Suddenly, nothing happened

After hectic M&A activity in 2016 that included some of the largest mergers in the semiconductor industry everything suddenly changed.

A view of a timeline over the top 15 semiconductor acquisitions of all time gives a very clear idea of just how hectic a period we have been through. Most experts in the industry expected this to continue and although this could still be the case, we have had a few very quiet months.

What could be happening:

There could be a number of reasons behind this slowdown in M&A activity:

• Companies are running out of candidates sufficiently large to be meaningful and sufficiently small to be affordable.
• Share prices of target companies are too high.
• Semiconductors have been declared strategic by Obama, and the Chinese government which could obstruct even modest size acquisitions.
• The predictions of the Trump era is that it is going to be unpredictable.
• Mergers fail to unlock value. Companies become larger but not better

As far as I have been able to establish there is no real evidence that M&A activity creates value above what the two companies would be able to create individually. This might have been the case when companies in the industry were smaller, but M&A might be less meaningful with the current scales.

Post merger activity always involve saving money, but this is not the same as creating better companies. Rarely the savings are founded in overhead - more often it is an executive order to make the numbers look good again.

Does scale of economies work in Semiconductors?

The economic assumption that makes mergers attractive is "scale of economies" - the larger a company become, the lower the relative costs it will have. The benefit of the increased size should exceed the overhead of buying another company. But with size comes increased complexity that can counter scale of economies.

For as long as I have been in the semiconductor industry, I have not met anybody challenging this assumption, nor have I seen any evidence to support or reject it.

Over the next period, I will try and shed more light on the issue beginning with a quick view on the Q3-2016 financials of a group of selected semiconductor companies that report more than revenue numbers. All of the top companies excluding Samsung, Toshiba, Renesas and Sony that does not report numbers. A few smaller companies have been included as a comparison. If scale of economies work in the industry.

Gross Margin

In a market with uniform pricing and uniform products, gross margin would represent the manufacturing efficiency of the company. Although this is not the case in the Semiconductor industry, there should still be an indicator that size matters.

The Q3 GM numbers do not reveal any clear correlation between size and GM except for companies above 15B yearly revenue. Below that there is no correlation.

Operating Margin

The operating performance of a company should also be impacted by size.

There could be individual events that can impact OM but as can be seen from the chart, there is no obvious correlation between revenue and OM.

Selling General and Administration expense.

Is the company's selling cost a function of the size of revenue or is it a business choice?

The chart suggests that semiconductor companies with revenues below 500M$/qtr follow a path where scale of economies does indeed impact the business. Above 500M$, selling cost is less impacted by size and more by business decisions.

This is not real research but that does not mean the numbers are meaningless. I don't mind you challenging this approach or my conclusions but I would rather see some more data that can enlighten us all on mergers and scale of economies. I am not really for or against mergers - however I would like to see some real evidence they are meaningful in other ways that CEO compensation.

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