LSI Logic Buying Agere -- No Bargain, But Threat to Marvell

Earlier on Monday, LSI Logic (LSI) announced a deal to acquire Agere (AGR) in a deal the companies say is worth about $4 billion. (Well, that’s what the deal was worth before the announcement; with LSI shares slumping on the deal news, the total price has dropped to $3.48 billion.)

Terms of the all-stock deal call for each Agere share to be exchanged for 2.16 LSI shares. Prior to the announcement, that meant compensation of $22.81 a share; that’s now down to $19.82 a share.

LSI holders will own 52% of the combined companies; Agere holders get 48%. The company will keep the LSI name. The deal is supposed to result in $125 million in cost savings by 2008; LSI says the deal will be slightly dilutive in 2007 and meaningfully accretive in 2008. Also, LSI announced a buyback of up to $500 million in stock.

Agere shares are higher on the news, and as noted, LSI is slumping badly. Here’s a quick rundown on some of the initial reaction to the deal from the analysts:

* Craig Berger, Wedbush Morgan: This is a good strategic combination that strengthens the combined company’s storage chip offering and engineering resources, and gives the firm a stronger product platform to battle Marvell (MRVL)…LSI’s purchase price of roughly 2.5x EV/S [enterprice value/sales] is not cheap, and is above LSI’s EV/S multiple (1.5x), and above peer group average (1.9x). LSI will need to reduce combined company costs and overhead to make this deal accretive…Maintain Hold rating.
* Allan Mishan, CIBC: We feel it is a prudent time for Agere to sell. New management has been focused on streamlining operations and rationalizing R&D investments, generating significant margin improvements. But revenue growth is a tougher challenge; by selling Agere leaves execution in LSI’s hands…Strategically, the deal makes sense…we believe the purchase price is fair and puts Agere roughly in line with its diversified peer group…note that Agere has received a discount to the peer group for several years since spinning out from Lucent as the company has struggled to generate revenue growth.
* Shebly Seyrafi, Caris & Co.: The combined entity will share Seagate as a top customer. We estimate that Seagate accounts for roughly 80% of Agere’s storage revenue and roughly 45%-50% of LSI’s storage semiconductor revenue…it has been speculated that Marvell will displace LSI at Seagate in selling HDCs [hard drive controllers], but the combined LSI-Agere entity may now have an increased chance of increasing its involvement with Seagate for the enterprise HDC/SoC [system on a chip] business in the future due to the amount of business that it will have will Seagate. Therefore, we view this merger as a negative for Marvell…Raising LSI price objective to $11 (from $9.)

Seyrafi also speculates that Agere could receive a competing bid; possibly from Broadcom (BRCM); Marvell might be interested, but is much less likely given the need to digest its acquisition of Intel’s communication processor business.

CIBC’s Mishan, in a note on Marvell, says the LSI/Agere deals “provides a long-term threat to Marvell’s HDD business,which remains about 50% of Marvell’s slaes and the primary cash flow engine for the company.” He notes that Agere has been losing ground to Marvell in recent years, and that with the merger, “we would expect Marvel to face a tougher opponent when it competes for new designs.” He does say that any “mis-execution by LSI” could actually open up opportunities for Marvell.

Finally, Mishan notes that Marvell also faces problems from today’s announcement that Qualcomm (QCOM) is acquiring the wireless networking startup Airgo as well as the RF Micro Devices (RFMD) Bluetooth business. “Marvell has dedicated a lot of resources to handset connectivity, specifically with wireless LAN but also more recently with Bluetooth, and now has has a huge playerto compete with in Qualcomm.”

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[pldevries:]

From Lehman analyst report on 2006 Lehman Global Technology Conference:

"Despite last year’s Supplier of the Year Award from Seagate and a recent enterprise storage design win at Seagate, which will begin in FQ2:2008 (April) and could reach $80 million in F2008, Marvell has no other presence at Seagate. Marvell notes that the hard drive business is tough to penetrate, as hard drive manufacturers often prefer to rely on old, yet working components rather than innovative new designs and are known to give their existing suppliers repeat business. In the eyes of hard drive manufacturers, engaging with a vendor whom they have not used is always more risky than engaging with an old partner. Despite these barriers, Marvell remains optimistic about winning designs at Seagate for desktop and laptop drives eventually. Marvell notes that development of their 90 nm read channel commenced three years ago."

In a somewhat unusual pre-merger statement, Bill Watkins of Segate blessed the Agere-LSI merger:
“As valued Seagate partners, both Agere and LSI play an important role in providing products that help us deliver our industry-leading hard disc drives,” said Bill Watkins, Seagate Technology chief executive officer. “We are excited by the innovative possibilities that this new combination represents.” [LSI Dec. 4, 2006 Press Release]

Seagte is both LSI's and Agere's largest customer.

For all of Marvell bravado, Marvell is at heart a price leader. Marvell has never been a technology leader or innovator. Marvell's compact DSP technology allows Marvell to design chips that are more compact and therefor cheaper. As a result, Marvell's client base is largely comprised of tier 2 storage OEMs. Marvell's largest customers are Western Digital (17%) and Samsung (14%) and Toshiba (14%). Of the three, only Toshiba might be accurately characterized as a technology leader and then only in certain HDD segments.

" In fiscal 2006, approximately 55% of our net revenue was derived from sales to four customers, each of whom individually accounted for 10% or more of our net revenue during this period. Of these customers, Western Digital accounted for approximately 17%, Samsung accounted for approximately 14%, Toshiba accounted for approximately 14% and Fujitsu accounted for approximately 10%. Additionally, Wintech, a distributor, accounted for approximately 11% of our net revenue during fiscal 2006. " [Marvell 2006 10-K]

With the economies of scale created by the AGR-LSI merger and the pooling of LSI and Agere's considerable HDD silicon IP and engineering talent, LSI-AGR should be able to handily beat Marvell in the HDD silicon market on all three fronts: price, performance and innovation.

2006 Dec 27 02:48 PM