Broadcom Ltd (NASDAQ:AVGO) – market cap as of 11/11/2017: $108.10bn

Qualcomm Inc (NASDAQ:QCOM) – market cap as of 11/11/2017: $95.19bn

Introduction

On November 3, 2017, Broadcom publicly announced an unsolicited $130bn offer to acquire Qualcomm, its California chip-making rival, which is backed by a strong portfolio of intellectual property that underpins cellular communications in most modern mobile phones.

A tie-up between Broadcom and Qualcomm would be the largest ever pure technology deal creating a company with a market value of more than $200bn and forming a business that would be crucial to the production of smartphones, including Apple’s iPhone. A combined Broadcom-Qualcomm would become the dominant supplier of chips used in the c. 1.5 billion smartphones expected to be sold around the world this year.

Moreover, the deal, due to its nature and size, sees several top Wall Street banks involved for advisory and financing services.

About Broadcom Limited

Broadcom Limited is a Singapore-headquartered designer, developer and global supplier of a range of semiconductor devices with a focus on digital and mixed-signal complementary metal oxide semiconductor (CMOS)-based devices and analogue III-V based products. The Company operates through four segments: Wired Infrastructure, Wireless Communications, Enterprise Storage and Industrial & Other. It offers a range of end-products, such as enterprise and data center networking, home connectivity, set-top boxes (STBs), broadband access, telecommunication equipment, smartphones, data center servers and storage systems, factory automation, power generation and alternative energy systems, and electronic displays.

Broadcom is focused on maintaining an efficient global supply chain and a variable, low-cost operating model. Accordingly, it outsources a majority of its manufacturing operations, utilizing third-party foundry and assembly and test capabilities, as well as some of its corporate infrastructure functions. Its strong presence in Asia – where approximately 41% of its employees are located and where it manufactures and sources the majority of its products and materials – places Broadcom in close proximity to many of its customers’ manufacturing facilities and at the center of the worldwide electronics manufacturing.

As of FY2016, Sales increased to $13.2bn (2x FY2015 in terms of YoY growth). Despite the impressive increase in revenues, the firm realized an operating loss of $409m which in the end, after having accounted for financial expenses and losses on extinguishment of debt, contributed to its $1.7bn Net Loss (FY2015 Net Income was $1.3bn).

About Qualcomm Inc.

Qualcomm Inc. manufactures digital wireless communications equipment and its products principally consist of integrated circuits (chips or chipsets) and system software used in mobile devices and in wireless networks. It also sells other products and services (which include integrated circuits for use in wired devices, broadband gateway equipment, desktop computers and streaming media players), software products and contents, push-to-talk enablement services for wireless operators, and products designed for the implementation of small cells.

Qualcomm is in a vulnerable situation since its stock has fallen this year due to a patent fight with Apple, which could stop using Qualcomm chips in its iPhones. Indeed, shares of Qualcomm traded near $70 as recently as December 2016 and topped $80 in 2014, while these days Qualcomm shareholders watch their investment trade near to its historical minimum.

For the year ended on September 25, 2017, Qualcomm registered $23.5bn in revenues, a 6.8% YoY decline. Nevertheless, its EBIT of $6.4bn increased with respect to the previous FY signalling an increase in efficiency in Qualcomm core-business operations. Finally, net income grew by 8.2% (vs FY2016) to $5.7bn.

Industry Overview

Moore’s law is reaching saturation, as admitted by its inventor and suggested in the industry’s forecasts in spite of the increasing global sales at an average compound annual growth rate (CAGR) of about 9% per year. The integrated circuit designers have been generating steeply increasing revenues though large investments in R&D to double the number of transistors on a single computer chip every 24 months. Apparently, the amount of capital required, especially due to the non-recurring engineering required, has become unaffordable for many small-size companies after five centuries of exponential development. Consequently, companies specialize in different roles of the value chain.

The producers could be grouped into four main categories: Integrated Designers and Manufacturers, Foundries, Fabless, and Design Service Companies. IDM companies including Intel, Samsung and Texas Instrument are the well-capitalized giants able to sustain the original integration from designing, manufacturing, packaging, testing and selling. Foundries only take charge of manufacturing, packaging and/or testing, represented by Taiwanese firms TSMC, UMC, ASE Group and SPIL. As the upstream part, they are faced with the biggest challenge given the investment scale and stagnant product efficiency rate. Fabless, by outsourcing other business to Foundries, are the designers and sellers of integrated circuits. Highly intellectual property-oriented Design Service companies provide relevant instruments, complete functional units and circuit design for designers. Broadcom and Qualcomm are both Fabless.

