The distribution channel is beginning to feel the fallout from rampant merger and acquisition (M&A) activity in the semiconductor industry. Analog Devices Inc., which is acquiring Linear Technology, announced it is naming Arrow Electronics Inc. as its sole global distributor and is cutting Avnet Inc., except for Avnet’s Premier Farnell unit.
Both Arrow and Avnet have carried the ADI line for years. Arrow has been its leading distributor, according to investment firm Stifel, generating about $700 million per year in ADI sales to Avnet’s $500 million. Avnet, however, does not carry Linear Technology; Arrow is considered Linear’s largest distributor.
It is not unusual for component suppliers to consolidate under a single distributor following a merger or acquisition. Rival semiconductor companies used to refuse to be sold side-by-side within a distribution organization for competitive reasons. If a distribution M&A brought these suppliers together, one line was usually dropped. Likewise, when suppliers merge, they often pare down their distribution roster.
In this case, ADI and Linear are consolidating under their largest distributor. Distribution represents roughly 52 percent of Analog Devices' total revenue, according to a Stifel market-update note, or a roughly a $1.9 billion run rate. Arrow and Avnet accounted for most of those sales. Arrow represented roughly 32 percent of Linear's total revenue; Avnet did not carry that supplier.
Other semiconductor suppliers have made similar moves. Broadcom expanded its relationship with Avnet following its merger with Avago last year, while Arrow lost that business in North America and Europe. At the same time, Microsemi designated Arrow its "lead" global distributor, shifting some business from Avnet.
Arrow will provide engineering, supply chain and fulfillment services for ADI customers. These services have become increasingly important to semiconductor suppliers as they try to support only their largest customers directly. Arrow has aggressively pursued the design and engineering market by adding engineers to its considerable salesforce. Distributors “create demand” for semiconductor suppliers by getting their devices designed in to an OEM end product.
However, as component profit margins have declined some semiconductor suppliers are scaling back on demand creation. Distributors are compensated for their demand creation efforts by their suppliers -- not by their customers. Once an OEM product reaches production volumes, distributors receive a higher profit margin or similar incentive from suppliers based on those volume sales. Texas Instruments has pulled its demand-creation business out of the channel, and analysts have said they “would not be surprised” to see more distribution changes given the ongoing consolidation in the semiconductor industry. The NXP-Qualcomm merger is a big question market in the channel: NXP is widely carried by distributors while Qualcomm's channel strategy is more selective. Only a handful of distributors carry both suppliers.
During Arrow’s Q4 conference call with analysts, CEO Mike Long said Arrow has so far benefited from semiconductor M&A. Even as suppliers such as TI scale back on demand creation, other suppliers want to beef up their programs. Arrow has significantly ramped up its design efforts in Asia and executives said they expect to benefit from those programs.
“It’s no longer fair to assume innovation happens in the West and moves to the East,” Long told analysts. Sales in Asia-Pacific, however, tend to be less profitable than other regions of the world. “It will take some time,” Long added, “but we have shown that as we migrate upstream there are more profitable opportunities.”
Avnet, in the meantime, is bolstering its higher-margin business through its acquisition of Premier Farnell. Premier Farnell specializes in catalog, or low-volume high-mix component orders, which carry a higher pricetag than volume sales.
The new ADI/Linear agreement is expected to take effect sometime in the June or September quarters. Stifel expects the ADI expansion to add roughly $220 million in revenue for Arrow in FY17 and $500 million in FY18. The impact on Avnet is estimated to be a decline of roughly $500 million in FY18.