Cypress Semiconductor Corp (CY - Free Report) is up roughly 25% this morning after news was released of a $9.4 billion deal with Infineon Technology’s (IFNNY - Free Report) . Infineon’s investors aren’t as enthusiastic, with IFNNY down over 8% today.
Infineon will be paying CY investors $23.85 a share, representing an almost 50% premium from its 30-day median price. Infineon investors are concerned that the synergies created by the economies of scale and scope of this acquisition will not be worth the significant premium. The semiconductor business is exceptionally cyclical and is expected to be in decline for the remainder of the year. As you can see below, EPS estimates are projected to be negative until Q1 2020.
Infineon’s acquisition of Cypress is expected to create economies of scale that amount to roughly $200 million in annual cost reduction by 2022 and more than $1.5 billion in additional long-term revenue. The combined business will be the #1 automotive chip company and the 8th largest semiconductor firm in the world, making the new Infineon a chip force to be reckoned with. Vehicles are getting smarter and the technology that goes into them is becoming increasingly in demand.
The acquisition will not only broaden Infineon’s portfolio, create economies of scale and scope, but it will also expand its customer base and distribution. This international acquisition will improve the German Infineon’s ability to operate in the largest consumer market in the world (The US).
Above you can see a visual that Infineon put together to illustrate the synergies to investors. 85% of Cypress’s R&D budget is currently going toward automotive and connectivity chips. As you can see the connectivity segment is expected to unlock the door to the digital world for their products, allowing billions of devices to connect on a “smart” level.
The combined portfolio of products will be quite diversified, giving the new business a little more of a hedge to the cyclical nature of the semi sector.
The biggest concern with this acquisition is the multiple at which Infineon is purchasing Cypress. Buying the firm for $9.4 billion or a roughly $10 billion enterprise value puts CY’s EV/EBITDA above 16x, which is more than double Infineon’s current multiple. This poses a lot of risk for IFNNY investors, especially when the equity market is already quite volatile.
Above is a 52-week relative performance chart comparing CY (blue) and IFNNY (red). As you can see these stocks tracked together until February when CY began to outperform IFNNY. This acquisition has accentuated the performance gap.
The economies of scale and economies to scope make the semiconductor sector ripe for consolidation. Like I mentioned above, a broaden chip portfolio will allow these firms to smooth out the sharp cyclicality that the semiconductor industry is prone to.
NXP (NXPI - Free Report) just agreed to acquire Marvell Technology (MRVL - Free Report) for $1.76 billion in cash, strengthening the firm’s position in connectivity chips. On Semiconductor (ON - Free Report) purchased Quantenna Communications back in March for $1.1 billion. The acquisition is anticipated to increase On’s automotive & connectivity position. Both of these acquisitions may have been a prerequisite for Infineon’s purchase of Cypress which would give the combined firm a strong positioning in both automotive and connectivity.
Since the end of April, the semiconductor industry has lost over 20% in market value, substantially underperforming the S&P 500. The reignited trade tensions have been pulling these stocks further down then the rest of the market because of their international exposure. Right now is not a bad time for an acquisition because of ostensibly discounted multiples. The semiconductor industry is trading below its 5-year median forward P/E and PEG.
The chip-making sector is always shifting and in order for these firms to quickly pivot to consumer needs a broader portfolio scope is needed. Consolidation in this industry is inevitable with apparent economies of scale, it is just a matter of balancing price and added synergies in order to create value for shareholders.
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