The Urge To Merge

The electronics supply chain will remember 2015 as a year of unprecedented consolidation due to relentless acquisition activity, mega mergers and a rampant restructuring of the industry. Almost every other week brought a momentous announcement. Seemingly, before one could appreciate the current status, the industry reverberated with yet another new deal.

To better understand the scope of M&A and interpret what the future holds in the microelectronics supply chain, SEMI recently hosted a panel of experts at its annual International Technology Partners Conference (ITPC). An industry economist, an investment banker, and a company CEO participated to provide diverse perspective on the causes, extent and implications of industry consolidation.

From a macro standpoint, the value of M&A globally and across industries topped $3.6 trillion so far in in 2015 as companies leverage low cost of capital and CEOs looked at supplement lower growth rates in their businesses. On top of the broad trend, semi industry M&A has also escalated dramatically.

Tom Stokes, senior managing director of Evercore, a premier independent investment banking advisory firm, said that Wall Street investment banks’ interest in the technology sector had been directed toward internet and software-as-a-service companies. In recent times, the semiconductor industry had become less of a preoccupation. This past year, however, the semiconductor industry regained prominence with about 42 deals accounting for more than $125 billion of M&A activity. The level marked a dramatic shift and surpasses the prior five years combined.

Stokes described an incredibly active environment and said, “It’s a staggering once-in-a-lifetime year in the semi industry from an M&A perspective. There has been consolidation not only among device companies, but really across multiple categories throughout the entire value chain.”

Having been in the back room on many of the deals as the former managing director of investment banking at Goldman Sachs for 13 years, Stokes says that many semiconductor industry deals have been under consideration for a long time. Some have been on boardroom agendas for a long as 10 years. “The logic has been there for a while, but the drivers have only been prevalent recently,” he said.

The trend is partially precipitated by the very low cost of debt and increasing amounts of cash on corporate balance sheets, which are effectively generating no return in the financial climate. 

“Whenever you can put that to work or tap into the attractive debt rates, the market really appreciates it,” Stokes said. “The pendulum of investor sentiment has swung on this point and rewards both sides.”

The rule of thumb over the past 25 years is that a target company’s stock price increases immediately as they were typically paid a premium. The acquirer’s stock typically goes down and has to earn its way back up to through the process of integration and fulfilling shareholder expectations set during the formation of the deal. Today it’s different. Over the last 3 or 4 years, both the acquirer and the target company stocks are consistently rewarded from the outset of the deal – even more so when significant synergies are announced.

Three drivers characterize the recent M&A deals:
1.) Diversification and new technology acquisition to tap a broader customer base;
2.) Big synergistic in-market consolidation aimed at achieving greater shareholder value through scale;
3.) The renewed national investment policy and funding aimed at greater self-sufficiency in China.

G. Dan Hutcheson, CEO and chairman of VLSI Research Inc. observed that any scale driven-industry experiences a start-up explosion and then goes through a mass consolidation. Both phases typically occur in financial market periods of excess liquidity. However, start-up periods see intense venture capital participation while consolidation phases are characterized by intense private equity participation.

Opportunity drives start-ups while a significant driver of consolidation is the attempt to achieve stable pricing power.

Referencing a SEMI genecology chart, Hutcheson delineated the expansion of the IC industry that began with the derivatives of Bell Labs and Shockley and culminated in 1968 – the same year Intel was founded. From there the expansion dwindled. Of more than 100 semiconductor companies in the world, there is only about nine left with leading edge technologies.

Hutcheson said that chip maker consolidation was driven by the need to scale, fab and R&D costs, periods of financial crisis, or in some cases a technology failure with the consequence that a company simply could not make it to the next node and dropped out.

The same scenario occurred in equipment industry 10 years later and in the fabless industry 10 years after that in the 1990s.

Hutcheson said that at one time, the industry featured more than 500 semiconductor equipment companies. Today, there are 17 left at the leading edge ─ 9 wafer fab equipment companies and 8 in the test and assembly segment.

Accordingly, he surmised that all scale-driven industries typically go through 20-year cycle, so it should be no surprise that the fabless industry is now consolidating. He says there is also a personal component to M&A and the CEO’s that drive it.

Personal motivations are seen in the industry demographics as many that were in mid-career in the industry’s expansionary period are nearing retirement. He observed that hard-working entrepreneurs start companies, hit their stride in their 40s, and often want to move on in their 60s.

A primary business factor in equipment consolidation was the lack of global scale – not that companies required a larger operation, but they needed to service tools around the world. Hutcheson noted that Applied Materials’ early success was in part due to the realization that the world was shifting emphasis from the importance to innovate to a greater importance on scale in order to support customers globally.

Aggressive supply chain management, such as PICOS (Program for the Implementation and Cost Optimization of Suppliers) was another factor forcing consolidation among suppliers. “Customers were simply hammering the equipment companies on price,” Hutcheson said.

The experts at ITPC agreed that the equipment industry is now beginning to be highly consolidated. There are only a few large deal opportunities remaining.

However, the packaging equipment segment remains fragmented and is therefore likely to see further consolidation. The Japanese equipment industry, while already comprised of many vertically integrated companies, may also be ripe for further M&A.

On the device side, consolidation is most likely to occur in a few remaining sectors. Looking at industry fragmentation as an indication suggests opportunities in passives, discretes, analog, sensors, and optoelectronics.

Capital expenditure requirement for leading edge foundry will also motivate further consolidation in the foundry segment.

Analog consolidation has been a topic of speculation for a long time – 10 years or more. What is different now is that more board room conversations revolve around the belief that, as a target, it may be a good time to sell if the stock price warrants. As an acquirer, some may be speculating that they could miss out on a unique period of opportunity they don’t do something soon.

Dan Hutcheson summarized his evolving perspective saying that he originally viewed consolidation as a disruptive force that resulted in monopolization which would ultimately impact the consumer. More recently, he has sided with the view that consolidation increased industry wide operational efficiency and that fewer companies bearing the ever-more-expensive development costs equated to greater R&D efficiency and perpetuated Moore’s Law. Hutcheson reconciles the debate saying that successful M&A needs to benefit the industry and advancement of technology, not just provide momentary benefits to corporate shareholders.

Good or bad, industry participants face further consolidation and must continue to innovate while being attuned to a dramatically changing industry landscape.

Upcoming SEMI executive conferences are Industry Strategy Symposium U.S. (January 10-13) in Half Moon Bay, Calif. and Industry Strategy Symposium Europe (March 6-8) in Nice, France. Other upcoming SEMI events include: SEMICON Japan 2015 (Dec 16-18), European 3D Summit (January 18-20), and SEMICON Korea (January 27-29).