Semiconductor M&A Heating Up: 3 Stocks to Watch

Consolidation in the semiconductor sector has increased over the last few years, but that hasn’t really caught our attention because the size of deals was small -- so small, in fact, that the acquirers were not even required to furnish too many details.

Integration is a major issue for semiconductor players because it’s not just a question of a culture match, but also the merging of product roadmaps including in some cases, manufacturing complexities (for example On Semiconductor’s acquisition of AMIS Holdings took 4-5 years to integrate).There are several advantages to small deals: they have cheaper valuations, don’t require too much cash outlay or disclosure and are easier to integrate.

Many semiconductor companies also have manufacturing and other licensing arrangements with each other that serve as obstacles to acquisitions by competing firms.

Despite these difficulties, there is the lure of rounding out the portfolio without re-inventing the wheel, which could in any case prove expensive because engineers don’t come cheap. Also, resultant synergies help expand into new geographies and markets.

So while the majority of the companies have been making small acquisitions (of design firms mostly), some like Broadcom have mastered the art (its CEO said last year that it acquired 50 firms over the last 10 years).

But the scope for these small acquisitions is on a decline. Here’s why-

• It’s become way too expensive for startups: The increasing complexities of developing and verifying chip designs have taken costs from a few million to $30-$40 million for a 28nm chip, according to Andy Rappaport of August Capital. What’s more, there’s a 50% chance you won’t recover 60% of your costs. So semi startups, especially in the U.S. have a hard time getting venture capital funding.
   
• Greater integration of chips: The rise of mobile and then IoT is shrinking the size of devices using chips. This calls for high-level integration of chips or SoCs such that a single chip can handle what multiple chips used to do earlier, thus limiting the number of chips being sold.
   
• Shift in innovation: Dado Banatao of Tallwood VC, which still investments in semi startups, says that the typical SoC today has very limited value add and all the investment is currently in power, performance and price. This limits the scope for innovation by startups and shifts the onus to the big guys.
   
• Alternative opportunities for VCs: Venture capitalists have flocked to the Internet segment, where the rise of Internet companies, social networks and so forth offer a faster and surer path to profit. This is diverting funds away from semiconductors.   

What this does not mean is a freeze on acquisitions in the sector. Companies like Apple (AAPL - Analyst Report), Google (GOOGL - Analyst Report) and Microsoft (MSFT -Analyst Report) may continue to acquire with vertical integration in mind. Intel, the biggest chipmaker is also expected to announce something big this year. But these companies aside, semiconductor players at large will be looking at bigger targets (listed companies), thus offering investors the opportunity to maximize their returns.

And here’s the proof-

• NXP-Freescale merger announced in Mar 2015 for $40 billion
• Infineon acquired International Rectifier in Jan 2015 for $3 billion
• RF Micro Devices and Triquint Semiconductor merged in Jan 2015
• Avago acquired LSI in May 2014 for $6.6 billion
• Texas Instruments acquired National Semiconductor in April 2011 for $6.5 billion
• NEC Electronics (70% owned by NEC Corp) and Renesas Technology (55%-45% JV between Hitachi and Mitsubishi) merger in April 2010 created the world’s third largest semiconductor company behind only Intel and Samsung.

But it may be a good idea to avoid the really big names because regulatory approval is harder to get in these cases (e.g. Applied Materials’ (AMAT - Analyst Report) acquisition of Tokyo Electron was set aside by the DoJ on anti-competitive concerns). 

MaxLinear Inc. (MXL - Snapshot Report) – Zacks Rank #2 (Buy)So what we have here is three stocks that are safe bets in this environment whether they acquire, get acquired or do neither:

While it is yet to turn in a profit, this stock looks good at $9.23 a piece. The company beat estimates in the last two quarters, reversing a trend when it consistently missed. Moreover, estimates for 2015 and 2016 have jumped a respective 15.8% and 5.9% over the last 30 days.

This maker of RF and mixed-signal chips for communications, networking and industrial applications has significant exposure to China (71% of revenue in 2014) and Asia (94%). Technology investments in China should be robust in the foreseeable future, which will help MXL shares.

NeoPhotonics Corp. (NPTN - Snapshot Report) – Zacks Rank #2

The company makes chips and modules that facilitate the transmission, receipt and switching of signals in high-speed optical communications networks and counts Cienna, Cisco and Huawei as core customers. The company beat estimates in each of the last four quarters at an average rate of 138.5%.

Shares are seeing some momentum (up 112.2% in the last 3 months), which has impacted the PEG ratio. But at just $6.79 a piece they might still be a steal (not that long-term earnings growth is 20% compared to 13.6% for the industry).

Integrated Device Technology (IDTI - Snapshot Report) – Zacks Rank #2

This maker mixed-signal semiconductor chips for communications, computing and consumer markets beat the Zacks Consensus Estimate in three of the last four quarters at an accelerating rate. Estimates are trending up with the consensus up 4.0% for 2015 and 3.5% for 2016. Shares spiked 10.6% over the past month with analysts turning more positive about its growth prospects.

To Conclude

Choosing a stock in this market could be a challenge and knowing how long to hang in there could be even more of a challenge. But proven Zacks methodology greatly increases your chances of success.

by Sejuti Banerjea 

Source: http://www.zacks.com/stock/news/175115/semiconductor-mampa-heating-up-3-stocks-to-watch