Cavium Acquires MontaVista Software

Digital chipmaker Cavium Networks CAVM announced that it has agreed to purchase MontaVista Software for $50 million, comprising $16 million in cash and the remainder in stock. The deal is expected to close in December. MontaVista provides embedded Linux software, which is used as the operating system for myriad electronic devices and equipment, such as networking and communications gear. Cavium and MontaVista have been partners, as MontaVista's software was combined to work with Cavium's highly advanced processor chips in networking and telecom equipment.

Cavium announced that MontaVista will retain its brand name and management team, and we are pleased that Cavium's executives won't lose focus on its chip business by trying to manage a software company. On the product front, the merger will help improve the integration of Cavium's chips and MontaVista's software, an important factor going forward as networking customers seek suppliers that can provide one-stop solutions. Intel's INTC acquisition of Wind River, another embedded operating system provider, appears to have had a similar strategic purpose.

We think Cavium paid a fair price for MontaVista at less than 2 times sales, and we're encouraged that Cavium didn't drain its cash balance or significantly dilute shareholders in making the acquisition. Cavium expects MontaVista to contribute $20 million-$25 million in revenue in 2010; the figure would be higher except that Cavium is unable to recognize MontaVista's current deferred revenue balance as part of the purchase accounting. The software firm will also increase Cavium's total gross margins by a couple of percentage points, and the deal should be accretive to 2010 earnings and beyond. As a result of the deal and Cavium's newfound revenue stream, we are raising our fair value estimate.