If past is prologue, Analog Devices Inc.’s $20 billion acquisition of Maxim Integrated Products Inc. will prompt a major shake-up in its electronics distribution channel. When ADI acquired Linear Technology in 2017, it consolidated its global volume distribution network under one distributor – Arrow Electronics Inc. – and discontinued with the industry’s second-largest player, Avnet Inc.
The stakes are huge if ADI once again realigns its post-merger channel. Both component makers sell more than 50 percent of their volume through distributors. ADI, which sells 55 percent of its products through the channel, reported 2019 revenue of $6 billion. Maxim, which derives about 52 percent of its revenue through distributors, reported sales of $2.31 billion in 2019.
The combined enterprise will be valued at $68 billion. Currently, Maxim sells its products through Avnet, Future Electronics Inc., RS Electronics, catalog distributors Digi-Key, Newark and Mouser and a number of specialty and regional companies. ADI sells through Arrow, Digi-Key and Mouser.
“Analog Devices’ move to acquire competitor Maxim Integrated, announced this morning, is […] a potentially negative blow to Avnet, which lost the ADI line in 2017,” Stifel said in a Monday industry update. “Although it's too early to tell whether ADI moves Maxim to Arrow or retains the Avnet relationship, keeping everything under the Arrow umbrella would seem to make better sense, in our opinion, than increasing business with Avnet. The move comes at a time when Avnet is losing its largest semiconductor line, Texas Instruments.”
At the same time, the Covid-19 pandemic could dispense with conventional wisdom following a supplier M&A. The coronavirus has wreaked havoc in the electronics supply chain, and customers are evaluating the risk of not receiving critical products on an almost daily basis. OEM and EMS companies currently procuring ADI and Maxim products from multiple distributors are unlikely to embrace a channel consolidation in the short term. Too much dependence one on source – such as a single distributor – is anathema to most large electronics manufacturers.
Trends point to consolidation
Channel trends still point toward distribution consolidation. Suppliers such as ADI and Maxim – which offer comparable, highly specialized product lines -- are rarely sold side-by-side within one distribution organization to avoid head-to-head competition, customer overlap and over-distribution. Customers, then, deal with multiple distributors. However, there are considerable supplier savings associated with consolidation -- suppliers incur costs when they are engaged with a distributor. Most provide training for distribution sales reps; distribution prices differ from customer-direct contracts; and transactions such as expedited shipping, consignment, cancellations, credit and rebates carry service-related fees.
Customers gain clout with both suppliers and distributors as they increase volume orders with that partner. There are price advantages to buying in large quantities and big customers are first in line in the channel if component supplies become scarce.
"Analog Devices terminated its relationship with Avnet in 2017 following ADI's acquisition of Linear Technology, which had an exclusive distribution agreement with Arrow. Roughly $500 million in sales shifted from Avnet to Arrow. Avnet is currently Maxim’s only global volume distribution partner, and made up 22 percent of Maxim’s revenue in FY19, or roughly $500 million," reported Stifel. "We believe margins in that business are above company average due to its demand-creation model. For Arrow, ADI represented roughly $2 billion, or 30 percent of ADI's sales in FY19, up from 28 percent in FY18 and 14 percent in FY17. Arrow performs both demand-creation and demand-fulfillment."
It is not unusual for component suppliers to consolidate under a single distributor following a merger or acquisition. If a distribution M&A brings highly-competitive suppliers together, one line is usually dropped. Likewise, when suppliers merge, they often pare down their distribution roster.
Catalog distributors, which specialize in low-volume design- and prototype-sized orders, provide sales leads for future production and are usually unaffected in an M&A. Fulfillment businesses such as Arrow, Avnet and Future are most likely to lose a franchise. RS – a division of Electrocomponents plc—specializes in automotive electronics.
“Given Arrow's strong global capabilities, extensive demand creation network, and global ERP system, adding Maxim would make sense from a logistical and economic standpoint, particularly if ADI integrates the Maxim products under one portfolio,” said Stifel. “For Avnet, we estimate roughly $20 million to $25 million in potential lost operating profit. For Arrow, the additional business would require some additional investments in engineering resources, and potentially some margin concessions to ADI, but net-net should be accretive fairly immediately.”
One argument against terminating Avnet would be that Arrow has had no relationship with Maxim since the mid-2000s, and coming up to speed on the products, technologies and customer base could be challenging, Stifel added. “But unless the Maxim business is kept separate, retaining Avnet may also require ADI to give access to its own product lines and shifting business away from Arrow. We don't see that making sense at this point.”
The demand-creation question
There has been another trend in distribution that will likely impact the ADI-Maxim channel roster: a practice called demand creation. Under such programs, suppliers incentivize distributors to get their devices designed into an OEM end-product. Incentives include protected pricing or higher profit margins for distributors that secure a design-win.
Texas Instruments Inc. upended the distribution channel four years ago when it discontinued its demand-creation program and retained its distributors for order-fulfillment. As ADI expands its product portfolio, it could contemplate a similar move.
Stifel sees this as a potential negative for ADI's and Maxim’s leading distributors.
As ADI broadens its product portfolio, it could bring demand-creation efforts in-house, said the analyst, using distribution solely for fulfillment. “TI is currently the only major semiconductor distributor that does not use distribution for sales, but it could be argued that, with an expanded portfolio and expanding digital sales capabilities, ADI could move to that model at some point.”
TI also made a second ground-breaking move in late 2019 when it announced it was discontinuing its relationship with six distributors, including Avnet, World Peace Group (WPG) and WT Microelectronics. Their contracts will end in December of this year.
“Dealing with the potential Maxim fallout comes at a time when Avnet is losing its largest semiconductor line, Texas Instruments, with still roughly $1.6 billion in revenue expected to unwind by year's end,” Sifel added. “Avnet management has said it believes it will fill that gap in gross profit by gaining share with other analog suppliers, as well as adding more lines. We believe this latest news creates yet another overhang for the stock.”
Although analysts and distribution-industry watchers expect Arrow Electronics will gain most of Avnet’s TI business, Arrow CEO Michael Long has said during several analyst conference calls that has not been the case.
Neither ADI nor Maxim addressed channel implications during its Monday morning conference call with analysts. However, Maxim cited some manufacturing issues during its FY Q3 2020 (ended in March) call that directly impacts its inventory position with distributors.
“Our manufacturing test operations were not able to run at full capacity during the last two weeks of the quarter, impacting our ability to ship products both to direct customers and to distribution,” said Maxim CFO Brian White. “Additionally, distribution resales increased from the prior quarter.” Maxim committed to replenishing its distribution inventory beginning in June.
The company admitted forecasts remain challenging. “And I think in today's environment, it's even more difficult, and then is combined with the challenge of trying to predict how our mix of shipments will ultimately play out as it relates to direct versus chain shipments,” said White. “So, I think what you've seen from us over the course of the last several quarters is very prudent management of our channel inventory. We've been very disciplined in managing that and keeping it well within our target range. You should expect us to continue to do that. We will.”
Maxim has since updated its Q4 guidance. Based on preliminary financial information, Maxim now expects net revenue to be approximately $545 million.The company told EPSNews it would provide updates on its channel strategy when available.
The transaction is expected to be finalized by summer 2021.