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Murata Manufacturing (OTCPK:MRAAY), a leading Japanese manufacturer of electronic modules and components, recently completed the acquisition of Eta Wireless for ¥16.0bn. The deal appears positive in securing key technologies that should strengthen its core MLCC business with potential development synergies heading into the upcoming 5G rollout as well. Although there are near term headwinds from COVID-19-related disruptions and inventory adjustments for products for Chinese smartphones, MLCC demand continues to be firm. In light of the solid demand outlook and company guidance that prices are holding steady (a positive shift from its previous conservative stance), the current c. 11x EV/EBITDA valuation seems undemanding.

Murata recently disclosed the completion of its acquisition of Eta Wireless, a Massachusetts-based US firm that owns Digital ET ("Envelope Tracking") technology allowing for reduced power consumption in RF circuits. Additionally, the acquisition also gives Murata access to its proprietary DPD ("Digital Pre-Distortion") algorithm, which minimizes distortion and noise in the RF circuit to drive a reduction in power consumption. Most importantly, the Digital ET technology supports new gigabit communication standards such as 5G-mmWave and WiFi (unlike legacy analog envelope tracking technologies). According to the latest disclosures, the acquisition comes at a total cost of ¥16.0 billion.

I view the acquisition as an important step - Murata's US rivals in the RFFE ("RF frontend") business already have their proprietary ET technology, so the addition of ET technology via the Eta Wireless purchase should enable Murata to further boost the competitiveness of its RFFE business. Over the medium to longer-term, this acquisition leaves Murata well-positioned to capitalize on upcoming 5G tailwinds by integrating the technologies developed by Eta Wireless with its internal development resources. While this acquisition likely will not lead to an immediate technological advantage for Murata, the securing of key technologies and the realization of development synergies should meaningfully strengthen its PA ("power amplifier") business.

The latest M&A announcement comes as welcome news following the company's August plant closure in the wake of a COVID-19 cluster infection at the Fukui Murata Manufacturing operations at the Takefu plant (suspended from August 25 through August 31). For context, cumulative infections over the period total 77 at affiliate companies and 21 employees at Fukui Murata Manufacturing. As Fukui Murata is a core base for manufacturing leading-edge MLCC ("multi-layer ceramic capacitors"), this raises concerns about the impact on Murata and the MLCC supply chain going forward.

As the shutdown was not prolonged, however, I expect any impact on the global MLCC supply/demand balance to be limited. Even at a company-level, any impact is likely to be minimal - assuming Fukui Murata contributes c. 30% of MLCC output (note the company also produces MLCCs at its bases in Fukui, Izumo, Wuxi in China, and Singapore), the impact of a one-week output suspension would imply a ¥4+ billion impact. And if we were to incorporate a contribution margin of 50+%, this would mean a negligible sub-1% impact on operating profits (relative to full-year projections).

Source: Murata Investor Presentation Slides

While MLCC orders have been strong amid a broadening of precautionary inventory buildup across supply chains, this trend appears to have peaked, if Murata's latest guidance is any indication. As a result, a slowdown in sales seems likely, alongside Y/Y growth in fiscal 2022 as well. Capacity expansion in the upcoming year should also be more muted than in prior cycles, especially with the elevated MLCC price alleviating any pressing need for price hikes. Murata likely will not opt to implement near-term price hikes anyway - even if these could be realized, such price hikes could prompt massive capacity expansion at its peers. As such, my base case remains for Murata to continue expanding capacity for high-end and mid-range MLCCs going forward, implying modest upside to the ¥170 billion projection in fiscal 2021.

Source: Murata Investor Presentation Slides

Looking ahead, it seems likely that Murata will exclusively invest in high-end MLCCs to optimize its capex spend. The key benefit is the operating leverage for the premium end, which should enable outsized capex reductions ahead. The other key opportunity lies in MetroCirc (a thinner multi-layer resin substrate comprising liquid crystal polymer sheets) - while the number of applications remains limited as the technology has limited applicability for most applications, this could change if the 5G-led mmWave penetration moves into full swing. In particular, the key advantages of MetroCirc, including its flexibility and low loss under higher-frequency operation, should more than offset its high price and switching costs over the medium to longer term.

Overall, Murata is making positive steps in building up its structural growth outlook in the MLCC field on the back of rising 5G and EV demand. While near-term fundamentals could be weighed down by channel inventories, many finished set makers now have higher optimum inventory levels, and so a return to the levels seen pre-pandemic is still some way off. Furthermore, with rising sales to China and a 5G catalyst on the horizon potentially benefiting MetroCirc, the module demand outlook looks robust going forward. While the valuation has fallen below the historical average, I believe a premium is justified due to Murata's robust balance sheet and leading MLCC market share, while longer-term business opportunities for MetroCirc present incremental optionality to the investment case.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.