This morning, ARM Holdings (ARMH) of the U.K. agreed to be acquired by Japan’s Softbank for $32 billion. This deal has a little something for everyone. It’s a result of multiple forces colliding within Technology, Geo-politics that have resulted in massive currency distortions and Central Bank policies.
Let’s start with the core of the deal, Tech. ARM derives most of its sales from licensing their large portfolio of semiconductor designs to original equipment manufacturers/ foundries with a massive presence in smartphones and growing portfolio foothold for connected devices (Internet of Things, Autos etc). In 2015 ARM registered a gross margin of ~96%. The purchase price, at nearly 20x expected sales, seems exorbitant. On a multiple of their sales it’s nearly double the premium Intel (INTC) paid for Altera last year in their $17 acquisition. The big difference here is that INTC is attempting to make a strategic fit to pivot from their reliance on PC and Servers, while Softbank is adding a portfolio company.
Next, geo-politics. Since the Brexit vote the British pound has been decimated vs foreign currencies like the Japanese Yen. So the purchase price just got cheaper. Assuming ARM was on Softbank’s shopping list on June 23rd, they’ve watched as that deal got significantly cheaper since. ARM get most of their sales from the U.S. and Asia, with only about 10% coming from Europe, so while Brexit’s currency effect has company cheaper to foreigners, the company doesn’t carry the same baggage on currency and their sales.
And third, central banks. Softbank is domiciled in Japan. Japan is ground zero for negative interest rates. So the company will fund the all cash deal with debt. Why not, right??
So what does this mean for the semiconductor industry as a whole? Well, it confirms the shift in focus from the PC/Smarphone chips where the decades old rule of Moore’s law has started to have diminishing returns. And now we’re witnessing a land grab for the best positioned companies in the IoT supply chain, where the prospects for growth could resemble the trajectory of PCs in the 1990s and Mobile devices in the 2000’s.
Back in May (MorningWord 5/23/16: Patent Tending) I gave thoughts on the buzziest of buzzwords in tech, Internet of Things (IoT). Most of the large established semiconductor companies (Intel & Qualcomm to name two) register less than 5% of their trailing 12 month sales in IoT. But as I said in May, before we get too dismissive of the premium being paid for growth in the nascent space, let’s consider the magnitude of the IoT growth opportunity, from a McKinsey report titled Internet of Things: Opportunities and challenges for semiconductor companies:
The McKinsey Global Institute recently estimated that the Internet of Things could generate $4 trillion to $11 trillion in value globally in 2025. These large numbers reflect the IoT’s transformational potential in both consumer and business-to-business applications. Value creation will stem from the hardware, software, services, and integration activities provided by the technology companies that enable the Internet of Things.
Analysts also estimate that the current Internet of Things installed base—the number of connected devices—is in the range of 7 billion to 10 billion. This is expected to increase by about 15 to 20 percent annually over the next few years, reaching 26 billion to 30 billion by 2020.
So who’s next?
Qualcomm (QCOM), is still too reliant on mobile devices and will need to pivot part of their company fast like INTC. To do that, QCOM will need to get into the IoT acquisition game. The short list includes Silicon Labs (SLAB), Microchip (MCHP) or NXP (NXPI).
QCOM sports a cash balance of $30 billion vs their market cap of $80 billion, net of their $12 billion in debt. That’s a whopping 22.5% of their market cap in cash. QCOM trades at a discount to the S&P 500 (SPX) at 13.4x expected 2016 eps, a discount to most peers including INTC. The only thing they have been interested in buying of late is their stock (the company launched a $10 billion accelerated share repurchase last May) at the behest of activist shareholders. Considering sales are only expected to be down 5% year over year, I suspect a strategic acquisition would be met with greater enthusiasm by QCOM investors than their March 2015 commitment to returning 75% of free cash flow to stockholders. The stock is down 25% since that proclamation.
QCOM reports Q2 results Wednesday after the close. The options market is implying about a 4.5% one day move, which is light of the 4 qtr average one day move of about 7% (skewed by a 15% decline following their fiscal Q4 results in early Nov).
To my eye, the results & guidance are likely the impetus for a 10% move in the coming weeks to a gap fill near $60, or back towards 5 month technical support at $50: