Mergers to Pick Up as Growth Slows
By: Steve Smith
Takeover candidates range from beaten down sectors in need of defensive consolidation to healthy companies looking to maintain growth through acquisitions.
For the third quarter S&P 500 earnings per share (EPS) are expected to decline by 2.8% for the quarter, and revenues to decline 4.4%. It will mark the first time the index has reported two consecutive quarters of year-over-year declines in earnings since 2009 meltdown.
As slack demand fails to fuel sales and little room for additional cost cutting to bolster the bottom line companies are increasingly turning to mergers and acquisitions. The deals are proving a boon to investors as they are not only coming with premium bids but also boosting the shares of the acquirer.
In the next few articles I want look some of the factors driving the M&A activity, whether it is horizontal consolidation or strategic verticals, and identify some of the likely takeover candidates.
Today’s focus will be on the semiconductor industry. Computer chips, whether they be for PCs, mobile devices or increasingly for “connected things” such as household appliances has allows been a cyclical business. And one prone to the commoditization of the product in which manufactures have little pricing power.
Earlier this year we saw Avago Technologies (AVGO) scoop up Broadcom (BRCM) for $37 billion. At the time Broadcom’s CEO, Scott McGregor said, “About six months ago, I said that in five to 10 years, half of the companies we know today won’t exist anymore”.
Those words are proving to be prescient as several large deals quickly followed Intel (INTC) to consummate the long-rumored deal for Altera (ALTR), KLA Tencor purchase of Lam and Freescales’ bid for NXP Semiconductor. All were done for at least a 20% premium.
All told there have been semiconductor deals worth $100.6 billion through mid-October 2015. And this does not include the recent Western Digital’s (WDC) bid of $85 for Sandisk (SNDK) represents a 40% premium over the prior 30-day closing average.
So what is driving this urge to merge? As stated above the chip industry is notoriously cyclical. With it currently experiencing a downturn organic growth is hard to come by, so companies turn to mergers. And once the consolidation begins deals beget more deals as companies need to increase scale and cut costs in order to remain competitive.
The deals are also in response to customer demand for one stop shopping and in which they can purchase and integrate a full suite of solutions for products across multiple platforms from desktop to mobile. As devices get more complex they require more chips. Customers would rather deal with one or two vendors that deliver fully integrated systems rather than purchase a host of parts piecemeal.
Consolidation allows chip companies to not only diversify their revenue streams but pick up higher margin businesses such as service contracts. By joining hands either through integration, joint ventures, mergers, or acquisitions, these players intend to capture a bigger slice of the semiconductor pie to carve out a space for themselves.
Another crucial driver behind chip M&A is an all-important one – cash. You can’t buy companies without it. And Potential buyers are flush and thanks to historically low interest rates, they can leverage that excess cash to buy even more.
For example Intel still has $14 billion in cash and $8.2 billion in long-term investments. QUALCOMM (QCOM), for example, which had over $15.5 billion in the bank at the end of the first quarter. Here are a few of the potential targets.
- Xilinx Inc. (XLNX)
- Micron Technology
- Atmel Corporation (ATML)
- Maxim Integrated Products, Inc. (MXIM)
- Cavium, Inc. (CAVM)
- Lattice Semiconductor Corporation (LSCC)
- M/A-Com Technology Solutions Holdings, Inc. (MTSI)
With a few of these companies such as Cavium and Atmel still set to report earnings in next few days listen for management to express words such as “explore strategic alternatives” to suggest the companies are in play.
The best and simplest way to play the semiconductor industry consolidation is to buy calls one strike out-of-the-money that have at least six months until expiration.