Lam To Acquire KLA-Tencor

In a major and surprising move in the fab tool business, Lam Research has entered into a definitive agreement to acquire KLA-Tencor for about $10.6 billion in cash and stock.

Lam’s proposed move to acquire KLA-Tencor would create a powerhouse in the fab tool industry. The combined company will have approximately $8.7 billion in annual revenue, propelling it to become the world’s second largest fab tool maker, behind Applied Materials.

If the deal goes through, the combined Lam/KLA-Tencor duo would compete against Applied Materials and other vendors in several markets. But the Lam-KLA deal could also come under intense scrutiny from regulators, much like Applied Materials’ recently aborted move to acquire Tokyo Electron Ltd. (TEL).

After several delays due to a myriad of complex regulatory issues, Applied Materials’ proposed deal to buy TEL was scrapped in April. Regulators were worried that the combined Applied-TEL entity would have a monopoly in certain fab tool markets.

It’s too early to say if the Lam/KLA-Tencor combo would have the same fate. To be sure, though, the Lam-KLA combination would create a fab tool powerhouse. The combined company would serve about 42% of the wafer fabrication equipment (WFE) market, according to Lam and KLA-Tencor.

LAM Research is especially strong in etch. It also competes in the chemical vapor deposition (CVD), wafer cleaning and other markets. For its part, KLA-Tencor is the world’s largest process control vendor.

With the acquisition of KLA-Tencor, Lam would enter into several new markets, such as metrology, inspection and others. Within those segments, KLA-Tencor is the world’s largest supplier of mask inspection tools and wafer inspection systems. It is also the largest supplier in the fragmented metrology market.

Under the terms of the deal, meanwhile, the combined company will use the name Lam Research. Martin Anstice, chief executive of Lam, will lead the combined company. Steve Newberry, Lam Research’s chairman, will continue in that role. Two board members from KLA-Tencor will join the combined company board effective upon closing.

“The pairing of Lam Research and KLA-Tencor brings industry leadership in process and process control together, accelerating our capability to address our customers’ most difficult challenges as they scale to meet the market demands of lower power, higher performance, and smaller form factors,” Anstice said in a statement.

Lam’s proposed acquisition of KLA-Tencor makes sense for other reasons. There must be a tighter coupling between the traditional process steps–such as deposition, etch and others–and process control. Process control involves inspection and metrology.

There are several reasons for this, namely yield and variation. “We are noticing that in a lot of our process development, you have to worry about yield once it goes into pilot production and production. It’s increasingly becoming more important,” said Dave Hemker, senior vice president and chief technology officer at Lam Research.

“But the other aspect is that as you shrink below 10nm, the process control aspect of it is becoming more important,” Hemker said. “There are variations. Now that we are controlling things on the atomic level, very small variations can impact the end result. It’s not just from a defect yield perspective, but also from a device performance perspective.”

So what’s the solution? “That was one of the big keys that led us to realize we have to get much closer in the process control space,” he said. “As we are developing these processes, (we want) to get a jump on understanding variability right from the beginning, rather than waiting for a customer to come and tell us.”

If chipmakers find the problem later in the flow, the challenges become more difficult. “We have to work on the problem out in the field,” he added.

Analysts, meanwhile, are bullish about the move. “This is just what the doctor ordered,” said Srini Sundararajan, an analyst with W.R. Hambrecht + Co./Summit Research, in a report. “It removes excessive dependence of Lam on memory and excessive dependence of KLA-Tencor on foundry/logic.”

Still, the deal also comes during a slowdown in the industry. Intel, TSMC and Samsung have recently cut their capital spending budgets.

Worldwide semiconductor capital spending is projected to decline one percent in 2015, to $63.9 billion, according to Gartner. This is down from the 2.5% growth predicted in Gartner’s previous quarter’s forecast. The forecast for 2016 is unchanged at a 3.3% decline over 2015. “We are continuing to see weakness in end-user electronics demand in response to an uncertain economic environment, which is putting a damper on 2015 spending,” said Takashi Ogawa, research vice president at Gartner, in a recent report. “Next year we are anticipating DRAM manufacturers to respond to oversupply conditions with dramatic deductions in their investment plans.”

Meanwhile, under the terms of the definitive agreement, Lam will acquire KLA-Tencor for approximately $5.0 billion in aggregate cash consideration and approximately 80 million shares of Lam common stock, valued at approximately $5.6 billion as of Oct. 20. KLA-Tencor stockholders are expected to own approximately 32% of the combined company on a pro forma basis.

The transaction is expected to be accretive to Lam’s non-GAAP earnings and free cash flow per share during the first 12 months post-closing. The combined company expects to realize $250 million in annualized cost synergies within 18 to 24 months of closing and anticipates generating approximately $600 million in incremental annual revenue by 2020 through improved differentiation of each company’s products and creation of new capabilities.

Lam intends to fund the cash consideration for the transaction and repayment of KLA-Tencor’s currently outstanding term loan using approximately $1.9 billion of cash on hand from the combined companies and approximately $3.9 billion in debt financing. The company intends to provide a direct, unconditional guarantee of KLA-Tencor’s senior notes upon the closing. Lam has obtained commitment for $4.2 billion of bridge financing for the transaction from Goldman Sachs.

The transaction is expected to close in mid-calendar year 2016, pending the receipt of customary regulatory approvals. In addition, the transaction is subject to customary closing conditions, including the adoption by KLA-Tencor’s stockholders of the merger agreement and the approval by Lam Research’s stockholders of the issuance of shares in the transaction. Given their complementary product lines and the significant industry benefits the transaction will enable, the companies believe that they will be able to obtain the requisite regulatory approvals on a timely basis.