After a short lull earlier this year, M&A in the chip sector has come roaring back with a vengeance.
Broadcom Ltd. (AVGO) recently unfurled a cash/stock bid for Qualcomm Inc. (QCOM) that could be worth up to $130 billion, while Marvell Technology Group Ltd. (MRVL) inked a $6-billion deal to buy fellow Broadcom rival Cavium Inc. (CAVM) . And there could well be more deals to come.
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Though elevated valuations likely gave would-be acquirers pause for a while, the arguments for further industry consolidation are still pretty strong -- especially since the potential acquirers have seen their multiples rise as well. The arguments for getting bigger typically break down along one of three lines:
1. Cost savings
By consolidating facilities and shedding duplicate sales, R&D and administrative functions, chip deals have led merged companies to have much smaller cost bases than they collectively had as independent firms. When Avago struck a deal to buy Broadcom in mid-2015, it promised $750 million in annual cost synergies within 18 months of closing. Analog Devices (ADI) is promising its purchase of Linear Technology will eventually yield $150 million in annual savings, and Qualcomm expects its pending deal to buy NXP Semiconductors NV (NXPI) would yield $500 million in cost savings within two years of closing.
But all of these figures could be trumped by the cost cuts that Broadcom -- known for taking an axe to spending at the companies it acquires -- would wring out from a Qualcomm deal. The R&D cuts alone could be massive: Qualcomm's R&D spend over the last four quarters ($5.5 billion) was more than twice Broadcom's R&D spend, even though its revenue was less than 70% higher, and its non-licensing revenue less than 25% higher.
2. Pricing power, both with customers and suppliers
Thanks to M&A, quite a few chip markets (microcontrollers, power management chips, various mixed-signal chips, etc.) have far fewer big suppliers than they did five years ago. That, together with the greater leverage chip companies often have with customers have post-merger due to their expanded product lines, has led to more favorable pricing environments. Here as well, Broadcom has been something of a standard-setter, often hiking prices at acquired firms shortly after a deal closes.
On the flip side, more scale and purchasing power can help companies obtain more favorable prices from common suppliers such as equipment makers, chip contract manufacturers (foundries) and chip packaging and testing firms.
3. Expanded product lines for big markets and top OEMs
In addition to to cost cuts and price hikes, Broadcom's buying spree has benefited the company by giving it a far-reaching lineup of chips, adapter cards, controller cards and optical components to sell to server, storage and networking OEMs, as well as cloud giants developing their own hardware. And it's safe to assume one of its key motivations for bidding on Qualcomm is to create a mobile chip colossus supplying top smartphone OEMs with modems, system-on-chips (SoCs), RF chips, Wi-Fi/Bluetooth chips and much else, and find various ways to make the whole more than the sum of its parts.
Likewise, Qualcomm appears keen on pairing its automotive SoC and modem offerings with NXP's expansive auto chip lineup. Intel Corp.'s (INTC) purchase of Altera was driven by how Altera's programmable chips (FPGAs) complement Intel's processors within products such as servers, networking equipment and autonomous driving systems. And deals such as ADI/Linear, Cypress Semi/Spansion and Microchip/Atmel allow the post-merger firms to supply a broader set of products to automotive, industrial and defense/aerospace clients.
Which chipmakers that haven't drawn M&A interest could still be targeted? Here are a few possibilities:
1. Xilinx Inc. (XLNX) ($18.3 billion market cap)
Together with Intel's FPGA unit (formerly Altera), Xilinx has a near-duopoly in the FPGA market. And that's a valuable thing to have these days, as the rapid programmability of FPGAs lead them to be more widely used in cars, data center AI projects and much else. They're also widely used in base stations, a market that should see demand pick up in a couple of years as 5G rollouts start. But Xilinx's market cap and relatively high multiples could act as deterrents.
2. Cypress Semiconductor Corp. (CY) ($5.8 billion)
Cypress' micro-controller business has been seeing healthy, if unspectacular, growth thanks to solid automotive and embedded/IoT positions. The company also has a growing automotive/IoT connectivity chip business.
Though shares have had a decent run, they still trade for less than 15 times expected 2018 EPS. And several microcontroller peers have already been snapped up.
3. Mellanox Technologies Ltd. (MLNX) ($2.9 billion)
Mellanox shot higher on Nov. 21 after activist investor Starboard Value disclosed a 10.7% stake while asserting the company can unlock "tremendous value" via "operational improvements or other strategic alternatives."
Mellanox remains the top supplier of InfiniBand connectivity chips and hardware, which (due to their high bandwidth, low latency and quality-of-service features) remain widely used in high-performance computing (HPC) projects. It's also a major supplier of Ethernet chips, adapters and switches to cloud giants, and (thanks to its 2016 purchase of EZChip) sells network processors used in edge routers and Ethernet switches deployed by carriers.
Throw in a reasonable valuation of less than three times expected 2018 sales, and there's much that could appeal to a suitor. That's so, at least provided that worries about competition from Intel and Broadcom don't act as a deterrent.
4. Qorvo Inc. (QRVO) ($10.1 billion)
Should Broadcom's bid for Qualcomm succeed, Qorvo's status as a top-three supplier of mobile and embedded/IoT RF chips could easily spark interest from a big-name chipmaker looking to better compete with Broadcom. And even if it doesn't, Qorvo's subdued valuation and long-term growth drivers could lead it to get offers.
Steady increases in mobile RF complexity -- increases whose pace will accelerate with 5G's arrival -- position Qorvo and its peers to continue growing their smartphone chip sales even if smartphone shipments don't rise much. The group should also see its automotive and IoT sales steadily rise, as the number of devices with built-in radios continues to mushroom.
Intel is one possible buyer -- particularly given the value of pairing its 4G/5G modems with Qorvo's RF lineup, and the fact that a Broadcom/Qualcomm deal would yield a top player in both modems and RF. Analog/mixed-signal chipmakers such as Texas Instruments and Analog Devices could also take a look.
5. Microsemi Corp. (MSCC) ($6.5 billion)
Microsemi's expertise in providing very reliable, high-performance analog and mixed-signal chips position it well within growing automotive, industrial and medical chip markets. The company also has a growing storage controller chip business catering to enterprise OEMs and cloud giants, and is doing brisk sales of chips used in 100-gig optical network deployments.
While Microsemi's exposure to a soft aerospace/defense chip market remains a headwind, the differentiated and high-margin product lines it has for various growth markets could lead it to join the ranks of analog/mixed-signal firms to be targeted. A valuation of just 13 times expected fiscal 2018 EPS also doesn't hurt.
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