The worst downturn seen by the semiconductor industry since the dot-com bust has hammered valuations of small and midsize chip makers, making them attractive targets for larger companies looking to emerge stronger from the recession.
In the past two years, the smaller chip makers have been hit hard by a supply glut, dwindling orders and growing competition — all signs pointing to an impending shakeout in the sector.
The S&P small cap semiconductor and semiconductor equipment index shed about 47 percent of its value in 2008. Even though it rose in 2009 as the sector began to emerge from its two-year slump, it is still 25 percent off pre-recession highs.
Seizing on the opportunity, several large- and midsize companies with deep pockets are moving in to acquire smaller niche semiconductor firms.
In November, wireless chip maker Broadcom said it planned to buy Dune Networks for $178 million.
Last month, ON Semiconductor, which makes chips used in mobile phones, cars and portable electronics, acquired California Micro Devices for $108 million.
Small chip makers, such as Silicon Storage Technology, Supertex, Ceva Inc., Advanced Analogic Technologies and Entropic Communication, could be possible acquisition targets, according to analysts.
Mid-sized firms such as Silicon Laboratories, Voltera and Monolithic Power Systems Inc are also expected to be on buyers' radar.
At the same time, many of the larger companies are sitting on a lot of cash, as the recession ensured tighter cost controls and put the lid on capacity expansion.
"To put that money to work, the best return on shareholder value is making accretive small tuck-in acquisitions that do not have a lot of baggage," ThinkEquity analyst Vijay Rakesh said.
Among the bigger players that have already been acquisitive are Intel Corp., Texas Instruments, ON Semiconductor and Broadcom. The market expects them to continue making small acquisitions.
"I don't think you will see two mid-caps and two large-caps getting together at all or even two small-cap companies combining," Needham & Co analyst Vernon Essi said. "I think you are going to see some bigger and smaller combinations."
Other companies like Applied Materials, Novellus Systems, Marvell Technology Group, Microsemi Corp., Linear Technology and KLA-Tencor are also speculated to be actively looking out for small public and private players.
Most of the smaller chip companies trade in a range of one to two times their sales, compared with the broader semiconductor sector that trades at about six times.
"A (small) company with a unique technology can easily go for a more than five times sales multiple," Brigantine Advisors analyst Ramesh Misra said.
Acquiring unique technology is the other reason why some of the large and midsize companies are eyeing "tuck-in" acquisitions.
Most of them are looking to add niche technologies to their portfolios or expand their product lines to position themselves better as the industry emerges from the slowdown.
When Sigma Designs, which makes chips for IPTV set-top boxes and Blu-ray players, agreed to buy Israeli home networking chip firm CopperGate Communications, it was exactly for this reason.
CopperGate specializes in chip sets for multimedia home networking using existing wiring. The deal gives Sigma Designs a head start in the fast-growing networked home entertainment semiconductor solutions market.
"What the stronger companies are trying to do is get in position to grow faster than the market in 2010-2011 and so they are going out and buying, either filling product niches or buying new markets for themselves and in some cases buying both, or buying growth," Morgan Keegan & Co. analyst Harsh Kumar said.
Coupled with this, the recession sucked out capital expenditure budgets in 2009 and left the smaller firms gasping for air and the larger firms looking for alternatives to grow their revenue.
Pacific Crest Securities' analyst Weston Twigg believes there were 20 semiconductor companies with capital expenditure budgets over a billion dollars in 2007. However, exiting the downturn the number could have probably shrunk to about six to eight companies with budgets that size.
This trend has led the larger chip equipment companies to gravitate toward their smaller peers for accretive deals.
"You can typically grow by growing revenues, which is a tough proposition given the economy, or you could simply go find yourself a nice acquisition and do the deal and trim costs and make it work," Kumar said.
Analysts also expect to see more mergers in the medical and automobile space as these markets have high barriers for entry but are seen having high growth opportunities for semiconductors in next five years.
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