Applied Materials (NASDAQ:AMAT) was No. 1 in 2012 revenue in the "Semiconductor Fabrication Equipment" market. It is proposing a "merger of equals" with Tokyo Electron (8035:JP), now No. 3.
Semiconductor Equipment Market Rankings
Hitachi High- Technologies
There have been many Seeking Alpha articles and a very large amount of commentary from the financial community about whether this makes economic sense and whether or not this merger will pass muster with the FTC. The overwhelming conclusion of the writers and commentaries is "yes" and "yes." They have beaten this into the ground, so I'm really not interested in doing that again. What I want to do is to explain what a merger of equals is, why they have a bad track record with respect to outright acquisitions, and why there may be much less to this proposed merger than you think.
Why do a merger at all? Primarily because the market is shrinking, there are fewer FABs that require less equipment and support, and this consolidation will place the revenues and profits of the two companies under one banner. It is certainly true that a strategy of properly executed mergers can combat shrinking markets by saving expenses through shared resources.
However, there is a long history of mergers of equals that have failed under these circumstances. Think ATT/NCR, AOL/Time Warner, Chrysler/Daimler, Alcatel/Lucent, Credence Systems/Nptest -- all, arguably, failures. So, what is a merger? It is the combination of two equities into one. Each of the stockholders of the original equities gets a defined percentage of the stock in the merged equity, depending on what percentage they owned of which equity prior to the merger.
Then, what's a merger of equals? That's when the value of the two equities were within spitting distance of each other and/or the surviving management agrees to treat them as equals from a voting/management perspective. So these two companies were ranked No. 1 and No. 3 in their markets, they are to be apportioned five seats each on the board of directors, and they are to get one of the CEO/board chairman jobs. Note that they added one more independent director (to break ties). What could more fair? Well, from a success standpoint, fairness doesn't count.
What does count, as always, is execution. Execution means to have a plan and to follow that plan unless there is good reason to modify the plan. Most mergers -- and particularly mergers of equals -- fail because there is no plan, a bad plan, and/or no execution or bad execution. In the case of AOL/Time Warner, each company thought that their management would be the ultimate survivor of the merger, and the "plan" was to direct the operations of the other management (which they knew little or nothing about). So there was no real plan and there was a disaster. Surprise? Nope.
I was right in the middle of one of these mergers and I can tell you how it went: My employer coveted a product under development by the company to be acquired (merged into my employer's company). My employer was also interested in a merger from the perspective of consolidation because the market was shrinking. The accountants decided that the merger would be accretive within six months, so management told that to the stockholders. Then they asked engineering to rubber stamp what they had already told the stockholders. So, engineering got on a chartered jet, flew to the new site, and listened for about five hours to what the equal (acquired company) was doing to finish their product development, and then they got back on the jet and that day told management that it was a pipe dream. They said it would take two years to finish the software before the product could be sold. So management proceeded with the merger -- and got obscene bonuses for doing so -- and two years later, before the software was actually ready, the surviving company was merged into another company at a valuation of about 5 cents on the dollar (and incidentally, the new product was dropped).
Now, I'm not saying that that's what is going to happen with Applied Materials. But I'm also not saying that that's not going to happen with Applied Materials. I have read what Applied's management has been telling stockholders, and a significant part of what they have said sounds like what my management said when they told stockholders about the merger described above. What struck me most was that there was a lot of talk that related to equality, and very little talk that related to how the two companies would be operating as one to take advantage of the merger -- things such as what resources would be shared, how much expenses could be reduced, what synergies would result, what product lines would be dropped, etc. These are things that indicate that there is a real plan, and I didn't read or hear what I wanted to.
On top of all these issues are the problems associated with the cultural differences between the two companies. One speaks English and one speaks Japanese. I know a lot about Japan. I've been there about 10 times during the last 20 years, on one- or two-week business trips. I've presented to Hitachi, Sony, Rohm, and a bunch of other companies. I studied the language and the culture. But I am still considered a Gaijin, and will always be so considered . I'm treated differently from a Japanese person, and even though I can understand the interplay that occurs during a presentation, I am forced to use a translator because that is customary. Try to imagine the differences between the way the Japanese part of the company and the American part of the company will approach the same problem, and how difficult it will be to resolve issues that are important to one part of the company or the other. I've been there, done that -- and it can be more difficult than you would ever imagine.
So, at this point I am not ready to risk my money on Applied Materials because I have very little confidence in the company's ability to bring this merger off -- to successfully integrate with Tokyo Electron and improve financial results significantly. What I would like to see is that the accountants get back together again and -- based up a credible plan -- work out what the expected numbers will look like in 2014 and beyond. Then I might consider parting with some of my hard-earned money.