MorningWord 7/27/16: Who’s got a Semi?

by Dan July 27, 2016 8:41 am • Commentary

The semiconductor industry is in the midst of one of the most massive waves of consolidation the technology world has ever seen.  Yesterday it was announced that Analog Devices (ADI) is making a near $15 billion offer to acquire Linear Technology (LLTC).  M&A in the sector has been a growing trend over the last year and a half. It’s born out of a desire to gain scale as the industry pushes into new technology, at a time where it is facing a sort of existential threat to existing profit margins (more on that later), but also to diversify away from its reliance on PCs and Smartphones that have for the most part stopped growing, and towards new computing frontiers like the car and the home. There is little sexy about the chips either ADI or LLTC) make, and their components that go into the most exciting electronic products of the last decade, like iPhones, may be in their rearview mirror (pun intended).

To get our arms around the consolidation boom, let’s look back to last March, when NXP Semiconductors (NXPI) made a nearly $12 billion offer to acquire competitor Freescale (Motorola’s old semi division), both suppliers of chips to the auto industry.  The deal was likely an effort to gain scale vs larger competition like Texas Instruments.

Last May, Avago Technologies (AVGO) offered to pay $37 billion ($17b cash & $20b in stock) for Broadcom, making it the largest tech deal ever. At the time of the announcement, Bloomberg summed up the rationale for such a deal in a pretty straightforward manner:

The deal is the latest in a round of consolidation in the $300 billion industry as the rising costs of production and design push manufacturers to combine.

But it wasn’t just a desire to get economies of scale, semiconductor companies like Intel (INTC), which for all intents and purposes failed to make meaningful inroads in wifi / wireless chips while remaining dependent on PCs/Servers got in the M&A game days after the AVGO/BRCM announcement by making a $17 billion all cash offer for Altera.  A company that specializes in programmable chips, with the intent to, per the Motley Fool:

package (INTC’s) Xeon processors with Altera’s FPGAs and offer the complete solution to companies. Intel says it’ll start pairing the two chips sometime this year, which will boost performance by up to 50%.

Intel wants to take this one step further and build the FPGAs directly into one single chip, which could make the processors two times faster than they currently are.

The deal was not only meant to bolster existing server offerings but also to push into new technologies like the Internet of Things (IoT), from the deal press release:

The acquisition will couple Intel’s leading-edge products and manufacturing process with Altera’s leading field-programmable gate array (FPGA) technology. The combination is expected to enable new classes of products that meet customer needs in the data center and Internet of Things (IoT) market segments. Intel plans to offer Altera’s FPGA products with Intel Xeon® processors as highly customized, integrated products.

This past fall, hard disk drive maker Western Digital (WDC) made a then $19 billion bid for NAND flash chip maker Sandisk (SNDK), closed recently at about $16 billion as WDC looked to diversify away from hdd in data storage towards flash.

Two weeks ago, 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 resulted in massive drop in the British pound vs the Yen. ARMH 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).

This massive wave of consolidation had little to do with PCs, Tablets and smartphones, the products that dominated the Semi industry’s sales over the last decade, and everything to do where technology is going.

Back to that existential threat to profitability for the group, I think it was well summarized by Marc Andreessen, co-founder of venture capital firm Andreessen Horowitz, in their A16Z podcast from July 10th – Software Programs the World. I’ll paraphrase, but definitely have a listen:

Andreessen contends that Moore’s law has been flipped. For decades, every 18 months processing speed would double, while the cost of the chip would remain the same as the predecessor version.  Now though, chip speeds have topped out. But the chips prices are now half the price of their predecessors.  Andreessen sees this to be a massively deflationary force in the technology world, where computing power is becoming almost free. But he sees many positive implications (and thus for his firm, investment opportunities) because it means chips will be embedded in everything, virtually all chips will be “on the network” whether that be mobile, internet etc.

And I suspect this is where Andreessen gets really geeked up (pun intended), in his words, “if you live in a world where there is a chip in every physical object, and then every physical object is going to be networked, then you can program the world, ie write software for all cars, or everything flying in the sky, or all buildings, homes, businesses etc…. and that’s all really just starting”.

The wave of consolidation is making a bunch of old semiconductor players get into shape for what could be the most massive switch in demand the industry has ever seen. When you consider declining sales of PCs/Tablets, and saturation rates of mobile devices, connected things like cars and hundreds of devices in the home or business, coupled with the cheap processing power of the public cloud, and you can see a world where lean mean industrial focused semi fighting machines may get a new lease on life, despite age old tech laws being turned upside down on their heads.  So this consolidation wave is about IoT, autonomous cars, drone delivery, augmented reality, virtual reality, artificial intelligence, machine learning and just about any other techno buzzword that you know of and probably have no idea what their practical uses will be.  But Andreessen knows, Zuckerberg knows and maybe even Tim Cook knows, and all this foresight has little to do with your smartphone, tablet or PC.