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

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.

LSI's Logic Flawed on Agere Systems Acquisition

LSI's recently filed Form S-4 gives a forthright and detailed account of the background of the merger, reasons for the merger, and valuation of LSI & Agere by their advisors (Morgan Stanley & Goldman Saches respectively).

secfilings.nasdaq.com/......

An Excerpt:

"Reasons for the Merger

Overview

The boards of directors and management teams of both LSI and Agere believe that the proposed merger is the best strategic alternative for delivering increased value to our respective stockholders.

LSI and Agere believe the merger presents a unique opportunity to create a combined entity that offers a comprehensive set of building block solutions, including semiconductors, systems and related software for storage, networking and consumer electronics products, and that the merger will allow the combined company to deliver significant new benefits to its customers, stockholders and employees. The LSI and Agere boards of directors and their respective management teams each analyzed alternative strategies to address their respective risks and challenges as stand-alone entities. See the section entitled “Background of the Merger”. After reviewing and debating their respective strategic alternatives and the opportunity created by the combination of the two companies, as more fully described below, the LSI and Agere boards of directors each decided on their own to pursue a merger of the two companies in lieu of the other alternatives. Each board of directors believes the merger will create a combined company that will be able to achieve the strategic and financial benefits described below.

The LSI and Agere boards of directors each identified the following anticipated strategic and financial benefits of the merger:

• Complementary Businesses. The products and development capabilities of the two companies are complementary, and should enable the combined company to compete more effectively in attractive markets. The combined company should be stronger than either company on its own, with greater breadth and depth in storage and networking/communicati... product offerings and a greater ability to develop new product offerings in these market segments. In addition, the combined company is expected to benefit from access to large growth markets, such as those provided by the mobile products business of Agere and the consumer products business of LSI.

• Customers. The combined company will have deep relationships with many of the market-leading customers in their chosen market segments. LSI and Agere expect to improve their existing ability to expand current customer relationships, and expect to increase the penetration of new customer accounts. LSI and Agere believe that the combination of the two companies’ product lines and engineering resources should enable the combined company to meet their customers needs more effectively and to deliver more complete solutions to their customers. In addition, LSI and Agere believe the larger sales organization, greater marketing resources and financial strength of the combined company will lead to improved opportunities for marketing the combined company’s products.

• Engineering Talent. The combined company will have over 4,200 engineers, including over 1,700 that hold masters or doctorate degrees, which should enable the combined company to compete more effectively by developing innovative products and delivering greater value to customers more rapidly than either company could do on a standalone basis.

• Intellectual Property Portfolio. The combined company will have over 10,000 pending and issued U.S. patents, which will be one of the largest intellectual property portfolios in the semiconductor industry. This portfolio is expected to provide the combined company with additional licensing opportunities.

• Reduction in Operating Costs. The combined company is expected to realize substantial cost savings beginning in 2007, with annual cost savings reaching at least $125 million in 2008 from increased efficiencies in manufacturing and operating expenses. LSI and Agere expect the combined company to achieve benefits from exercising greater purchasing power with its suppliers; consolidation and reduction of areas of overlap in operating expenses; and elimination of redundant expenses, including the expenses of maintaining two separate public companies.

• Stronger Financial Position. The combined company will have greater scale and financial resources, including total cash and short term investments of approximately $1.4 billion on a pro forma basis as adjusted to reflect the repayment of LSI’s convertible notes in November 2006. LSI and Agere expect that this stronger financial position will improve the combined company’s ability to support product development strategies; to respond more quickly and effectively to customer needs, technological change, increased competition and shifting market demand; and to pursue strategic growth opportunities in the future, including acquisitions.

• Stock-for-Stock Transaction with Fixed Exchange Ratio. The stockholders of each company will share in the benefits expected from the synergies and cost savings the combined company will generate. The fact that the merger consideration is based on a fixed exchange ratio provides certainty as to the number of shares of LSI common stock that will be issued to Agere shareholders."


An additional reason for the merger, which surfaces in other sections of the S-4 filing, is that the merger will help satisfy LSI's need to hire a significant number of experienced engineers with extensive expertise in storage and related data path technologies. There is currently a shortage of such talent on the open market and a surfeit of such talent at Agere.

LSI's Logic Flawed on Agere Systems Acquisition

Management has been quietly making these points (cc.talkpoint.com/LEHM0...) to those willing to listen. Nonetheless, short term traders have gained the upper hand as long term investors analyze the merger and they have focused on the short run implications of the merger, a year of managment preoccupation with integration of two historically slow growing companies, rather than the long run value and opportunities created by the merger. This week, there has been a lot of jockeying by risk arbs and other short term opportunists and that has pushed LSI's stock price down.

To date, LSI management has focused its attention on the hand full of institutions that own the majority of LSI's and AGR's stock rather than making a loud and forceful pitch to the general market.

Finally, LSI and AGR operate in arcane corners of the semi market. Many sell side analysts obsess on short term financial metrics, superfacial valuation criteria and are not familiar with the subtlies of many sub-sectors of the semi sector. Nor are many concerned with long term competitive strategies.

Personally, I expect LSI to rise steadily from here as the short term jockeying subsidies and cooler headed long term investors come to appreciate the potential benefits and strategic sense of the merger.

LSI's Logic Flawed on Agere Systems Acquisition

Bad analysis!

LSI is now essentailly a storage company. 85% of LSI's sales are in storage and related data path technologies (SerDes in particular). LSI is purchasing Agere to acquire Agere's storage silicon technology (read channel in particular) and product lines (HDD preamp and storage SOC). By purchasing Agere, LSI gains the opportunity to become the dominant player in the storage silicon market, LSI acquires important hard disk drive technology that it currently lacks and desparately needs, and LSI also removes a major competitor in the HDD silicon market.

Secondarily, Agere's fairly large networking business gives LSI expanded access to an important semi market adjacent to the storage silicon market.

LSI has no interest in becoming involved in the cellular baseband market. LSI does have some image and video processing technology (Domino/Zevio) which it has just begun to introduce to the handheld (non-celluar) market. But these efforts are modest. Image/video processing represents only 15% of LSI's current sales. The addition of Agere's baseband business provides LSI with somewhat easier access to the cellphone handset market but this is certainly little more than a side show to the main event, LSI's acquisition of Agere's storage and networking assets.

If LSI executes well on the merger, a dominant player in storage silicon, currently a highly fragmented market, could emerge. That is why LSI is willing to shell out $4b for Agere and why Agere is accepting LSI stock in payment. That is why the merger is a smart move by LSI and Agere.