Included in the $85bn are three record breaking deals: Intel’s acquisition of Altera; NXP’s acquisition of Freescale; and Avago’s acquisition of Broadcom. In Rhines’ view, the deals are: “A large company buying a medium one, a large company acquiring another large company and a large company acquiring an even larger company.”
Speaking on a recent conference call, Rhines wondered about the motivation behind the deals. He offered three reasons: economies of scale; governmental issues; and financial leverage.
With the rise of the foundries, Rhines questioned whether these acquisitions would bring economies of scale. He noted that 30% of semiconductor industry revenues now come from wafers made by foundries and said this shows no sign of slowing. “Acquiring companies to improve economies of scale makes less sense as more manufacturing costs are borne by the foundries, so is probably not the reason behind these acquisitions.” Rhines said economies of scale came down to discounts from the foundries. “But they’re already buying lots of wafers from foundries, so their discount will only be a few percent.”
Rhines also presented figures which, he suggested, showed ‘no correlation’ between operating margin as a percentage of revenue and company size. “There’s no relationship,” he asserted.
Rhines thinks it’s part of a global mergers and acquisition (M&A) frenzy. “Financial leverage is the main reason behind what we’re seeing. There’s a lot of cash available and companies can borrow at low long term interest rates.”
Money being made available by the Chinese government may also be playing a part. “It’s five year plan is to put $20bn into the semiconductor industry.” He added this is being topped up by $97bn from private equity and local and regional goverments. “So $20bn has become $120bn and that’s a lot of money for an industry that only has revenues of three times that amount.”
Figures from Bloomberg suggest this year could see $4.5trillion spent on M&A – and Rhines believes this is simply down to the low cost of money – and it’s his opinion that the current frenzy is therefore only temporary.
But one thing worries Rhines. A theme common to all M&As is the ambition to cut operating costs. And he thinks that, with slim savings in manufacturing costs, companies will be tempted to reduce their engineering headcounts and the amount invested in R&D.
Rhines has produced some interesting analyses of the semiconductor industry over the years. In this latest analysis, he notes that R&D investment has remained ‘almost constant’ at 14% over the last 30 years. “There’s a fixed percentage of revenue you have to spend to grow your semiconductor revenue. If you choose not to invest, products will become less competitive and others will take market share.”
Rhines also warned about the dangers of cutting engineering staff. “If you make engineers redundant, they go quickly to start ups or competitors; the unemployment rate amongst engineers is one of the lowest of all sectors.”
Does Rhines see a bleak future? “Consolidation will continue because it’s financially attractive. But if there are too many acquisitions,” he concluded, “supply and demand will drive up prices.”
And perhaps that’s really what’s behind ‘merger mania’.
