By Don Clark
Chip makers are facing many pressures pushing them to combine.
The biggest, though, comes from Wall Street.
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. Some chief
executives of publicly held silicon companies also are concluding
that the only way to boost share prices is to sell out. A savvy
tie-up can bring cost savings or other benefits that yield fatter
margins that investors love. Meanwhile, some potential buyers are
flush with cash or are finding it easy to raise debt for deals that
could boost their earnings.
The pressure has led to a wave of consolidation in the industry
that reached a peak--perhaps momentary--with Wednesday's
announcement that Avago Technologies Ltd. offered a rich $37
billion for rival wireless-chip maker Broadcom Corp.
The pressures facing chip makers are paradoxical.
Microprocessors are the engines of the digital transformation that
is remaking business and cultural life world-wide. Small squares of
silicon are at the center of trends that are expected to generate
major growth well into the future, especially mobile computing but
also the Internet of Things, which promises to put processors in
everyday items from refrigerators to luggage to clothing.
Some companies that haven't found a buyer are feeling the heat.
Intel Corp. and Altera Corp. recently renewed buyout talks that had
stalled in April, people familiar with the matter said, after
Altera shareholders such as TIG Advisors LLC protested its earlier
rejection of an Intel offer at a valuation that was seen as higher
than the company could reach on its own.
Intel and Altera are in advanced talks and could strike a deal
as soon as Monday, people familiar with the matter said. Altera
shares soared nearly 29% in March when The Wall Street Journal
first reported the companies were in talks. Intel's share price
rose more than 6% then on the news.
On Thursday, Broadcom said rewarding its shareholders was the
prime motivation for accepting the cash-and-stock offer from Avago,
a company that has pursued acquisitions and whose shares have
outpaced its peers.
The two companies predicted they could cut $750 million in
annual expenses from the combined entity within 18 months of the
deal closing, leading to operating profit margins of 40% versus 24%
for Broadcom alone.
The push to consolidate isn't a positive trend for employees.
Avago and Broadcom said it was too early to spell out plans for
head count reduction, but they pointed to duplication in support
functions like sales, administration, marketing and customer
support.
"To reduce costs, you have to get rid of people," said Handel
Jones, a consultant to semiconductor companies who heads
International Business Strategies Inc. "This is a job-destruction
activity."
Besides cutting jobs, chip makers find they can cut costs by
pushing more products using a sales force that remains roughly the
same size. That tactic is expected to drive much of the $500
million in cost savings predicted by NXP Semiconductor Inc. after
its $11.8 billion purchase of Freescale Semiconductor Inc. has
closed.
Cypress Semiconductor Corp. has benefited in the same way from
its purchase of Spansion Inc., which it acquired recently in an
all-stock transaction valued at $1.6 billion when it was announced
in December. The companies estimated they could deliver $135
million in cost savings in three years, in part by offering
additional products without hiring more sales staff.
Cypress CEO T.J. Rodgers, who leads the combined companies,
estimated that more than 1,000 employees would be laid off and 50
offices around the world would close as the operations were
combined.
Beyond the cost savings, Mr. Rodgers said, the deal filled in
the product line. Cypress, for example, gained access to Spansion
chips that allowed it to become a supplier of electronics for
cars.
"We are in the middle of a wave right now," he said in a March
interview. "The new theme is, you have to integrate to get scale to
survive."
The semiconductor industry's consolidation coincides with
declines in some chip businesses, notably for PCs, said Jon
Erensen, a Gartner Inc. analyst. Meanwhile sales of tablets, which
helped draw consumer dollars from PCs, have been slowing since
2013; Gartner predicts sales to grow just 4% this year. Smartphone
sales outside of China are also softer than in recent years, he
added.
After total chip sales grew 7.9% in 2014, Gartner recently
estimated 2015 sales would grow 4% to $354 billion--and Mr. Erensen
expected that forecast to be trimmed. He believed the
Avago-Broadcom combination and others were inspired by what's
called the Internet of Things, the use of sensors, processors and
other chips to an array of items in homes and businesses.
Investors also view chip makers less favorably than they once
did. Over the past 20 years, semiconductor companies enjoyed an
average price premium of 32.5% over other companies in the S&P
500 stock-index, as measured by their ratio of stock price to
earnings, according to analysts at Sanford C. Bernstein. They are
currently trading at a 15% discount to that index.
Tech investors more recently have preferred to put their money
into companies like Facebook Inc. that have much wider profit
margins and prospects of much faster revenue growth. Semiconductor
margins are held down by factors like price competition from Taiwan
and China, and chip makers must cut their prices accordingly.
"Pricing is collapsing," says Stacy Rasgon, a Bernstein analyst.
"The profit pool is going away.
Qualcomm Inc., the biggest maker of chips for smartphone, faces
concerns about lower prices due to competition from rivals such as
Taiwan-based MediaTek Inc. Activist investor Jana Partners is
pushing the company to consider options such as breaking up to
boost its share price, which is off about 12% over the past
year.
Other barriers to fat margins are technological. Miniaturization
techniques that squeeze more transistors on a chip raise the cost
of designing them. At the same time, device makers demand that more
functions once found on separate chips--sometimes from separate
companies--are integrated onto single pieces of silicon.
Companies should respond by combining with others that sell
different chips, and by integrating disparate engineering
disciplines, said Levy Gerzberg, the former chief executive of
Zoran Corp., which was sold to British chip maker CSR PLC in 2011
for $679 million. "It's not just a matter of being bigger," he
said. "By combining the two companies, we could provide a more
complete solution to our customers."
Dana Mattioli contributed to this article.
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