KLAM Kommentary – Assessing the political landscape of approval

LRCX & KLAC’s merger continues to be closely watched given the recent turns and reversals we have seen which call into question the ability to get the deal done. The deal was announced in October of 2015 and we are on our second request from the DOJ and the deal will almost certainly go beyond the Oct 20th, one year deadline to get it done.

We still think that the probability of deal approval is over 50% but that the remedy and other potential business costs will likely increase making the deal less attractive than when first announced.

On Semiconductor and Fairchild – Throw the dog an IGBT bone……..
A good comparison to the KLAM deal is the $2.4B acquisition of the storied Fairchild Semiconductor by On Semiconductor. The deal was announced on Nov 18th of 2015, about a month after the KLAM deal was announced and much like the KLAM deal also got a second request from the DOJ in March.
The issue revolved around the IGBT (Insulated Gate Bipolar Transistor ) business’s when combined would exceed 60% market share in the automotive segment, which was a clear HSR issue.

Our observation is that while it is clear that its an HSR issue the amount of business involved is only about $25M per year which is not even a rounding error in the $2.4B deal. For the DOJ to care so much about so little gives you an idea about the state of affairs and current attitude about M&A deals inside the DOJ. Obviously every deal gets the microscope treatment and the DOJ obviously listens to every complaint even if its the auto industry which is hundreds of billions complaining about a component that costs relative pennies and is an even smaller rounding error on a rounding error in the industry.

On Semiconductor made it clear when the second request came out that they were willing to divest the IGBT business back in March and the deal was recently approved and ON Semi announced it had an agreement to divest the business.

Basically it took five months from agreeing to divest to find a buyer and get DOJ clearance.
In the case on ON Semiconductor, it was relatively easy for them to agree to throw the DOJ dog a small bone, the IGBT business, in order to win approval. It was far from crucial to the deal so it was a no brainer.

In the case of KLAM, however, the potential remedies are not small nor insignificant, and there is no small bone to throw the DOJ , only an arm or a leg, as the CD (critical dimension) or thin film businesses are key to the suite of products that KLA provides.

This obviously makes for interesting discussions and negotiations with the DOJ. The timing could get very long and border on AMAT/TEL timing if we compare that ON Semi was announced a month after KLAM and only just got approval of a simple divestiture. It implies that the deal could drag out along time.

For more info:
FTC IGBT Agreement
FTC anti competitive analysis

Comcast & Dreamworks…..Problems with the Panda…
Recently China’s MOFCOM (Ministry of Commerce, the equivalent of the FTC/DOJ) announced an investigation of the proposed $3.8B acquisition of Dreamworks, the animation studio that brought us notable classics such as Kung Fu Panda, by Comcast the cable giant. The deal was originally announced in April but recently MOFCOM said it received several anti-competitive complaints that triggered the investigation.

Given that China has made it a strategic goal to become a leader in semiconductor technology and has already been active in spending an alleged $100B war chest dedicated to the semiconductor industry we would imagine that MOFCOM may be even more interested in chips than cartoons…..

China has be rebuffed in several instances in buying US technology companies and was also rebuffed in its efforts to buy Fairchild with an offer higher than ON Semi.

There are small equipment companies in China like AMEC that both Applied and Lam have gone after in recent years.

China has also investigated and fined a dozen M&A deals this year alone for “gun jumping”, proceeding with a deal without prior approval. This suggests that China is already sensitive to M&A deals that are not in its national interest (and KLAM is certainly not).

The KLAM combination is likely scary as China has no domestic companies with similar technology to KLA. AMEC does compete with Lam and Applied but has been really held back by these larger competitors.KLAM likely really hits a very sensitive spot with Chinese regulators. The prospect of KLA and Lam getting together is a lot more scary to Chinese regulators than a fluffy Panda.

Uncertainty discounts and spreads….
The stocks of LRCX and KLAC have not suffered too much from the added uncertainty of the deal. We would continue to be owners of KLAC but think that LRCX is overdone over $90 especially given deal uncertainty.

There is likely near term risk with trickle down from the Apple announcement in addition.
As we have said from the very beginning when the deal was announced, it will take longer and cost more than predicted, and so far we have been correct…..

Every additional day that goes by increases costs and risks and reduces synergies. Much as Lam flourished while Applied and TEL were engaged so has Applied flourished while the KLAM engagement has gone on…..