael's basically been doubling his EPS. We're growing at the fastest rate. So you can't time this stuff, Liz. There's no way to time it perfectly. You just got to do it. And I think the fact that we're the first mover also is taking some people some time to absorb. But I'm pretty sure when this is all said and done, the next players that want to go make these moves on the chessboard will now be looking at a number two or a number three, combining with a number 3 or a member for the two number ones have had the foresight and to do it. But you take more risk when you do it, and it's sometimes being unorthodox is what you have to do in order to get the outside. result. You know, time will tell, but I'm sure Broadcom's looking at this saying maybe we need to be doing something. Either way, when I hear accretive to earnings, that is a positive. We shall wait to see if investors in Wall Street continue to see it. But Matt, I hope you come back for earnings. And Michael, thank you once again for coming on. It's great to have you both. And listen, there's never a right time. It'S like, when should we have a baby? There's never a right time to have a baby so just do it thanks guys good to see you yeah thank you so much thanks a lot thanks all right you bet all right