Chip-Equip Marriages Still Rocky

Recent mergers to make ends meet haven't made shareholders any richer.
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A pickup in chip-equipment consolidation doesn't necessarily mean shareholders won't be let down.

"I'm not sure we have the track record to say consolidation is a true wealth creator," said equipment analyst John Pitzer with Credit Suisse First Boston during a panel discussion last week. "Very few companies have pulled off successful mergers from a Wall Street investor perspective."

Likewise, Mark Morris, lead technology analyst with NWQ Investment Management, a unit of Nuveen Investments with $34 billion in assets, says mergers have been relatively scarce in the equipment sector because of cyclicality. "No one wants to sell out at a bottom because they think the buying price is too cheap, and no one wants to pay at the top because the asking price is too expensive."

But that hasn't stopped companies from trying. In the previous weeks,


(ENTG) - Get Report




have agreed to merge, and

Brooks Automation

(BRKS) - Get Report


Helix Technology


. Also,

August Technology


remains the center of a bidding war between

Rudolph Technologies

(RTEC) - Get Report



(KLAC) - Get Report


The logic behind the mergers is clear enough. There are fewer chipmakers with the resources to build their own state-of-the art factories because of ever-escalating R&D and manufacturing costs. Profit margins are also compressing, as price leadership and cost efficiency have become just as important as technology leadership.

This has led to increased pressure on the equipment manufacturers to do more with less, such as sharing development costs with chipmakers. No equipment company is immune to this squeeze, but smaller companies feel the pain more than the larger companies do.

"If you're small, you can't support global customers," said Michael Wright, president of Entegris, a firm in the process of merging with Mykrolis in a $579 million stock swap.

The two companies make products and materials used during the semiconductor manufacturing process, such as liquid filters, purifiers and silicon wafer handling systems. Wright said the combined company will have the appropriate scale and leverage for its global customers. "This is an opportunity for two companies to do something together that would take a long time to do separately," he said.

The implication here is that a company can't be a long-term player if it isn't among the largest in the world. Wright cites data showing that of the operating income generated by the 50 largest equipment companies, the 10 largest firms control 89% of it. That doesn't leave much on the bottom line for the other 40.

Others still see technology as the best indicator of future success.

"At some level of critical mass, just about anyone can compete as long as they bring the best technology," says Mary Puma, chief executive of

Axcelis Technologies

(ACLS) - Get Report

, adding that her company has faced off against

Applied Materials

(AMAT) - Get Report

, the world's largest semiconductor-equipment maker, for two decades. "This is not about size, this is about technology."

For investors, however, it's only about making money. And it seems that neither size nor technology helps these stocks. The main problem here might not be with companies combining forces, it may be with the industry's lackluster shareholder returns -- for big and small players.

Since the start of 2002, Applied Materials' shares are off 16%, Entegris shares are down 1%, Axcelis is off 45%,

Novellus Systems


is down 32%, and KLA-Tencor is off 4%. During the same period, the

S&P 500

is up 6.3%, and the


is up 10%.

"This is a tough business to be in," says Dave Cavanaugh, director of manufacturing technology with Semico Research, adding, however, that a company with both a leading technology and a leading business plan will typically be able to survive.

Investors want to see their companies do more than just survive. Mergers might seem like the panacea to weak stock prices for some executives, but investors should know that in this industry, nothing is guaranteed.