What’s Driving This New Wave of Semiconductor Merger Mania?

Nvidia/ARM $40B. AMD/Xilinx $35B. Marvell/Inphi $10B. Despite the disruption of COVID, a wave of high value semiconductor acquisitions is sweeping the industry. Why? Did something happen that stimulated this consolidation? Until 2015, the industry was experiencing continuous “de-consolidation” that started in 1965. Combined market share of the top 50 companies steadily decreased as small companies entered the market and grew to displace the previous leaders.

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Even today, only one company, TI, has remained in the Top 10 since the 1950s. Growth prior to 2015 was largely organic rather than by acquisition. In 2015 and 2016, the consolidation generated by acquisitions of Broadcom, Freescale, Altera, Linear Technology and ARM provided a temporary burst in acquisition activity. Analog Devices’ July 2020 announcement of a proposed acquisition of Maxim, however, seems to have been a precursor to a new wave. Following are some possible differences in the industry today that might be driving this recent merger mania.

Cheap currency?
Market value for semiconductor stocks is volatile. Most acquisitions are done for a high percentage of cash, thus avoiding uncertainty of value and a lengthy shareholder approval process. In this case, the acquisitions are primarily for stock (over 60% for nVidia/ARM and Marvell/Inphi and 100% for AMD/Xilinx). AMD’s stock price has risen over 150% over the past year (2200% since Lisa Su took over in 2014) and now sells for a multiple of ten times revenue. nVidia’s stock is up 300% and now values the company at 25 times revenue, nearly two times the value of Intel despite having less than one sixth the revenue. Marvell is up 60% and sells at nine times revenue. When your currency is hot, maybe it is a good idea to convert it to something that has more lasting value, even if the company you acquire also has a high valuation compared to historical levels?

Market segment specialization?
One of the few semiconductor market segments that is destined to grow at a more rapid rate than the overall market for at least the next decade is the server market. All of these most recent announcements focus on growth of the cloud and the strength that these combinations will provide. For nVidia/ARM, it is a chance to take the next step toward challenging Intel’s dominance of the data center. Ditto for AMD/Xilinx. Even the Marvell/Inphi announcement focuses on “Marvell’s leadership in the cloud” while also highlighting 5G opportunities. Total server revenue increased 60% over the last four years and continues to be a standout in a year of relatively low semiconductor end equipment growth.

Regulatory approval?
Regulatory approval is a long and uncertain process. Uncertainty is the enemy of employee stability and customer loyalty. Companies usually don’t subject themselves to that uncertainty unless there’s a high likelihood of approval. The U.S. Federal Trade Commission has reasonably firm guidelines concerning the degree to which a combination may increase the market influence of a competitor. Frequently, the result depends upon what the FTC decides the relevant market is. In all these cases, there are larger competitors in both the total semiconductor market as well as relevant segments, except for graphics chips where the nVidia/ARM combination would have only a small effect upon the size of nVidia’s graphics chip strength. For European agencies, the controversial issue would likely be the threat of losing a local jewel rather than the actual market share effects. That kind of threat is usually handled by requiring future guarantees of employment or corporate location. MOFCOM in China is normally the most difficult and lengthy approval to achieve. In these recent cases, we are not dealing with a Qualcomm/NXP kind of transaction, where Chinese businesses lack power in dealing with one of the parties. MOFCOM gains little or nothing by veto of the transactions. Greater benefit can be achieved by making demands of the companies and the way they conduct business in China in the future.

Likelihood of successful integration?
Statistically, the larger the company being acquired, as a percent of the acquiring company’s revenue, the more difficult the integration. This is probably because of power and cultural struggles in the combined company after the merger. The most successful acquisitions occur when the acquiree retains a high degree of autonomy or when it is so small that it can readily change its culture to conform to the policies and management of the acquirer. At least in the cases of nVidia/ARM and AMD/Xilinx, the differences in their businesses argues for a high degree of autonomy after acquisition. In the nVidia/ARM case, there are restrictions that prevent tight integration so that disclosure of sensitive customer data can be prevented.

Economies of scale?
I leave this for last because it hasn’t been a primary driver for semiconductor acquisitions ever since silicon foundries became a major force in the industry. If companies buy their wafers from foundries, then the difference in wafer cost discount rate that results from growing company size through acquisition is too small to justify the transaction, unless the companies predominantly use their own manufacturing facilities, as in the case of some analog and RF companies. Increasingly, in recent times, semiconductor business cost differentiation comes from factors other than manufacturing, e.g. product definition, development and marketing costs, customer sales and support, administrative, legal, finance and regulatory costs, etc. The fact that all of these acquisitions are targeted at strengthening the companies in specific markets, like the cloud and AI, suggests that the companies see economies of scale in defining, designing, marketing and supporting products sold to similar customers in similar markets.

Maybe there’s nothing new driving these acquisitions?  Or maybe there are other forces of business viability that make combinations desirable right now?  Whatever the case, one may wonder if this merger mania puts us on a path to domination by a few big companies as has been the case in some other industries as they mature?

I doubt it. Whenever there is rapid change in technology, new companies enter an industry with innovative new products and gain market share from the incumbents. We are in a period of rapid semiconductor innovation.  After fifteen years of declining venture capital investment in chip companies, the annual investment has jumped to an average of more than $2 billion per year for the last three years and appears to be on track for $2B or more in 2020. Applications like AI, machine learning, 5G and the IoT are growing because of the increase in availability of big data and the need to analyze it, use it and protect it. The new companies and businesses that emerge will give the industry ample opportunity to create new leaders.