Spansion Inc. (CODE), a NOR flash and microcontroller company, is merging with static random access memory, or SRAM, producer Cypress Semiconductor (NASDAQ:CY). Cypress is paying $1.59 billion for all the outstanding shares of Spansion in a share-for-share transfer. Shareholders of both the companies will own 50% of the combined entity. In effect, Spansion's shareholders are getting 2.457 shares of Cypress for a single share of Spansion, translating into 12% gain on Monday's closing price. However, the stock is now trading at a premium to the Cypress' offer, thanks to the after-hours action. Cost savings of $135 million per annum are expected as a result of the deal. Cypress will pay annualized dividend of $1.08 per Spansion share, translating into a 4% yield for the Spansion shareholder. The deal is expected to close in the first-half of 2015 and cancellation by either party will render them liable to pay a break-up fee of $60 million and/or reimburse the other company as much as $5 million in expenses.
The merger reflects Cypress' efforts to diversify away from the handset business. Revenue of the chipmaker has fallen in the past two years. The deal makes sense as it enables Cypress to benefit from the growth of microcontrollers, see Spansion's initiation report for more details. Not only this, the deal unites complimentary technologies, and proper execution of operations will result in synergistic benefits. Furthermore, earnings of Spansion are expected to grow at CAGR of 39% during the next five years as compared to 10% growth of Cypress' earnings. Acquiring such a company at 13.92 times 2015 earnings seems a bargain and reason enough to pursue such a merger. On the surface, it looks like shareholders of Spansion are losing as they get a stake in a slow growth company trading at a higher PE multiple. But it should be noted that the shareholders are getting capital appreciation and dividend income. Spansion shareholders are getting 12% in capital appreciation and 4% in dividend yield* that can effectively be considered as $30/share without dividend after adjusting for opportunity cost like risk free rate. Moreover, Spansion's shareholders have a real shot at the growth of the combined entity as the companies have complementary product lines, which can boost shipment per customer going forward.
In my view, the deal is a win-win for Cypress and Spansion's shareholders. Cypress gets the growing MCU business at a slightly cheap multiple while Spansion's shareholders get value from capital appreciation, dividends and expected growth of the combined entity. The combined entity is not a bad bet given combined** forward PE of around 16 and earnings growth of 24% p.a. excluding any synergistic benefits and cost savings. Add the benefits to the mix; the combined entity may get cheaper on PE basis. But, if you're not to wait for cost savings benefits or, for some reason, believe that these benefits won't be realized, now is the best time to take profits on Spansion shares.
*Dividend yield based on after-hours share price of Spansion
**Combined PE and growth is based on average PE and expected growth of both the companies
Coverage was initiated with "Spansion: You Can Benefit From The Growth Of MCUs"
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