While MACOM Technology Solutions Holdings (MTSI) celebrates securing multi-million dollar defense and satellite contracts, a hidden gem within their recent Q2 2024 earnings call might be the true game-changer. The acquisition of Wolfspeed's RF business, initially perceived as a margin-dilutive burden, could actually be the catalyst for MACOM achieving their ambitious goal of surpassing 30% operating margins.

On the surface, the Wolfspeed acquisition seems like a mixed bag. It boosted revenue by $30 million in Q2, aligning with MACOM's projection, and is expected to be modestly accretive to earnings. However, the low gross margins of the RF business, hovering around 40%, are dragging down MACOM's overall consolidated margins. Analysts, focused on the short-term margin impact, seem to have overlooked the potential long-term transformation this acquisition offers.

MACOM's management, however, sees this as a familiar challenge. Back in 2019, they inherited a MACOM with gross margins below 40%. Through a focused eight-quarter campaign, they propelled those margins to 60%, eventually reaching nearly 63%. They are now implementing a similar program for the Wolfspeed business, confident in achieving similar results.

Here's where the unnoticed opportunity lies: cash flow. While revenue might be down from the initial $150 million projection, MACOM's CEO, Steve Daly, confidently expects the Wolfspeed business to generate substantial cash flow: $20 million in the next 12 months, $35 million in year two, and $45 million in year three. These figures, when combined, closely approach the acquisition's purchase price, hinting at a rapid return on investment.

Projected Cash Flow from Wolfspeed Acquisition

Source: MACOM Q2 2024 Earnings Call Transcript

The real magic isn't just about replicating past successes. MACOM is essentially merging the number one and two U.S. merchant suppliers of RF power GaN technology. This strategic positioning unlocks a $2 billion (and growing) GaN SAM, with a strong emphasis on the $1 billion defense-related portion. This acquisition isn't simply about adding revenue, it's about dominating the rapidly expanding GaN market.

Daly, brimming with confidence, describes the newly acquired GaN technology as a 'bazooka' and views the combined team as poised to 'do some serious damage' in the market. This aggressive stance, coupled with MACOM's proven ability to dramatically improve margins, paints a picture of explosive growth and profitability.

The key to unlocking this potential lies in leveraging MACOM's expertise in mimic product design. Daly highlights the 'way too small' size of Wolfspeed's mimic product line and prioritizes expanding it. By applying their mimic design prowess to Wolfspeed's GaN processes, MACOM aims to capture significant market share, boost profitability, and fuel revenue growth.

This strategy aligns perfectly with the growing demand for high-power transmitters in defense applications like drone defense systems and electronic warfare systems. Wolfspeed's GaN technology, ideal for high-frequency, high-power applications, perfectly complements MACOM's existing offerings.

Hypothetical Growth Trajectory

This chart demonstrates a hypothetical path to achieving 30% operating margins, based on MACOM's strategic goals.

Here's the hypothesis: By focusing on mimic product expansion within the Wolfspeed portfolio, MACOM can create a high-margin, high-growth segment within the RF business. This, coupled with their operational efficiency improvements across the acquired business, could rapidly propel the RF business to 50% gross margins. As the core MACOM business rebounds with the anticipated recovery in telecom and industrial markets in the latter half of fiscal year 2024, the consolidated gross margin should trend back towards 60%.

With a leaner cost structure and a revenue base exceeding $700 million, MACOM's operating margin trajectory becomes incredibly compelling. Achieving 30% operating margins, once viewed as an ambitious goal, now seems well within reach.

"Fun Fact: Did you know MACOM's technology played a crucial role in the Mars Rover missions? Their high-performance components enabled vital communication links between the Rover and Earth."

While Wall Street focuses on the near-term margin pressures, MACOM is quietly building a GaN powerhouse. The Wolfspeed acquisition, coupled with their laser focus on mimic product expansion and margin enhancement, could be the secret weapon that propels them to unprecedented levels of profitability. Investors, ready to look beyond the immediate headlines, might just be witnessing the birth of a new semiconductor giant.