Semiconductors: Healthy M&A Prospects

S&P says some recent deals show that chip companies are finding attractive prices and ways to improve by combining

S&P Equity Research continues to have a positive fundamental outlook on the technology sector and recommends overweighting it, despite recent volatility and negative price performance. Scott Kessler, Standard & Poor's group head for technology coverage, thinks the stocks have been reflecting the potential for a U.S. recession. However, he also believes the sector should continue to benefit from longer-term trends, such as strong international demand, notable new products and upgrade cycles, and a likely growing corporate focus on productivity in light of economic uncertainties.

Further, Kessler believes that tech sector merger-and-acquisition activity among strategic partners will continue, despite the credit crunch, reflecting healthy fundamentals and prospects, strong corporate balance sheets, and ample opportunities to generate related shareholder value.

Consolidation Opportunities

"We expect acquisitions to be driven by the pursuit of growth opportunities, greater diversification, and cost savings," he says. "We also believe strategic buyers are well positioned to capitalize on compressed valuations and less competition from would-be financial purchasers like private equity firms."

Kessler noted that he has been encouraged by a number of proposed M&A deals announced in mid-December, largely in semiconductors and semiconductor equipment, whose stock prices "have been hit hard of late." He thinks the deal flow, which ranged in size from $300 million to $1.7 billion, "underscores that companies believe fundamentals are decent and/or poised to improve, and valuations are attractive" and he thinks both acquirees and acquirers could benefit in the current environment.

Deals in Progress

Here are S&P equity analysts' reactions to some recently announced deals in the chip industry:

AMIS Holdings (AMIS; ranked hold; $9) agreed to be acquired by rival ON Semiconductor (ONNN; ranked buy; $8) for $915 million in stock Dec. 13. S&P equity analyst Angelo Zino says the deal is favorable for AMIS. The deal is scheduled to close in the first half of 2008, subject to approvals. Zino maintained his hold opinion on AMIS, while S&P technology equity analyst Clyde Montevirgen maintained his buy opinion for ON Semiconductor.

Montevirgen notes how ON Semiconductor identified up to $50 million in potential pretax cost synergies in 2009. ON also expects the deal to add to EPS as it exits 2008, before amortizations and share buybacks. Specific opportunities include rationalization of $10 million to $20 million in capital expenditures, interest expense savings, and tax benefits.

On Dec. 12, Zino also reiterated his buy ranking on Teradyne (TER; ranked strong buy; $11) on the announcement that the chip-equipment maker agreed to acquire Nextest (NEXT; $12) for $325 million in cash, net of cash received. Then, on Dec. 13, he upgraded the shares to strong buy.

"We view the deal as favorable, as we believe Teradyne has been looking to progress into higher-growth, adjacent markets," Zino pointed out. Teradyne expects the deal to be slightly accretive to earnings, before purchase accounting impacts. Zino sees the deal closing in the first quarter of 2008, pending approvals.

Also Dec. 12, S&P equity analysts Montevirgen and Clara Van Der Elst reiterated their buy opinion on chipmaker STMicroelectronics (STM; ranked buy; $15) after it agreed to acquire Genesis Microchip (GNSS; $8) for $336 million.

"We believe that the deal, subject to approvals, could be accretive in the second year after the acquisition close. Although we anticipate notable pricing pressure in the digital TV chip market, we see the deal providing high-growth opportunity and product synergies," the analysts said in a note.

On Dec. 11, Zino reiterated his hold opinion on the shares of Lam Research (LRCX; ranked hold; $45) after it agreed to acquire SEZ Group, a supplier of single-wafer clean technology, for $568 million in cash.

"We think the combined company will offer competitive advantages, as Lam establishes a presence in clean technology, adding to its already dominant position in the etch market," Zino said. He expects the deal to close in the March, 2008 quarter, subject to approvals.

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