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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