More Negativity on the LSI Logic-Agere Merger

At first glance it may seem as though we spoke too soon when we criticized talk of more semiconductor acquisitions. Soon after a big one was announced:

Consolidation in the semiconductor industry continues apace, with a set of acquisitions in the wireless chip business and another related to storage chips.The biggest deal of the field took place Dec. 4, when LSI Logic (LSI) said it would acquire Agere Systems (AGR), the former semiconductor unit of Lucent Technologies (LU), for $4 billion in stock. The deal is LSI’s bid to boost its presence in the market for chips used in hard drives.

Our article said the reason the deals suggested wouldn’t happen was that the stocks were trading above the 8-10x EBITDA that buyers would likely be willing to pay. Yet the LSI/Agere deal paired two companies with EV/EBITDA ratios (at the time) of more than 14x (Agere) and 12x (LSI) respectively. So were we wrong?

Not exactly. It is one thing for a private equity firm to pay cold hard cash, as was done in the Freescale acquisition. It is quite another for one company to exchange its own overpriced stock for that of another company. You can see it from the action in the two stocks after the deal was announced. LSI, the acquirer, shed $1.44 per share or $575 million in enterprise value. Although Agere gained $1.51 it amounted to just $255 million in enterprise value due to Agere’s lower share count. Net result: the combined enterprise value of the two companies declined by $220 million despite assurances that the deal would create $125 million in annual cost savings beginning in 2008.

Furthermore, we would hazard a guess that at least some LSI shareholders were hoping to be on the receiving end of a buyout. Instead, the premium paid has left them holding the bag.

Something to think about if you bought a semiconductor stock in hopes it will be acquired.

Comments

[Andrew Schmitt:]

I like your stuff but you are reaching here.

First of all, you should figure in a fully priced Agere - the stock won't reach buyout value till the deal closes.

Second, you are ignoring the larged fixed opex cost reductions that come with such a combination. This will make the EBITDA returns look better.

You are applying the same private buyout logic to a merger, which doesn't work.

This makes a lot of sense to me, and I expect to see more.

2006 Dec 06 08:17 PM

[William Trent_:]

I'm not really trying to apply PE logic to a merger, just to illustrate why this differs from a cash buyout from an investor's perspective. There are tons of rumors about what chipmaker is going to be bought next. If you buy one at 14x EBITDA hoping they will be bought out at a premium you are either dreaming or will get stock in a company you haven't bargained for.

There are two ways for the arbitrage to go away. Agere could go up or LSI could go down. There is a very specific reason I am not "fully pricing" Agere, and that is because there is no such thing right now.

As to the synergies, I am neither purposely including them or purposely ignoring them. If you look at other mergers such as or a href="stockmarketbeat.com/bl.../" title="Valassis/Advo" /a> the combined EV rose on the announcement, suggesting the market believed in the synergies. When the combined value of the two companies declines, as in this case, it suggests that, at the very least, the market is skeptical of the synergies.

I agree that the semi industry needs to consolidate. I have said so Where we may (or may not) differ is on whether we think it will be through cash buyouts.

2006 Dec 06 10:48 PM

[William Trent_:]

Sorry. Apparently I don't know how to embed a link in the comment section.

2006 Dec 06 10:49 PM

[Andrew Schmitt:]

Maybe we don't disagree.

The companies that are best candidates for mergers are the least desirable for private buyout.

I just don't see how the LSI/Agere merger is even related to a private party takeover...

2006 Dec 07 10:13 AM

[William Trent_:]

It isn't. However, there have been at least three breathless sell-side reports issued on "likely semiconductor buyout candidates." My point is just that if you are buying semiconductor companies for a buyout you could be disappointed, and the LSI/AGR merger shouldn't count as evidence that the buyout theme is working.

I think we do agree on the overall consolidation theme.

2006 Dec 07 10:18 AM