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Leading analog semiconductor manufacturer Avago Technologies Limited (AVGO - Analyst Report) recently inked a definitive agreement to acquire LSI Corporation for $6.6 billion in cash. The strategic move is aimed to diversify Avago's existing business line from wired infrastructure, wireless and industrial businesses into the storage chip market in order to augment its revenues, as the industry braces for more consolidation amid challenging macroeconomic environment.

The all-cash transaction will be funded by a combination of $1.0 billion cash in hand, $4.6 billion term loan from a consortium of banks, and $1.0 billion investment from private equity firm Silver Lake Partners. The purchase price equates to a cash payment of $11.15 for each LSI share, representing a premium of about 41% on its closing price of $7.91 on Friday – the day before the deal was announced.

The announcement cheered investor sentiment as LSI shares jumped 38.6% to close at $10.96 on Dec 16. Even Avago shares, which were up 42.7% so far this year till Friday, rose 9.8% following the announcement of the deal. The transaction is expected to be complete by the first half of 2014, subject to regulatory approvals and fulfillment of customary closing conditions.

With annual revenues of approximately $5 billion, the combined company is expected to be one of the behemoths in the semiconductor industry offering a complementary yet diversified product portfolio to a wider range of customers. Leveraging on economies of scale, the transaction will facilitate Avago to benefit from rapid increases in data center IP and mobile data traffic, and will position it to be an undisputed leader in the enterprise storage market.

In addition to cost synergies from a combined resource pool as the cost of designing and building semiconductors rises, the acquisition is likely to improve the operating margin of the combined company, creating greater scale to further drive innovation into the datacenter. The transaction is expected to be accretive to Avago's free cash flow and recurring earnings with an immediate effect, leading to annual cost savings of $200 million by fiscal 2015.

The acquisition is the second-largest transaction of its kind in the industry this year, following the purchase of Tokyo Electron Ltd by Applied Materials, Inc. (AMAT - Analyst Report) for $9.6 billion. Whether the current deal is a precursor to several such deals in the semiconductor industry is too early to speculate. However, the combination of two complementary businesses in Avago and LSI is worthy to take note and might encourage other rival companies to take a similar plunge to gain traction.

With an expertise in compound semiconductor design and processing, Avago is a premier designer, developer and global supplier of a broad range of analog, mixed signal and optoelectronics components and subsystems. The company boasts over 4,200 patents serving three primary target market segments: wireless communications, wired infrastructure, and industrial and other. Avago presently has a Zacks Rank #3 (Hold).

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