Fitch: Applied Materials' Acquisition of Tokyo Electron Positive for SemiCap
NEW YORK -- September 25, 2013
Fitch believes semiconductor capital (semicap) equipment-maker, Applied
Materials Inc.'s (Applied Materials), acquisition of competitor, Tokyo
Electron Ltd. (TEL), strengthens the credit profile of the semicap equipment
industry and combined company. If approved, the deal better matches supply
with demand, given ongoing consolidation of capital spending among
Credit Positive for Combined Company
The acquisition addresses three credit concerns for the semicap equipment
space: lower equipment demand from slowing personal computer (PC) sales,
exponentially more costly technology transitions and a consolidating customer
First, the deal consolidates supply of equipment and services at a time of
lower customer demand. Applied Materials and TEL both are one-stop-shop
semicap equipment providers, meaning they provide a full suite of products and
services for semiconductor manufacturing. Front-end equipment purchases have
been hurt by lower PC sales, the volume of which is anticipated to remain
pressured by faster growing mobility products.
The deal enables the joined companies to reduce costs for higher profitability
through the semiconductor cycle, while reducing irrational pricing behavior.
The transaction incorporates expectations for $250 million of cost synergies
after the first fiscal year and $500 million of annual synergies after the
closing's third anniversary. Applied Materials and TEL are targeting 25%
operating profit margin over the longer term versus 11.5% and -0.5%,
respectively (6.3% for the combined companies) in the latest 12 months.
Second, the price tag for the continuation of Moore's Law for the
semiconductor supply chain is growing exponentially, requiring heavy research
and development (R&D) investments to enable technology transitions. The
industry points to exponentially higher costs associated with the transition
to 3D NAND memory and to 22 nanometers (nm) for logic.
As a result, R&D spending is expected to remain in the 10% to 20% of revenue
range for semicap equipment-makers. The company's meaningfully greater scale
and larger installed base should enable Applied Materials to meet growing
investment requirements without impairing free cash flow.
Third, the deal should better balance supply and demand by combining two
leading broad based semicap equipment-makers. This relationship has
increasingly been pressured by a consolidation of semiconductor capital
expenditures among Intel Corp. (Intel), foundries, and memory-makers, a trend
that is expected to continue.
The exponentially higher cost of technology transitions should drive increased
outsourcing by semiconductor companies to foundries, ongoing consolidation of
NAND flash memory providers, and market share consolidation for both foundries
and NAND makers. Intel's strategic evolution is also expected to drive
significant ongoing capital spending to maintain its leading manufacturing
Credit Positive for Semicap Equipment-Makers
Fitch believes the acquisition is a net credit positive for semicap
equipment-makers because it better balances supply and demand, given the
ongoing consolidation of capital spending among semiconductor companies.
On the customer side, the top 10 buyers represent roughly two-thirds of all
semicap equipment purchases. However, Intel, Taiwan Semiconductor
Manufacturing Company (TSMC), and Samsung Electronics Co. (Samsung) represent
nearly half of all equipment purchases, reflecting the consolidation of
advanced technology manufacturing and, therefore, the capital spending to
support the continuation of Moore's Law.
Consolidation among NAND memory providers and strategic shifts in focus by
certain foundries to non-leading edge manufacturing have amplified the
consolidation of equipment buyers. Capital spending budgets for the #2 through
#4 foundries, United Microelectronics Corp., GLOBALFOUNDRIES Inc. and
Singapore Manufacturing International Corp., have not kept pace with that of
Applied Materials' acquisition of TEL marks the ongoing consolidation among
semicap equipment suppliers. In May 2013, ASML Holdings NV (ASML), a
semiconductor tools supplier, spent $2.6 billion to buy Cymer, Inc. to
strengthen its extreme ultraviolet lithography capabilities. This follows
wafer etching company Lam Research Corp.'s (Lam Research) purchase of Novellus
Systems Inc. (Novellus) for $3.3 billion in 2011.
Fitch believes further defensive consolidation among leading semicap equipment
providers could be a challenge, despite expectations for a low growth
environment. The top five - Applied Materials, ASML, Tokyo Electron, LAM
Research, and KLA-Tencor - represent more than half of industry revenues in
aggregate, with even greater concentration in key subsectors such as
lithography, etching and yield tools.
Additionally, the trend is toward increasing consolidation. In 2012, revenues
for the top 10 providers approached 70% compared with approximately 60% five
years ago. The estimated $37.8 billion semicap equipment market in 2012 is
projected to decline by mid-to high-single digits in 2013 and rebound sharply
Potential Long-Term Risk for Competition
Fitch views the transaction as a potential long-term risk to the competition,
including KLA-Tencor, which has significant share in yield maximization
markets. Both Applied Materials and Tokyo Electron compete with KLA-Tencor in
certain yield maximization markets but invest their R&D across a broader set
of technology platforms to serve a full line of semicap equipment products and
KLA-Tencor's sole focus on yield maximization has resulted in technology
leadership and significant market share. To the extent a combined Applied
Materials and Tokyo Electron use its greater scale to increase investment in
yield maximization technologies, KLA-Tencor's share leadership and 30%+
mid-cycle operating profit margin could be eroded.
The potential near-term impact on Lam Research is more meaningful, given
considerable market share consolidation in etching and film layering as a
result of the deal. Nonetheless, Lam Research's more focused investments over
time, as well as capabilities acquired in the Novellus deal, have resulted in
technology leadership. Bridging this technology gap could require intensified
R&D spending by Applied Materials and TEL.
Beyond the broader benefits of a consolidating capital equipment industry,
Fitch does not view the transaction as having an impact on ASML's industrial
position or credit profile - given the latter's unique focus and leadership in
photolithography, a process technology that does not directly overlap from a
product or service perspective. Recent corporate activity at ASML, including
the Cymer acquisition and the customer co-investment program involving Intel,
Samsung and TSMC, does, however, highlight the importance of maximizing R&D
and consolidating customer relationships.
Applied Materials acquisition of Tokyo Electron
Applied Materials announced the acquisition of TEL for $9.4 billion in stock,
representing a more than 16x multiple of EBITDA but only a 6% premium over
TEL's closing stock price. This is substantially lower than previous
acquisitions in the semicap equipment space, including Applied Materials' 55%
premium paid for Varian Semiconductor Equipment Associates Inc. (Varian) in
The deal is expected to close in mid- to late-2014, pending customary closing
conditions, including regulatory approval. Achieving regulatory approval may
be a challenge considering the deal is one of the largest ever foreign
takeovers of a Japanese firm and the companies have a greater than 30%
combined market share.
Fitch views the transaction as mainly defensive, given some overlap as
broad-line semicap equipment providers, but with some complementary products
and disparate profitability profiles. The deal nearly doubles Applied
Materials scale with pro forma revenues of more than $12 billion, creating the
largest semicap equipment provider by revenues and leader in precision
materials engineering and patterning.
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Fitch Ratings, Inc.
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