II-VI Incorporated (NASDAQ:IIVI) shares slipped on Friday as investment firm Morgan Stanley downgraded the semiconductor equipment maker, noting the Coherent acquisition helps diversify its business, but it also increases its risks in the near-term.
Analyst Meta Marshall lowered his rating on II-VI Incorporated (IIVI) shares to equal weight from overweight and cut the price target to $59 from $75, noting that integration risk of the deal, as well as Coherent's focus on smartphones could hurt the stock over the next several months.
Marshall noted that the deal is expected to be dilutive in the "near term" though II-VI (IIVI) has said it will be breakeven in year 2, but higher interest rates could be a challenge, given it has a large proportion of its debt at floating rates. Coherent also has a "large exposure" to the OLED market, which is "heavily tied to smartphone displays," according to the analyst.
"Longer term, we think opportunities to expand customer base, grow other segments of the business, synergy realization and debt pay down will help this deal be very accretive to valuation, but headwinds likely cap moves in near term," Marshall wrote in a note to clients.
II-VI Incorporated (IIVI) shares fell more than 2% to $51.45 in premarket trading.
Marshall noted that the company has said it can achieve $250M in synergies and get to 2.5x or less gross leverage two years after the close of the deal, but with rising interest rates, it could create "an overhang in a weaker macro scenario," given that $2.8B of its $5B pro forma debt is floating rate.
Despite the downgrade, Marshall said II-VI Incorporated (IIVI) has a growth opportunity with the Coherent acquisition and can be a player in telecom, data communications and other opportunities with silicon carbide. However, with recent channel checks in China showing slowing smartphone going into the second-half of the year, the analyst added "we would like to get past negative data points and dilution risk before stepping back in."
Positive catalysts include an improvement in the smartphone market, realization of synergies and the combined company generating "meaningful cash flow."
Last month, Morgan Stanley listed II-VI Incorporated (IIVI) as one of the companies that could benefit from persistent inflation.
Analysts are largely positive on II-VI Incorporated (IIVI). It had an average rating of BUY from Seeking Alpha authors, while Wall Street analysts rate it a BUY. Conversely, Seeking Alpha's quant system, which consistently beats the market, rates IIVI a HOLD.
