Two semiconductor stalwarts have elected to combine. Texas Instruments (TXN) is to acquire National Semiconductor (NSM) for $25 per share in a deal that will be valued at about $6.5 billion. Nearly 80% above its prior close, the purchase price is indeed at a significant premium. The proposed deal combines TI’s leading market position with NatSemi’s high value offering, significantly boosts TI’s production capacity, and will combine two fairly compatible cultures and product lines.
A Closer Look at the Details
Much about the deal is appealing. As TI’s CEO Rich Templeton notes, National has significantly honed in on its most profitable products while decreasing expenses. With a portfolio of 12,000 products and a strong position in industrial products and power management, National nicely augments TI’s offering of 30,000 analog products. Moreover, due to idiosyncrasies of the analog market, there is less overlap than one would imagine. Analog products, especially high-performance analog products, are typically optimized to specific functions and applications; hence their huge number and high margins. Dual sourcing at this end of the market is uncommon.
TI leads the market for analog semiconductors, which generated worldwide revenues of $42 billion in 2010. With 2010 analog revenues of $6.0 billion TI attained a share of just 14.1% in this relatively fragmented market. And according to market research firm Databeans, NatSemi’s share, with $1.6 billion in revenues, was just 3.7% in 2010.
Indeed, this is a “Smaller Is Better” market in many respects. The most profitable participant, Linear Technology (LLTC), targets only the most profitable products to capture just 3.4% of the market; in so doing, it achieves gross and operating profitability of 77.5% and 51.7%, respectively. By way of comparison, NatSemi’s gross and operating profitability were 66.5% and 26.5%, respectively. (All data as of the most recent quarter; note that NatSemi’s calendar year operating margin was higher at 30.1%.)
National Semiconductor has worked hard in recent years to exit lower-profit products, which has indeed muted revenue growth and its stock valuation. But having focused on its most profitable business, the company will indeed boost TI’s profitability. In fact, the deal is expected to be accretive upon close.
Moreover, with TI’s strong global sales force, revenue growth should in fact accelerate, as the managements of both companies claim. NatSemi’s manufacturing capacity, consisting of three fabs in Maine, Scotland and Malaysia, will augment TI’s ongoing program to increase its own capacity. TI is currently ramping the industry’s only 300mm analog fab in Richardson, Texas (a former Digital IC fab). And it has fairly recently acquired two fabs from Spansion (SPSN) and another from China’s Semiconductor Manufacturing International Corp. (SMIC).
A Look Back
This transaction forms a significant interval in the progression of both companies over the past 10-15 years. In the mid-1990s, it was still possible, if a bit dated, to talk of the “Big Three” semiconductor manufacturers -- Texas Instruments, National Semiconductor and Motorola (MMI). Intel (INTC) had in fact dwarfed them all with the ascent of the PC. To boot, the entrance of Asian commodity memory and logic manufacturers (first Japanese, then Korean) further challenged this famed trilogy.
In this context, both TI and NatSemi deliberately honed their business models through a series of acquisitions and divestitures. TI exited the memory business it once dominated, selling much of it to Micron (MU). It over time divested most of its non-semiconductor businesses as well, selling its defense electronics, notebook, and software businesses. Most importantly, it significantly added to its analog capabilities through a series of acquisitions, most notably including Unitrode (for $1.2 billion in 1999) and Burr Brown (for $7.6 billion in 2000). Throughout, its aim has been to focus on markets it can profitably lead.
National Semiconductor’s progression over this time frame has been less linear, at least until recent years. In 1997, management elected to divest its standard products business, which subsequently emerged as the publicly-held Fairchild Semiconductor (FCS). This significantly improved gross profitability.
Less successful was its merger that same year with Cyrix, a small microprocessor manufacturer. It both generated losses and disrupted an accretive relationship with Intel. Cyrix was thus sold to Via in 1999. More recently, the company has focused on improving the profitability of its business, exiting less desirable products as part of the “60-30-30” model: Achieve 60% gross profit and 30% opex to deliver 30% operating margins to investors. Management has thus attained a higher value model, though to the temporary detriment of revenue growth.
And Going Forward?
We have never liked huge acquisition premiums, as they are almost never justified. And at 78%, this is surely among the largest we have seen. That said, we believe NatSemi stock was relatively undervalued, both due to the transitional character of the most recent quarter, and to the fact that subdued revenue growth has hindered its appeal to investors. Moreover, as we note above, the transaction will be accretive and does much to augment the strength of both businesses. To this degree, the premium seems justified.
Having had a bundle of cash fall from heaven with the deal’s announcement, NatSemi investors can rejoice. It is a tougher call for TI investors. The stock has appreciated 50% since last summer’s doldrums and is approaching the consensus target of ~$38 per share, a plight that afflicts many semiconductor stocks at this seasonal juncture.
The transaction, though expensive (at 4.2x out year revenues), clearly benefits the core business of this high-quality semi holding. And even after this nice run, it is trading at just 2.6x out-year revenues and 12.2x the corresponding earnings per share. So while it may be a good time to take profits, TI stock remains a high quality holding, especially for longer-term investors.