Analysis: Applied-TEL Scrap Merger

After several delays due to a myriad of complex regulatory issues, Applied Materials’ proposed deal to buy Tokyo Electron Ltd. (TEL) has been scrapped. It appears that the U.S. Department of Justice (DoJ) stepped in and blocked the deal.

Now that the deal has been terminated, Applied Materials and TEL are separately re-grouping, and are back to where they originally started as fierce competitors in the fab tool market. But to some degree, the two companies have lost some momentum, if not share, in the market over the last year, according to analysts.

Meanwhile, as reported in September of 2013, Applied Materials announced a definitive agreement to acquire TEL in a stock deal valued at around $9.3 billion. At the time the deal was announced, Applied Materials was to own approximately 68% of the new company and TEL would own about 32%. The combined entities would have a new name, dubbed Eteris.

But the blockbuster deal kept getting pushed out amid a host of complicated regulatory issues.

Now, the deal has been scrapped. Regulators feared that the combined Applied-TEL entity could end up with a monopoly in the fab tool business. Some fab tool customers, namely Intel, were clearly not in favor of the deal, according to sources. It would have given chipmakers too few fab tool choices in an already consolidated market.

“Combining Applied and Tokyo Electron would have created a 1,600 lb. gorilla with strength across the expanse of every module in the industry, including etch, deposition, testers, litho and tracks,” said Srini Sundararajan, an analyst with W.R. Hambrecht + Co./Summit Research, in research note. “The power of such an entity to dictate terms to its customers would have been enormous–or at least the U.S. DoJ felt that way.”

In fact, the decision to scrap the Applied-TEL deal came after the U.S. DoJ advised the parties that the coordinated remedy proposal submitted to all regulators would not be sufficient to replace the competition lost from the merger. Based on that position, Applied Materials and TEL have determined that there is no realistic prospect for the completion of the merger. No termination fees will be payable by either party.

“We viewed the merger as an opportunity to accelerate our strategy and worked hard to make it happen,” said Gary Dickerson, president and chief executive of Applied Materials, in a statement. “While we are disappointed that we are not able to pursue this path, our existing growth strategy is compelling. We have been relentlessly driving this strategy forward and we have made significant progress towards our goals. We are delivering results and gaining share in the semiconductor and display equipment markets, while making meaningful advances in areas that represent the biggest and best growth opportunities for us.”

Analysts, who expected that the deal would be completed in 2015, were surprised by the outcome. “The deal cancellation is a huge shocker,” said David Motozo Rubenstein, an analyst with Shared Research in Japan. “Since September of 2013, TEL has been reminding us each month of the benefits of the merger. Now, at the 11th hour, after TEL’s stock has doubled, TEL and Applied have pulled the plug.”

From Rubenstein’s perspective, the ill-fated deal represents a setback for both Applied and TEL. “(The companies) lost opportunities due to wasted time on the merger,” Rubenstein said. “Transaction costs and legal fees were wasted.”

What happen?

So why did the deal fall apart? When the Applied-TEL deal was originally announced in late 2013, the combined entities were supposed to create the world’s largest fab tool vendor, thereby posing a serious threat to DNS, Hitachi, KLA-Tencor, Lam, Nanometrics, Ultratech and others.

To be sure, Applied Materials and TEL have a large portfolio of complementary, and overlapping, product lines. Applied is the world’s largest supplier of tools for CMP, ion implantation, PVD and RTP. It also sells tools in other markets, such as ALD, electroplating, epi and inspection/metrology.

For its part, TEL is the world’s largest player in wafer probe and wafer track. It is also strong in the fragmented wafer cleaning market. Both Applied Materials and TEL have CVD and etch lines.

At the time of the merger announcement, Applied Materials and TEL hoped to combine their vast resources and for good reason. It was simply too expensive for one company to fund and develop all products in a number of key markets, such as 3D NAND, 450mm, finFETs, stacked die and others.

Over the year, though, the reasons to combine their resources began to dissipate. Chipmakers put 450mm on hold. Advanced 2.5D/3D stacked die is still taking root. 3D NAND and finFETs are happening, but those markets are taking longer than expected to take off.

There were other challenges. The integration of Applied and TEL was expected to be challenging. The two companies reside in different locations and have distinct corporate cultures.

But the big problem became even more clear. It appeared that Applied and TEL underestimated the regulatory issues involved in such a complex deal. Originally, the companies expected the transaction to close in mid to second half of 2014, but the deal kept getting pushed out. By March of 2015, the Applied-TEL deal was approved by regulatory bodies in Germany, Israel, Korea and Singapore. However, China, Japan and the United States had not approved the deal.

Recently, the merger deadline was extended from March 24, 2015 to June 30, 2015. But it appears that Applied and TEL decided to throw in the towel and go their separate ways.

What’s next for Applied? Over time, Applied may look for other and smaller acquisition candidates. “Overall, there will be a drive towards opex reduction and this kind of ‘efficiency improvement’ will likely result in a reduction of workforce (layoffs) in our opinion,” said Sundararajan of W.R. Hambrecht + Co./Summit Research. “We also think that some of the senior executives that came into Applied by way of Varian Semiconductor might be used to turnaround the process diagnostics and control (PDC) segment to compete effectively against KLA-Tencor.”

This week, TEL posted its results and provided a mixed outlook. To be sure, though, Applied and TEL will once again compete in the market, but the business appears to be slowing down. Not long ago, in fact, Intel reduced its 2015 capital expenditure budget to $8.7 billion, plus or minus $500 million. This is down from the previous mid-point guidance of $10.1 billion. Then, TSMC recently cut its CapEx forecast by $1 billion to $10.5 billion to $11 billion for 2015.

As a result, Pacific Crest Securities cut its worldwide 2015 semiconductor capital spending (CapEx) forecast. The new CapEx forecast is now $62.5 billion in 2015. This is up 4% year-over-year, compared to the previous estimate of up 5%.