merger mania in the computer chip business: why?

This year has been market by a spate (like that word?) of mergers/acquisitions in the computer chip industry, the latest being the potential combination of stodgy Analog Devices with Maxim Integrated Products.   Why is this happening now?

Three reasons:

–cheap financing, even though not necessary in all cases, is still plentiful.  This may not continue to be the case as interest rates in the US rise

–the cost of creating and fabricating new generations of products is becoming very expensive, to the point that some firms can no longer afford to stay independent and remain in the game

most important, though, is the emergence of mega-customers like Apple and Samsung, or Acer and maybe even Asus, which has changed the competitive structure of the industry.  The situation now is that these few large buyers of components can play one supplier off against another to get better prices.  The only way suppliers can get any market clout is to combine.


One might think that this is evidence of the overall tech industry maturing, meaning that we’re entering a period of slower industry growth.  While that may be true, maturity isn’t the sole, or even the main, reason for consolidation.  When the EU was created, for example, cross-border mergers became feasible for the first time.  Small national supermarket chains combined to become EU-wide powerhouses.  For a while, food suppliers remained as small as before.  But the mammoth size of EU-wide purchase orders from the big supermarket chains became so enticing that food suppliers offered unusually high discounts to get the business.  These firms soon realized that they needed scale, both just to get the big supermarket orders and fulfill them and to streamline operations and lessen profit-destroying discounting.  The large scale of the customers forced the suppliers to scale up as well.

The economics works in the other direction, too.  Large scale on the suppliers’ part forces customers to scale up.

In the case of chip companies, I don’t see an easy way to make money right away from ongoing consolidation.  Many of the actors remain unattractive on a stand-alone basis, in my view.  Also, the general rule is that half of the combinations won’t work out, either because the principals can’t get along post-merger or an acquirer pays too much for a target.  Better to let the dust clear and try to assess the combined firms, say, next Spring.  Having said that, I do own Intel and Avago, two consolidators.

Avago (AVGO) and Broadcom (BRCM) …and Intel/Altera

Two days ago the rumor hit Wall Street that chipmaker and serial acquirer AVGO had found its newest target, BRCM.  Yesterday the offer was announced:  cash and AVGO stock, in approximately 45/55 proportions, totaling $37 billion.

my thoughts

When customers in a given industry group become bigger and more powerful, the natural response among suppliers is to do the same.  This is part of what is going on here.  More than that, AVGO appears to seek out companies whose technological virtuosity far outstrips their management skills.  So it gains not only the marketing benefit of size but also the rewards of improving the profitability of firms whose main virtue has been their intellectual property.

What’s striking about this deal is that in revenue terms AVGO is more than doubling its size.  Although I have no intention of selling the AVGO shares I own, experience says that acquirers often bite off more than they can chew when they make the jump from small acquisitions to super-size ones like this.

One of AVGO’s rumored other targets had been Xilinx (XLNX), the junior partner with Altera (ALTR) in the field programmable gate array duopoly.  I had thought that ALTR would feel more favorably disposed to overtures being made by Intel (INTC), given the possibility that AVGO would buy XLNX and turn the firm into a much more aggressive competitor.  That threat is now gone.  INTC must now rely on pressure on ALTR management from its major shareholders (shareholders are, after all, legally the owners of ALTR and the employers of management) to return to the negotiating table.

As a practical matter, managements have a lot of autonomy, despite the fact that we the shareholders are, technically speaking, the bosses.  Wall Street seems to believe that ALTR is holding out for a higher price from INTC.  While that may be the rhetoric being used, I think the real issue is more basic.  Who would want to go from being the master of all he surveys as the top dog (and treated as a demigod) at a major publicly traded company to being a near-invisible division head in a conglomerate?

an Intel (INTC) – Altera (ALTR) deal re-emerging?

Market gossip is that ALTR recently refused a friendly offer from INTC at $53 a share.

Speculation resurfaced yesterday with rumors that talks have started up again.

The catalyst seems to be the fact that serial acquirer Avago (AVGO–I own shares) appears to be considering a bid for ALTR’s rival Xilinx (XLNX).

AVGO seems to have a knack for finding firms that have excellent technology but which, for one reason or another, find it difficult to achieve consistent profit growth.  AVGo buys them, reorganizes them and puts the profit machine into high gear.

