The Semiconductor Industry Needs to Go Private
With the announcement that Motorola (MOT - Annual Report) spinout Freescale Semiconductor (FSL) is being bought by private equity firms, the entire sector has rallied on hopes that any particular company will be the next to be taken private at a high premium. According to a recent Forbes article (that we found much more illuminating than most media stories):
The unexpected reports that Freescale might be a takeout candidate certainly benefited its current investors. Shares shot up 20% to $37 to start the week and are still holding those gains. The potential that other companies might also be targeted could result in similar pops. Intersil shares are up 13% to $26.25 since the week began.
Of course, we were quick to point out that those premium prices apply only when the price hasn’t already run up. By our logic, today’s Intersil buyer has already given 13% of the 20% premium to speculators.
But regardless of how much investors will gain from semiconductor consolidation, we believe the industry has a great deal to gain. The Forbes article also notes:
Chip companies’ cash piles are particularly attractive to private equity. It can help buyout firms pay off the debt that they take on to buy the company, and it’s also a prime reason why these target companies aren’t showing explosive growth or generating their market multiples of years past. If companies have a use for their cash they should put it into play, something that might be easier if they are not publicly traded and are out of the glare of investors focused exclusively on the short-term. With more flexibility, private companies can pursue other acquisitions and strategies that may not immediately add to earnings but will be beneficial only after several years.
“The willingness of sophisticated private market buyers to employ leverage in an industry where leverage has historically been a wretched idea is highly noteworthy–and likely to be of no small relevance to chip sector investors in the medium term,” wrote Arnie Berman, chief technology strategist for Cowen & Co. in a research note on Wednesday.
As we have noted frequently, semiconductor manufacturers are… well… manufacturing too many semiconductors. What’s worse, they continue to order equipment to manufacture even more semiconductors at a faster rate than the underlying demand can support. Although some companies are starting to get the hint (Intel said it would “avoid” $1 billion of new equipment purchases it had originally planned for next year) there are many who still don’t get it. Perhaps the only way to slap some sense into them is to buy their company and take away their cash hoard.
Again, Forbes gets to the heart of the matter:
“The problem here is that while the industry is gradually slowing down, the costs are not slowing down,” said Jim Tully, chief of semiconductor research at Gartner. “Something has got to give.”
Tully predicts that 350 of the roughly 1,000 companies making semiconductors will be either absorbed or disappear in the next ten years and that the number of companies able to build their own factories will fall by half.
For the sake of the industry, we hope so.
Disclosure: William Trent has a long position in SMH.
Like this article? Why not try out:
[…] What with Freescale, Yahoo!, Adobe, Oracle, Thailand, etc. this week we almost missed this story: Linear and mixed-signal IC supplier Maxim Integrated Products Inc. today lowered its revenue and EPS guidance for fiscal Q1 2007. […]
[…] Of course, with the money flying around in private equity-land these days, who knows? It sure wouldn’t hurt the industry to catch a little bit of private-market discipline. The author may hold a position in the securities discussed. The author’s current holdings are as follows: Long: Intuit (INTU) put options; Nasdaq 100 (QQQQ) put options; Bookham (BKHM; Ballard Power (BLDP); Syntax Brillian (BRLC); CMGI (CMGI); Genentech (DNA - Annual Report; Ion Media Networks (ION); Lion’s Gate (LGF); Three Five Systems (TFS); Adobe Systems (ADBE) call options; IShares Japan (EWJ); StreetTracks Gold (GLD); Starbucks (SBUX); U.S. Oil Fund (USO); Plantronics (PLT) call options; Short: Ceradyne (CRDN) put options; Lion’s Gate (LGF) call options; Dell (DELL) put options; Plantronics (PLT) put options; […]
[…] He thinks those companies could substantially raise their valuations via a combination of share repurcases and the issuance of debt; he says potential upside to the shares could be as high as 20%-40%. We agree that the semicondustor industry could use some financial discipline. However, when the excitement first started cranking up, we said if you figure the average buyout will be at 9x EBITDA and you expect a 25% buyout premium to make speculating worth your while, you should only buy stocks trading below 7.2x EBITDA. Let’s see how Prudential’s list compares: […]
[…] Now that we’ve gotten our derisive comments toward sell-side analysts out of the way, we’d like to point out an analyst we think is on the ball: Citi’s Tim Arcuri (courtesy of Tech Trader Daily): Citigroup’s Timothy Arcuri asserted in a research note today that many semiconductor equipment companies are “flush with cash,” and could easily be buying back stock. “While much of this depends on the sustainability of memory spending (overall capex is running well above what we would consider “normalized” levels), balance sheets at most equipment companies remain significantly over-capitalized,” he writes. Can’t get much plainer than that. Semi equipment companies are overcapitalized and should be spending their cash on reducing capital rather than expanding it. Sounds like something we’ve heard before. Not that we think they’ll listen, but kudos to Tim for getting the story right. For more information, see all articles on: Stock Market, Semis, AMAT, KLAC, SMH […]