As I mentioned a couple of weeks ago, the tech sector saw a record level of M&A activity in May.
But the frenzy isn’t over yet.
FBR & Co. analyst, Christopher Rolland, reveals, “At the pace of consolidation set thus far this year, 32% of all U.S. publicly traded semiconductor companies would be acquired in 2015.”
[ad#Google Adsense 336×280-IA]And Broadcom (BRCM) CEO, Scott McGregor, says, “About six months ago, I said that in five to 10 years, half of the companies we know today won’t exist anymore.
And it’s pretty solid on that track.”
I actually appeared alongside Rolland on CNBC’s Closing Bell recently to discuss the merger mania.
But there’s never enough time on air to share all my research.
So let’s dig into all the reasons why the stage is set for even more M&A in the semiconductor industry.
I’ll also share a shortlist of seven companies that are most likely to be acquired next. At substantial premiums, no less…
What’s Driving the Urge to Merge?
In business, deal-making always begets more deal-making. Why?
Because when two companies combine forces, there’s no way for other companies in the industry to stay competitive in terms of market share, product offerings, etc.
Catching up via organic growth or in-house innovation simply isn’t an option. It takes too long. So they’re forced to find a suitable partner, too.
We’ve seen proof of this in the chip industry recently. For example, when Avago Technologies (AVGO) scooped up Broadcom for $37 billion, it compelled Intel (INTC) to get off its duff to finally consummate the long-rumored deal for Altera (ALTR).
But the current M&A frenzy isn’t just about momentum. In this case, there are more specific and powerful forces at work…
Chip Consolidation Driver #1: Customers Crave Systems, Not Parts
We can all attest that our mobile gadgets (smartphones and tablets), keep getting more complex.
And more complexity requires more chips.
However, gadget makers (i.e., chip buyers) keep pushing for simplification. That means they want to reduce their list of vendors by purchasing comprehensive system solutions, not more individual chips.
Skyworks Solutions (SWKS) has embraced this reality wholeheartedly – and profitably. The company admits that its chart-topping growth is a direct result of its ability to deliver “integrated systems solutions.”
But not every company is in Skyworks’ position. And the only way for them to provide system solutions is to join forces (and products) with another company. And that’s precisely what’s driving many chip deals.
Levy Gerzberg sums it up. The former CEO of Zoran Corp., which CSR Plc (CSRE) bought in 2011 for $679 million, states, “It’s not just a matter of being bigger. By combining the two companies, we could provide a more complete solution to our customers.”
Chip Consolidation Driver #2: Overcoming the Margin Squeeze
“The stock market lately has penalized semiconductor companies that don’t show they can improve profit margins – a tough task in a mature industry subject to fierce price pressure.”
So says The Wall Street Journal’s Don Clark. And he’s right.
At the end of May, chip stocks traded at a 15% discount to the broader S&P 500 Index. That’s a radical departure from the historical norm, when they’ve traded at about a 30% premium.
However, collaborations from acquisitions represent an opportunity for companies to expand their margins and, in turn, win back investors’ favor.
The Avago-Broadcom deal is proof. The companies estimate that by combining, they’ll slash annual expenses by $750 million – enough to expand operating margins to 40%, versus 24% for Broadcom on a standalone basis.
Sure enough, Avago has risen 10% since it announced the acquisition.
Chip Consolidation Driver #3: Need More Cookies Growth
Tech research firm Gartner predicts chip revenue growth will slow from 7.9% in 2014 to 4% this year.
Despite that still-decent growth, though, it’s not enough to keep investors satisfied – a fact that isn’t lost on leading chip company executives. So they’re looking for acquisitions to beef it up.
“Management teams are looking at their business and predicting little growth going forward,” says Gus Richard, an analyst at Northland Securities Inc. “The M&A wave is a function of them trying to drive earnings growth.”
That’s especially true, since the right acquisitions can simultaneously solve another “revenue” problem…
Chip Consolidation Driver #4: Diversity, Please!
Chip companies are notoriously cyclical, with sales tied to seasonal product launch cycles for the most popular consumer gadgets.
Admittedly, many investors shy away from chip stocks because of this inherent revenue volatility. But that’s where acquisitions come into play.
They represent an opportunity for chip companies to diversify sales across multiple markets, which helps smooth out sales.
Again, the Avago-Broadcom deal is a perfect example. It allows Avago to extend its web services and cloud computing business with Broadcom’s Ethernet switches and network processors. But it also adds a new, consumer-facing business line in chips for Wi-Fi routers and smartphones.
“In short, Broadcom would bring an expanded product offering to Avago, with very little, if any, redundancy,” says Will Strauss of Forward Concepts.
Chip Consolidation Driver #5: An Abundance of Ammunition
The last driver behind chip M&A is an all-important one – cash. You can’t buy companies without it.
Potential buyers are flush, too. And thanks to historically low interest rates, they can leverage that excess cash to buy even more.
Take Intel, for instance. At the end of March, the company had $14 billion in cash and $8.2 billion in long-term investments. So the $16.7-billion purchase of Altera – Intel’s largest acquisition ever, by the way – was a no-brainer from a financing standpoint.
Other potential acquirers are equally flush. Like QUALCOMM (QCOM), for example, which had over $15.5 billion in the bank at the end of the first quarter.
So who’s ripe for a chip acquisition next?
Seven Timely Takeover Targets
Over $80 billion in semiconductor M&A has already been announced so far this year – the most since 2000, according to Reuters.
And we’re not done yet.
Rolland predicts that there will be a strong backdrop of consolidation for the next year or two.
I agree – and so do plenty of other analysts – which is why they’re all speculating on the next semiconductor takeover.
Their shortlists include:
- Xilinx Inc. (XLNX)
- Atmel Corporation (ATML)
- Maxim Integrated Products, Inc. (MXIM)
- Cavium, Inc. (CAVM)
- Lattice Semiconductor Corporation (LSCC)
- M/A-Com Technology Solutions Holdings, Inc. (MTSI)
- And Skyworks Solutions, which I mentioned above
In terms of singling out targets, Atmel appears particularly ripe for a takeover. Why?
Well, the company has reportedly hired an investment bank to “explore strategic alternatives.”
Second, the CEO is retiring in August. In addition, the Board of Directors recently approved “change of control” severance benefits for senior management. This is often done in anticipation of a deal.
In fact, the last company to make a similar change was Altera, which Intel ended up buying.
As for the next mega-merger, I’m hearing chatter that cash-heavy Qualcomm could splash out for the $20-billion-market-cap Skyworks.
I expect both deals to be done at 20%-plus premiums to current market prices, too, which makes them attractive and timely investments to consider for speculators.
Ahead of the tape,
Louis Basenese
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Source: Wall Street Daily