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The world’s biggest maker of capital equipment used for manufacturing semiconductors, Applied Materials Inc. (AMAT - Analyst Report), has announced that it will merge with Japan-based Tokyo Electron in an all-stock deal. The merger will create a new company with a market value of $29 billion. Following the announcement, the shares of Applied surged 9.1%.

As per the deal, Applied shareholders will get one share of the new company for every share that they hold, while Tokyo Electron shareholders will get 3.25 shares for each of their shares.

The deal is expected to close by the second half of 2014, subject to approval by shareholders of both the companies and antitrust reviews. The new company will be incorporated in The Netherlands, with headquarters in both Tokyo and Santa Clara. The stock of the new entity will be listed on both the Nasdaq and the Tokyo Stock Exchange.

The new company’s management will consist of eleven directors — with five directors appointed by each company and one additional director to be appointed by mutual consent. Gary Dickerson will be the Chief Executive Officer (CEO), Bob Halliday will become the Chief Financial Officer (CFO) and Tetsuro Higashi will serve as the new Chairman.

The deal is expected to be accretive to pro forma earnings in the first full year of operation. Moreover, cost synergies are expected to be $250 million by the end of first fiscal year of operation and $500 million per annum within the third year of operation. Also, the company plans to start a share buyback program worth $3 billion within a year after the transaction closes. 

Strategic Move

Both Applied and Tokyo Electron make machines that are used to manufacture semiconductors, flat-panel displays and solar photovoltaic products. The deal combining two major players in the global chip industry will be one of the biggest tech mergers in recent years. According to a report from Gartner, Applied held 14.4% share of the global semiconductor manufacturing equipment market in 2012, followed by Netherlands-based ASML Holding NV (ASML - Snapshot Report) and Tokyo Electron with 12.8% and 11.1% shares, respectively.

Currently, the semiconductor industry is struggling with the effects of a plunge in sales of personal computers and a fundamental shift to other electronic devices. The companies need to develop a more advanced technology to cater to the growing needs of smartphones and tablets. The development of a new technology requires huge investments by the companies, thereby increasing R&D costs, ultimately affecting the company’s margins and bottom line.

Thus, pooling the knowledge, resources and expertise of both the companies will help to improve the new company’s technological advantage.

Management believes that the merger will give the new company the necessary scale to pursue new semiconductor manufacturing technology for smartphones, TVs and solar panels.

Conclusion

We believe that consolidation within the industry will continue due to slow demand for new processors and displays, as well as a continued need for a more advanced technology.

In 2011, Applied Materials acquired telecommunications equipment maker, Varian, leading to the formation of a combined entity which became the biggest player in the industry beating ASML Holding. With the Tokyo Electron acquisition, Applied Materials will further increase its market share and likely have an edge over its other rivals.

Applied shares currently have a Zacks Rank #3 (Hold). Other stocks that are performing well include Micron Tech. (MU - Snapshot Report) and Silicom Ltd. (SILC). Both the stocks carry a Zacks Rank #1 (Strong Buy).

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