Conexant Sags on Globespan Deal

Updated from 11:41 a.m. EST

Conexant(CNXT) shares sagged after the company agreed to merge with rival GlobespanVirata(GSPN) in a deal valued at more than $800 million in stock.

The two said in a press release that the new entity, to be called Conexant, will offer the "world's most complete and most advanced portfolio of semiconductor solutions targeting the broadband digital home."

The linkup will cement the combined company's dominance in DSL chips, giving it as much as half of a market that's expected to grow at a double-digit clip this year.

Today analysts gave the deal a mixed review, noting that it will hurt Conexant's short-term earnings just as the company has started to show profitability. But in the longer-term, the acquisition will help it compete with Broadcom(BRCM), the force to be reckoned with in the broadband market.

Broadcom and the new Conexant will compete in the DSL, wi-fi, set-top box and cable modem markets.

Under terms of the deal, Newport Beach, Calif.-based Conexant will issue almost 1.2 shares for each GlobespanVirata share outstanding. The combined company will be based at Globespan's Red Bank, N.J., headquarters, and be run by Globespan CEO Armando Geday. Conexant's Dwight Decker will be chairman.

Shares of both companies slid Monday on the news. Conexant dropped 11%, sliding 62 cents, to $5.22, while Globespan inched down a penny or 0.2%, to $6.14.

The stock decline is likely due to Conexant's comment that the acquisition won't offer any earnings upside for another six to nine months, explained Dushyant Desai of C.E. Unterberg Towbin. He expects Conexant to be stuck in a trading range between $5 and $6 until the deal becomes accretive to earnings.

Still, he thinks the merger makes strategic sense.

"The combined company is better positioned and has a wider broadband product and customer portfolio. They're now looking at a comparable size to Broadcom in the broadband area," at around $1 billion, said Desai. He predicts the combined entity will put pressure on Broadcom, which has been trying to make inroads into the DSL chip market. "Broadcom has a minuscule single digit market share," he said, estimating the new Conexant could account for as much as 45% or 50% of the market.

Desai projects the DSL chip market will show growth of between 10% and 15% in 2003, to around $800 million.

Another strategic plus, he said, is that the acquisition will allow Conexant to cross-sell Globespan's wireless LAN silicon into the DSL, set-top box and cable modem markets.

C.E. Unterberg, Towbin hasn't done banking for either Conexant or GlobespanVirata. Desai has a market perform rating on Conexant and buy on Globespan.

But other analysts said the timing of the deal could have been better, given Conexant has only recently emerged into the black.

"My concern for the combined merger is that for several quarters it will be dilutive to Conexant's earnings and they might dip into negative free cash flow," said Drake Johnstone of Davenport & Co.

In the most recent quarter, Conexant swung to a profit of $37.2 million, up from a $176.2 milllion loss a year ago. Sales rose to $164.7 million from $133.1 million.

"I'm a bit surprised they didn't announce some significant cost cuts to improve earnings," said Johnstone. "My preference for Conexant would have been they should have driven forward a few quarters and demonstrated improving earnings, and if they made an acquisition, they should have only made it where they can cut costs substantially and support earnings."

Another worry is that latest merger comes as GlobespanVirata is still digesting its purchase of Intersil's(ISIL) wireless LAN business last July. Laying another merger on top of that will be tricky, said Johnstone.

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