In this case, the sub-industry involved is the sleepy world of field programmable gate arrays (FPGAs), dominated by the cozy duopoly of ALTR and little brother XLNX.  AS the name suggests, FPGAs are chips whose program structure is not hard-wired (those are application-specific integrated circuits–ASICs).  So they can be reprogrammed, upgraded, debugged…even after they’ve been put into machines that are now in use.  This allows manufacturers to get, say, cutting-edge telecom equipment into customers’ hands very quickly.  The drawback is cost.

The AVGO move suggests the FPGA arena is about to become considerably more competitive.   AVGO/XLNX would be four times the size of ALTR, implying easier access to capital and the ability to offer a much wider variety of products to customers than ALTR.  This suggests ALTR realizes the status won’t be quo for much longer and it needs to be part of a bigger entity in order to compete.

To my mind, the big winner in all this would be INTC.

Intel (INTC), Microsoft (MSFT) …or an ETF?

When I was reading the Seeking Alpha transcript of INTC’s 1Q15 earnings the other day, I notice that an ad popped up to the right of the text.  It was mostly a list of passive tech-oriented ETFs, with a performance comparison against INTC.  The list showed that INTC had handily outperformed any of the other entries over the pat twelve months   …but that the year-to-date results were a markedly different story.

That started me thinking.  Would I be better off with an ETF than with INTC?

On the one hand,  INTC is a relatively cheap, high dividend yield stock, whose glory days of the PC era are far behind it.  the company finally recognizes this and is in the midst of an attempt to morph into a 21st century-relevant firm. If it’s successful, I can imagine the stock could have, say, a 35% gain in price as Wall Street discounts better future earnings propects (I’d say much the same of the post-Ballmer MSFT).

This isn’t a bad story.  I’m arguably paid to wait.  The stock’s valuation is reasonable.  And at the moment I don’t believe the overall US stock market has very much near-term upside.  So I’ve been content to hold.

The ETF ad, though, got me thinking.   Can I do better, without taking a significantly larger amount of risk?

This question has two parts:

–is there a better tech stock than INTC?, and

–can I locate it?

I’m convinced that the answer to the first is Yes and that the area to look is online services for Millennials and the companies that supply support and infrastructure for them.

For me, the issue is whether to search for, and concentrate, on a single stock–something that requires a lot of time and effort.  I think it’s better to look for an ETF or mutual fund.  The best I’ve found so far is the Web X.O ETF from Ark Investment Management.  The ETF is tiny, so liquidity is a risk–in fact, Merrill Edge wouldn’t accept an online order from me for this reason.  I had no problem with either Fidelity or Vanguard, however.  The other thing is that ARK is a startup.  The principals may have had long Wall Street careers but I see very little evidence of hands-on portfolio management experience.  So ARK is in a sense establishing its bona fides with (a small amount of) my money.  Not exactly the same risk profile as INTC.

Personally, I’m not so concerned about the portfolio manager.  The organization publishes its holdings every day.  For me, liquidity is the bigger worry–and something that would make me reluctant to recommend ARK to anyone else.  Still, I own some.  And I’m looking for other vehicles that can potentially serve the same purpose in my portfolio.

Intel (INTC0 and Altera (ALTR): implications

What can we conclude from INTC’s interest in acquiring ALTR?

–when I became interested in INTC as a stock a couple of years ago, it seemed to me that the firm could be viewed as having two businesses–a high-growth one selling servers and a low-growth, cash cow one selling chips for PCs.   At the time, I thought the server business alone more than justified the then stock price, and that the PC business was mainly important for its contribution to overhead and its free cash flow generation.  A desire to acquire ALTR seems to confirm that this is also INTC management’s view.

–good companies periodically reinvent themselves.  After a period of stagnation, this appears to be what INTC is doing

–the threat of low power servers run by ARM chips is serious

–my guess is that a bid will take the form of all or mostly INTC stock.  An all or largely cash offer would imply either that INTC thinks its shares are deeply undervalued, that debt financing is too ridiculously cheap to pass up, or that long-suffering ALTR shareholders want  to declare investment victory and move on.

–an INTC-ALTR merger spells trouble for Xilinx (XLNX), the main competitor to ALTR

–the main source of value in ALTR is its software.  Assessing that, thorough accumulated R&D spending, is the key.

Numbers tomorrow.