On the face of it the answer to the question in the headline above would have to be a definite yes. Many industry executives certainly believe this is the case, hence the recent spate of multi-billion dollar mergers and acquisitions. Since the beginning of 2015 there have been nearly 40 M&A deals in the semiconductor space, estimates IHS Corp. They range in size from the $40 billion purchase of Freescale by NXP to snack-size deals valued below $1 billion.
Other potentially large semiconductor acquisitions have been scuttled by regulators in the West bristling at Chinese moves in the sector. These include the reported $23 billion offer for Micron Technology Inc. by Tsinghua Unigroup, a Chinese investment firm. As a result, most of the transactions so far have been between Western companies, including Intel Corp.’s $16.7 billion for Altera Corp.
As the ranks of chipmakers shrink with each M&A transaction, the role of the surviving companies has become more critical to customers and in the supply chain. They will fight over the same procurement budgets but there will be fewer contestants divvying up the spoils of war. Their ability to influence OEM activities will also increase and the need for tight relationships between suppliers and buyers could crimp the flow of new players or negatively impact their success. Analysts watching the current environment are raising questions about the primary drivers for the acquisitions, the implications for the supply chain and whether the industry has too many chipmakers and need to whittle down the number to improve operating efficiency.
The deals raise other questions. Will these M&A transactions boost innovation, improve efficiencies, broaden the effectiveness of sales campaigns and spark growth throughout the industry? Or are these strategic moves by cash-rich companies to take out competing firms and potentially eliminate the technologies they offer?
One thing is certain. These transactions are not similar to the ones that spread like a rash through the industry during and after the brutal downturn of 2001 when OEMs abruptly stopped purchasing components and left many vendors gasping for air. At that time the weakest players largely had no other recourse but to run into the arms of any willing buyer. Many of them collapsed, filed bankruptcy or were sold for a fraction of their intrinsic value.
The classic example was that of Nortel Networks’ optoelectronic components business that the now defunct Canadian company hawked around for as high as $100 billion when the industry was going through its explosive boom in 2000. Corning Inc. briefly considered buying the Nortel division but backed out because it considered the price too high. It was. Soon after the deal was scuttled, the market for optical components similarly cratered. Nortel’s optical components business was sold two years later to Bookham for $108 million.
None of today’s deals look remotely similar. Yes, valuations are really high but the underlying fundamentals of the industry are much stronger. The companies being acquired are generally in good financial conditions, have strong sales, cash flow and solid market shares. The buyers are taking on loans to finance the biggest purchases but in reality they are also swimming in cash and can borrow more easily from the equity market. Interest rates, too, are at record-low levels. Why shouldn’t a company make an acquisition in this climate if it is in a position to do so and can justify the investment to shareholders?
Analysts are certainly edging them on. Investors who typically prefer higher dividends payments or stock buybacks appear to have had their fill. Technology companies are paying out billions of dollars in dividends each quarter and buying back stocks by the truckload. Even after doing these for the last several years the electronics industry is still flooded with liquidity. Apple Inc., alone, reported $205.7 billion in cash and marketable securities in the September quarter, 91 percent of it parked outside the headquarter country, according to Luca Maestri, the chief financial officer.
“We were very active in the market during the quarter and returned over $17 billion to our investors. We paid $3 billion in dividends and equivalents and we spent $14 billion to repurchase almost 122 million Apple shares through open market transactions,” Maestri said while discussing the September results. “We have now completed over $143 billion of our $200 billion program, including $104 billion in share repurchases of which $36 billion was repurchased in fiscal 2015 alone.”
Apple is, of course, an exceptional company but the leading chipmakers are doing fairly well too. Intel Corp., for example, finished the third quarter with approximately $21 billion in cash and short-term investments, plus $15 billion in long-term investments and other long-term assets. It could have written a check for its planned $17 billion purchase of Altera and still have billions more left. Plus, Intel also has access to the equity market and has taken advantage of this already; in September its long-term debts rose sharply, to $20 billion, from $12 billion in the June quarter.
The strong cash positions of these chipmakers highlights the fact that they are not in any financial turmoil and that the M&A activities aren’t being conducted to shore up their balance sheets. So, why are they making these deals? IHS analyst Greg Wood sums up why in a report:
With slower growth projected for the semiconductor industry, company executives are looking more toward acquisitive growth versus organic growth in 2016. This coupled with the semiconductor industry’s solid performance over the past three years and low cost of borrowing, have created cash rich companies with new opportunities. Many semiconductor companies are also looking to improve their product portfolio by offering a more complete solution to customers with more integrated systems. Some companies look to acquisitions to create more steady revenue year around with less seasonal spikes. And finally, semiconductor companies are also looking to improve margin and/or market share by buying competitors or sell off less profitable business lines.
The benefits of these acquisitions to the semiconductor companies is clear but how about the long-term implications for their customers? This question should be paramount in the minds of OEMs. Whether one agrees or not with their strategy, it's indisputable that the number of semiconductor manufacturers is falling and that this will have implications for everyone. How many are enough and how long will it take the industry to get to whatever optimal number experts believe the industry can sustain? Also, will start-ups be able to thrive in this environment where they must compete against much larger and richer rivals?
This is not just an idle question. Figures are significant in every economic sector. In the semiconductor market the number of competitors impact the allocation and effective use of capital and other resources. It impacts every segment of the supply chain, starting with OEMs and contract manufacturers – the primary users of products made by chip suppliers.
The most critical issues and decisions taken by procurement experts who work at OEMs and EMS providers will be directly challenged or limited by the number of suppliers from which they can source components. Component demand/supply equilibrium, one of the more perplexing challenges the industry has historically struggled with, is influenced by a variety of factors, including:
- Number of competing vendors
- Variety of product portfolios
- Level of supplier dominance – that is, if a monopoly or quasi-monopoly structure exists for a specific group of products
- Number, size, technology node and effectiveness of fabrication plants in operation
- Volume of products available to buyers
As the pace of consolidation in the semiconductor market accelerates, purchasers at OEMs and EMS providers will need to put more efforts into such issues as product availability, access to innovative components, demand-supply variabilities, logistics, pricing, possible reductions in the opportunities for second-sourcing and security of supplies.
Distributors will also be impacted. Broadline distributors pride themselves on the variety of products they carry and the number of suppliers they represent. If consolidating companies stop production of certain lines after acquiring a supplier, it will impact distributors’ ability to support the device and their existing customers. This is when end-of-life problems start to emerge.
Nevertheless some distributors welcome the ongoing semiconductor market consolidation and believe it will not have a negative effect on their operation. They actually see benefits in the addition of new lines, larger portfolios and broader reach offered by surviving , according to Michael Long, chairman, president and CEO at Arrow Electronics Inc.
“At this point in time, the mergers we have seen have been positives for us,” Long said in response to questions from analysts on the subject during the company’s latest conference call with investors. “What we've seen is an expansion of products usually on our line card, which we like because we have more to sell. It widens the market and gives us a better opportunity, especially in slow growth environments. And then if you get a good growth environment, it sort of actually maximizes for you.”
Long added that he expects further supplier consolidation because the environment appears to support M&A activities. That’s when it may get dicey for everyone. The semiconductor industry is often thought of as a monolithic market whereas it is anything but this. The range of products is wide and it is virtually impossible for any single suppliers to service the entire market.
Consolidation could result in a reduction in the number of suppliers in any key product sector to a handful or even just a couple of players as in the PC microprocessor market. That could lead to too much of a good thing.