The world's largest manufacturer of chipmaking equipment, Applied Materials (AMAT) recently announced its plans to acquire Tokyo-based Tokyo Electron (TOELF.PK), its No. 2 rival and No. 3 player in the semiconductor industry. Tokyo Electron currently holds around 11.1% of the global market share.
There is every reason to believe that a successful merger could lead to a significant increase in the company's stock price. Investors in both companies have a lot to be thankful for since in the long term, they stand to gain from the several benefits of the intended merger. The deal will also see investors in Applied Materials holding approximately 68% of the new company's shares with the rest going to shareholders in Tokyo Electron.
A little about Applied Materials and the industry it operates in
Applied Materials is a California-based tech company specializing in the manufacture of equipments used by companies operating in the flat panel displays, semiconductors, and solar photovoltaic industries. It is the largest player in the industry it operates in and holds around 14.4% of the total global market share. Applied Materials maintains YTD returns of around 56.41% which is by a high margin, above the industry and the S&P 500 average, with dividend yield (TTM) of 2.28%. Considering these and a good number of other fundamental metrics, Applied Materials is a performance leader in its industry.
The semiconductor industry is cyclical and in the past couple of years, has recorded very little growth. This is as a result of the continued rise in the cost of developing cutting-edge chips and which has in turn, dampened the demand for equipments manufactured by Applied Materials and its competitors. If this intended deal finally sails through, it will be the second-largest foreign acquisition of a Japanese company, following behind Citigroup's (C) acquisition of Nikko Cordial in 2007, in a deal valued around $7.9 billion.
What the intended acquisition means for the company
According to the management of Applied Materials and Tokyo Electron, the merger will see both companies saving up to $250 million in costs within the first year and up to $500 million by the third year. It will also see both companies having a combined control of up to a quarter of the global market. Other benefits of the merger include:
· Better price breaks.
· Increased efficiency in manufacturing operations.
· Better management of supply chains.
· Increased technology strength.
· Commendable profit margins
· Minimal losses in earnings
It won't be an easy race
It is no longer news that every intended acquisition goes through rigorous scrutiny before it is approved and this particular deal is not an exception. There are speculations that the deal might not be approved by the regulatory body in the U.S. The reasons include the assumption that there might be overlaps between the two merging companies.
According to a Deutsche Bank analyst, Vishal Shah, however, there is "minimal overlap between the two companies". Applied Materials' management also allayed such fears when the executive chairman, Mike Splinter, said in an interview with Reuters that the management has thoroughly analyzed both companies and come to the conclusion that the overlaps are minimal. This means that the deal has higher chances of being approved by the U.S., Japan and the European Union regulators.
Applied Materials operates in a competitive industry but its closest competitor is Veldhoven, Netherlands-based ASML Holding (ASML). ASML currently maintains around 12.8% global market share in the industry and No. 2 position behind Applied Materials. In May 30, 2013, ASML acquired a California-based chipmaking equipment manufacturing company, Cymer, in a deal valued around $2.5 billion.
This acquisition is necessitated by the need for ASML to maintain a significant presence in the EUV lithography field. This field happens to be the in-thing in terms of creation of smaller, faster and more energy-efficient cutting-edge chips. With its stance as a leading developer of lithography light sources, Cymer is expected to make a positive impact on ASML's revenues and earnings going forward.
Lam Research (LRCX) is the No. 4 player in the industry and maintains around 7.4% of the global market share. Lam has made a name for itself in the manufacture of etch and single-wafer clean equipment and in order to further position itself in the semiconductor industry, it acquired a company specializing in thin-film deposition and surface preparation technologies, Novellus Systems. The acquisition was completed in June 2012, in a deal valued around $3.3 billion.
With this acquisition, Lam expects to further boost its revenues and grow its profit going forward. It also expects the acquisition to help the company in reducing operating costs to the tune of approximately $100 million annually, starting from the fourth quarter of 2013.
Catalysts for further growth in the industry
Even though the growth recorded in the semiconductor industry has been sluggish in the last two years, there several catalysts for renewed and sustainable growth in the industry. They include:
- Increasing demand for cutting-edge mobile chips.
- The move by the industry to commercialize EUV lithography, which is expected to gather steam in the second half of the decade.
- Increased capital spending by the top three biggest chip manufacturers, Intel (INTC), Samsung (SSNLF.PK) and TSMC in order to further boost their technological capabilities.
- Increasing recovery in the Dynamic Random Access Memory (DRAM) market.
- Compelling product portfolio from the top players.
- Projected growth in the Wafer Fab Equipment (WFE) market from 2014 going forward.
- Rapid changes in technological development.
- Sustained increase in mobile shipments.
If the intended merger is successful, the semiconductor industry, the new company and shareholders all stand to benefit. For the industry, a successful merger will further enhance the industry's credit profile. For the new company, it will push the combined company's stock to higher levels as it will be dual listed in Tokyo and Nasdaq. For investors, the reduction in cost of production and improved profit margin means increased earnings.