There has been a bevy of communications-chip merger activity that makes this sleepy technology sector look like a Kardashian party in Beverly Hills. What’s behind it? Is easy money a factor? The Internet of Things? Envy?
Each of the above is a factor (apart from the Kardashians, who haven’t yet expressed an interest in FPGA technology). Technology M&A reached a recent record in 2014 and appears to be accelerating. This is fueled by the open debt markets and the need for technology players to scale into new growth markets such as mobile and IoT.
The recent focus has been on the chip sector, where Avago Technologies is acquiring Broadcom, one of the preeminent communications chip companies in the United States, for $37 billion. And Intel has announced a $17 billion deal for Altera.
Let’s break down these deals and see what they mean.
Avago bids on Broadcom
First of all, let’s point out that at the beginning of this year Avago was announced in the Rayno Report Model Portfolio as a technology growth play. This is a savvy deal in which the smaller company is buying the bigger company to become the third largest chip player in the world. Avago’s (Nasdaq: AVGO) $37 billion bid for Broadcom was in cash and stock, with $17 billion in cash. A lot of this will be fueled with new borrowing, so easy money is a factor. Avago will be refinancing $6.5 billion in standing debt and raising $9 billion of new debt to finance the acquisition.
According to Tim Arcuri with Cowen & Co., this deal will make Avago the third largest semiconductor company after Intel (Nasdaq: INTC) and Qualcom (Nasdaq: QCOM), with combined revenue of about $16 billion and enterprise value of nearly $80 billion. He downgraded the stock, however, pointing out that the estimated $750 million in “cost synergies” were likely optimistic.
There is another factor in this deal, however, which is taxes. Avago is based in Singapore, which has a lower tax rate than the US, where Broadcom is based. So one could make the argument that this looks like the tax-driven deals in the pharmaceutical industry, which are referred to as “tax inversions” and have been driving all sorts of deals in that sector.
The Wall Street Journal points out that the deal is driven by fancy tax loopholes, which are certainly a factor in the deal.
Some experts have said they expect Intel to try to bid on Broadcom to stop this deal, but as you can see with the next item, Intel already has its hands full.
Intel buys Altera
Intel and Altera (Nasdaq: ALTR) have been going back and forth since Intel submitted a bid at $54 a share in April. The Altera board decided it couldn’t get a better price, and that offer has now been accepted.
Bloomberg pointed out that since Altera reported a disappointing quarter, this price looks pretty lofty, at $14.3 billion after subtracting net cash.
“Intel’s offer values Altera at 25 times its earnings before interest, taxes, depreciation and amortization in the last year,” according to this article by Bloomberg’s Brooke Sutherland. “That’s about 70 percent higher than the median multiple paid for similar transactions in the last five years, and roughly in line with Avago Technologies Ltd.’s pricey purchase of Broadcom Corp. announced last week.”
Hmm. Pricey purchases, eh? So what’s driving this? Strategy or easy money?
What’s driving the deals
US companies in industries were targeted for a record $215 billion worth of acquisitions during May, according to Bloomberg. It was also the busiest 12-month period for deals ever at about $1.58 trillion.
These deals could not happen without extraordinarily low interest rates to finance the leverage. Just look at the example of Avago in which it is borrowing $9 billion to buy a company that is 60% larger by revenue, with a fancy tax scheme included. This is financial engineering at its best. I like this deal though — it takes cojones and is savvy. Avago instantly becomes one of the premier global players in communications chips, which it can then marry to its mobile business: It now covers mobile, data-center, broadband, and enterprise networking. And yes, it’s a deal that makes Intel nervous, considering Intel’s disappointing progress in mobile and communications.
Which leads to my next question: What is Intel’s next move, and why did they pick Altera? There are so many things out there to buy, including companies like Skyworks Solutions (Nasdaq: SWKS). Skyworks currently has a market price tag of $20 billion, so yes, it’s a little more pricey than Altera, but it recently had year-over-year revenue growth of 60% and earnings growth greater than 100%. (Disclosure: I own SWKS in a select retirement account, which I have disclosed since I made it a stock in the Rayno Report model portfolio in 2014. SWKS was up 170% in 2014.)
Intel likes Altera’s field-programmable gate array (FPGA) technology because it is low cost and low power, making it good technology for specific applications in the data center, but once again Intel is missing the bigger picture in mobile and IoT, where the growth of millions of devices will make the wireless chip market the most attractive.
FPGA technology, which is used to build specialized processors that supplement the Central Processor (CPU), are being positioned by Intel as an IoT technology. But Altera’s recent sluggish growth make this story a dull one. Intel would have been better off making a play in the pure mobile space.
Avago’s deal, though riskier, is much more interesting. And yes, these deals are frothy, fueled by easy money, and give an indication that the risk profile for technology valuations is starting to rise. But I do not expect it to end in 2015. I expect more deals.
(Disclosure: The writer is a technology analyst who believes in putting his money where his mouth is. Therefore, from time to time, he may take long-term positions in technology stocks mentioned in these pages, but always as “investments,” not short-term trades, and usually in retirement accounts. These ownings are typically held for at least six months and disclosed on these pages. The writer currently owned SWKS in some retirement accounts at the time of writing. Skyworks and Avago are also both included in the Rayno Report Model Portfolio, published every year, in which the author is usually fully invested.)