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Chips Ahoy: Semiconductor Firms Are on the Prowl

20 December 2013 in Trading Ideas

With two huge deals worth a combined $16 billion in just the past three months, the semiconductor sector is demanding some serious attention.

On Monday, Avago Technologies said it was spending $6.6 billion to purchase LSI Corp. According to Bloomberg, the purchase provides Avago with a range of storage chips that it can sell to data-storage customers.1

This deal follows a $9.4 billion transaction in September that saw Tokyo Electron acquire Applied Materials.

And that may just be the beginning. Topeka Capital Markets analyst Suji De Silva told Bloomberg that LSI and Avago may be combining to gain more resources as the cost of designing and building semiconductors rises, which may portend a wave of consolidation.

“The question is whether this is the beginning of a consolidation trend in semiconductors,” De Silva said. “Scale does make sense.”

Raymond James analyst Hans Mosesmann, meanwhile, pointed out that the development will be a boost to the industry’s biggest players: “In this day and age, as things consolidate, the bigger guys are going to have more power.”

But the LSI/Avago deal also is informative for where each company has been in its recent past, and how each company evolved to keep up with the chip industry’s fast-changing dynamic, which has essentially mirrored the technology developments in its end-markets.

Avago, for example, began as a division of Hewlett-Packard, pioneering the market for LED displays. Now, however, the company makes chips for everything ranging from cellphones to computer servers.

LSI, which once shut down the manufacturing of its own chips, now has a specialty in semiconductors used in networking and data-storage hardware that use disk drives or flash memory chips.2

This phenomenon, of course, is perfectly logical. The strong that survive will be those chipmakers that are able to answer the needs for better and faster technology. Conversely, behind all of the latest “big” developments in technology – smartphones, tablets, data storage – are the chipmakers supplying the engine.

That’s why you see a significant semiconductor component in our Tablet Takeover (44.5%) and Mobile Internet Tsunami (40.7%) motifs. (The Tablet Takeover motif is up 26.7% this year, the Mobile Internet Tsunami motif is up 14.0%. So far in 2013, the S&P 500 has risen 24.9%.)

That’s also why you see companies shelling out billions of dollars to round out their product offerings for fear of missing a key opportunity. It’s an arms race that can prove beneficial for investors.

1James Callan and Nick Turner, “Avago Will Buy LSI for $6.6 Billion to Gain Storage Chips,” Bloomberg.com, Dec. 16, 2013, http://www.bloomberg.com/news/2013-12-16/avago-to-buy-lsi-in-deal-valued-at-about-6-6-billion.html.

2Don Clark, “Avago Agrees to buy LSI for $6.6 Billion,” WSJ.com, Dec. 16, 2013.