Apart from specialization, the recent years witnessed unprecedented M&A deals within the industry, which indicate a convergence to traditional industries like oil and steel in terms of entry barriers and capital requirements. In 2015 and 2016, total announced M&A transaction volumes reached hundreds of billions of dollars. For example, Qualcomm announced that it agreed to buy NXP for about $38bn last year, seeking to expand the reach of its chips from phones to cars. An increasingly acquisitive and mature semi-conductor industry will also contribute to the block of new entrants.


If a conglomerate consisting of Broadcom, Qualcomm and NXP would be created, it could surpass SK Hynix and become the third entity in the device solution division, which includes all the IDM, Fabless and Design Service companies capable of generating c. $50 billion revenues based on their LTM performance.

Deal Structure

Qualcomm confirmed on November 6, 2017, that it had received the non-binding proposal and stated that its board of directors, in consultation with its financial and legal advisors, would assess the proposal in order to pursue the course of action.

The $130bn unsolicited offer was made at $70 per share to acquire all the outstanding shares of Qualcomm, $60 in cash and $10 in Broadcom stock. Compared to the closing market price before the announcement of deal, the bid valued Qualcomm with a 28% premium, and the deal would be the largest tech acquisitions ever.

Meanwhile, given the huge amount of the cash components ($88bn) and the additional $25bn net debt to be carried by Qualcomm if it succeeds in closing the $39bn purchase of NXP in a few months (the result of which will not influence the bid according to Broadcom), the company will strive for a giant sum of debt – almost 5x EBITDA – from banks.

It is believed that the overture is likely to be rejected, and Broadcom will need to nominate its director slate by December 8 for them to be considered at the 2018 annual meeting, where the voting will happen. The company is said to be currently analyzing scenarios and reviewing candidates.

Deal Rationale

In the context of the semiconductor industry, the proposed deal represents the most significant instance of the sweeping wave of consolidation that has transformed the sector over the past few years. The maturing industry’s slowing growth has put pressure on prices, prompting incumbents to consolidate in order to increase margins through synergies and reduced competition.

This specific deal fits perfectly with Broadcom CEO’s strategy of purchasing market leaders, gaining scale and creating value by increasing efficiency. Qualcomm is the undisputed leader in 3G and 4G intellectual property, whose royalties generate two thirds of its profits. It has also positioned itself as one of the frontrunners in the race to bring the 5G cellular standard to market, amassing a substantial portfolio of new patents.

Its strength in the cellular business would be an excellent complement to Broadcom’s leading position as one of the largest makers of Wi-Fi and Bluetooth chips. Cross selling has the potential to generate significant top line synergies. Margins could also benefit, thanks to greater efficiency, and increased bargaining power with pure-play foundries.

Lastly, the tie-up would create a dominant player in one of the fastest-growing segment of the industry, the one for wireless connectivity. The Internet of Things – the trend in which everyday devices such as cars and refrigerators become connected to the internet – is expected to boost demand for wireless chips, the core business of the two companies.

Another important aspect of this merger is the underlying legal dispute between Apple and Qualcomm over the size of the royalties the iPhone maker is expected to pay Qualcomm to use its wireless technology. The prolonged fight has pressured Qualcomm’s share, which in November of last year were trading around the $70 mark, the same price Broadcom offered to pay for the company today. A change of leadership at Qualcomm could increase the prospects of a settlement with Apple thus putting a welcome end to the expensive dispute.

Finally, Broadcom’s move came only one day after its CEO paid a visit to President Trump, announcing its intention to relocate the company’s headquarters to the US. From Broadcom’s perspective, the move was likely intended to improve the prospects of the merger’s regulatory approval. From the President’s, the deal would create an American semiconductor champion, thus stemming the rising threat of Chinese competitors like Huawei, while also creating new jobs in the United States.

Market Reaction

Shares in Qualcomm rose 12.7% on November 3, in New York and closed at $61.81, giving the company a market value of $91.1bn. Broadcom shares climbed 5.5% to $273.63, making the company worth $111.6bn. Broadcom’s offer represents a premium of 27.6% to Qualcomm’s closing price of $54.84 on November 2, the day before media reports of a potential deal pushed up the company’s shares. On November 6, Qualcomm shares rose again by 4% to $64.43 in premarket trading. Today, they are still traded at a price around $64 per share, 8% below the bid price offered by Broadcom suggesting scepticism about the closing of the deal.

Advisors

Broadcom is being advised by Moelis & Co., Citi, Deutsche Bank, JP Morgan, Bank of America Merrill Lynch and Morgan Stanley. Financial advisory to Qualcomm is being provided by Goldman Sachs and Evercore.


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