Markets

Is the New and Improved Cree a Buy Today?

I started a position in Cree (NASDAQ: CREE) seven months ago. At the time, I expected the company to build long-term value from slow but stable growth in its light-emitting diode business, perhaps with a jolt of more exciting results from its Wolfspeed semiconductor unit. That investment thesis was turned on its head on Monday when Cree sold the LED division to specialty computer memory expert SMART Global Holdings (NASDAQ: SGH).

This game-changing deal forced me to take a good, hard look at my Cree investment to see whether I should cash in my shares, hold tight, or buy more. Here's what I learned.

A handshake between a flesh-colored hand and a green hand, both printed with circuitry.

Image source: Getty Images.

First, the basics

SMART will pay as much as $300 million for Cree's LED business, starting with a $50 million cash payment upon closing and $125 million on the maturity of a seller note in August 2023. The price tag could increase by as much as $125 million if the LED business meets certain revenue and gross profit performance goals, also in the form of a three-year note. The deal has been approved by both Cree's and SMART's board of directors and should close in the first calendar quarter of 2021, assuming the transaction clears the usual regulatory hurdles and other closing conditions.

SMART is gaining a strong revenue stream with annual sales of roughly $430 million and a respectable gross margin of more than 20%. By comparison, SMART's total sales stopped at $1.1 billion over the last four quarters at a lower gross margin of 19%.

What Cree wants from this deal

Going all-in on the Wolfspeed business is a dramatic shift from Cree's original intentions. The Wolfspeed division was created in 2015 and immediately earmarked for a future as a separate company. The IPO fell apart, followed by a failed attempt to simply sell the gallium nitride (GaN) and silicon carbide (SiC) semiconductor division to Infineon Technologies (OTC: IFNNY) for $850 million. Cree wanted to be a "more focused LED lighting company," leaving Wolfspeed's power management and radio frequency transistors for some other company to figure out. That idea also fizzled out, so Cree never separated from Wolfspeed.

The failure of Wolfspeed's spinoff ideas may have been all for the best, though. GaN traces on SiC substrates can handle the high temperature and power requirements of modern 5G systems better than traditional silicon chips. As a result, Cree's Wolfspeed stands at the threshold of a massive growth opportunity as 5G networks roll out all over the world. This division already beats the LED segment's revenue growth with a far more generous gross margin of 39%, so focusing on this promising business makes sense right now.

Two hands in front of an uncut sheet of silicon chips, one giving a thumbs-up signal and the other going thumbs-down.

Image source: Getty Images.

I'm definitely not selling Cree here

Both Cree's and SMART's shares rose more than 8% on the news, though both also cooled down a bit during Monday's trading session. By 3 p.m. EDT, Cree's stock traded 3% higher, while SMART Global Holdings was back to breakeven for the day. For Cree, that works out to a market-beating 54% return over the last year and a solid double from my entry point in March.

The stock isn't exactly cheap at these prices, trading at 318 times forward earnings and 8.7 times trailing sales. But the LED sale will shift Cree's operations into a more exciting gear with a combination of faster sales growth and wider profit margins. The company is targeting two huge growth markets in 5G wireless systems and power control products for electric vehicles.

"The shift to electric vehicles represents one of our most exciting opportunities with the automotive industry making up roughly half of our device pipeline," Cree CEO Gregg Lowe said on a conference call devoted to the SMART deal. "Through the divestiture of our LED business, we will be even better positioned to enhance our leadership position as we power the next generation of semiconductor technology."

I like what Cree is doing here. This asset sale certainly hasn't given me any reason to sell my Cree shares. This is an interesting play on several important market trends. The company is going down a different road, but I can't wait to see where it leads.

10 stocks we like better than Cree
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Cree wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of September 24, 2020

Anders Bylund owns shares of Cree. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story

IFNNY SGH

Latest Markets Videos

    The Motley Fool

    Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

    Learn More