Sept
2017
ISSUE
No. 33


SemiWatch

What does Lattice rejection mean for chip M&A? 
Does it help or hurt further consolidation?
Does "buying blockade" slow China's chip ambitions?
Although the rejection of the Lattice deal was expected, it none the less has an impact on a number of dynamics in the chip industry and further M&A and consolidation.
Freezing out China removes a "catalyst" in the market which help bid up values and add fear to both potential targets or those left out.
Cross border deals are obviously more difficult to get done and even small deals with China will likely be put under a microscope now.
The Xcerra deal is likely very safe given the size and lack of critical technology. Much like the Mattson deal before it, China will only be allowed to acquire second or third tier small chip companies with no unique technology or critical market position.

Does this slow down China's chip ambitions?
Does this slow down M&A and consolidation further?
Does this negatively impact future sales of equipment to China?

Building a Wall

With the final rejection of Lattice which was well anticipated the US has successfully built a virtual wall specifically aimed at keeping China out of US high tech.  Using CFIUS as the building blocks it would appear that China will likely be shut out of further significant deals.  Aixtron was a pre cursor and certainly signaled the US resolve as CFIUS blocked a Chinese acquisition of a German company (albeit one with US technology assets).

We did not see similar behavior when Japan, Taiwan and Korea got into the chip business as they were obviously viewed as friendly competitors.

Small deals will get through the 'Lattice" wall

Much as small fish can get through the "lattice" structure of a net designed to catch bigger fish, so too will small buys get through the CFIUS review.  Mattson got through as it was a small third tier  company with no unique technology. We think Xcerra is a safe bet as it is dwarfed by Teradyne and Advantest and remains a distant third in a segment of the market not viewed as a driver of Moore's law.
The problem here is that small fish don't get China to where it wants to be very quickly.  These size and types of acquisition don't get China either technology or market share. China will never catch up by buying second and third tier companies....but obviously thats the whole point....let China buy the leftovers that no respectable US company would ever buy.

Roadblocks and detours for China's grand semiconductor plan

The industry is obviously concerned about China's ambitions and $100B checkbook to turn them into reality.  The number of fab projects in China sounds like it almost exceeds the rest of the world put together.  We have obviously been very dubious as to how many are real and how many are wishful hyperbole.
We have thought that you could easily halve the number of Chinese projects that are announced but will never get built. Of those that get built, how many will be impactful?

The lesson of SMIC

SMIC had sky high aspirations of being a TSMC beater based in China. Many Taiwanese engineers left the island to go work for SMIC, bringing much talent with them. However, it turned out that SMIC never got very far.  The US government clamped down on tools that could be shipped to China and the talent never fully coalesced into a viable team that could keep up.  Today SMIC is a respectable foundry but not the world beater it wanted to be. Not having both the technology assets as well as the human assets kept it from joining the country club of Intel, Samsung, TSMC and Toshiba as chip leaders in their respective countries.  Having a big checkbook isn't the only thing that gets you membership in that exclusive club.....

Could this dampen China's spending on US tools and technology

We don't think that any US based tool company had factored all that much China spend into their future plans so its unlikely this will cause any significant disappointments. We could see some spending shift to local suppliers like AMEC in China or SEMES in Korea or maybe even Tel & Hitachi in Japan , but just using those companies exclusively will never get you to the bleeding edge.  China will still be stuck buying from US tool companies just as SMIC is

Not likely to be a repeat of China's smothering of Solar & LEDs

In a recent conversation with an industry executive, they noted that on a technology scale, building solar panels was likely a "one" and building 10NM chips was a "ten", with LEDs a "two" and OLED probably about an "eight". We agree. The economics reflect this as you can start making solar panels or LEDs with a $25M to $50M factory but we all know the astronomical cost of a chip factory.  OLEDs aren't that easy either as Samsung has "cracked the code" but LGs OLEDs are far behind as Apple found out as it was forced to cough up beaucoup dollars for single source supply on high quality OLEDs for the Iphone X coming from arch enemy Samsung.
In short, although rightly concerned we aren't scared about China's entry into the Semi market or even the OLED market as a repeat of the solar/LED movie. While the US was forced out of Solar and companies like Veeco were crippled in LED we don't see the same threat in Chips. AMEC in China has made great strides in MOCVD against Veeco but has nothing close to Lam's high aspect ratio etch tool for 3D NAND (not yet anyway...)

No China =Less pressure = lower prices = no rush 

If China can no longer reasonably expect to bid on US Chip assets then the ability of this irrational buyer to overpay and drive up valuations has been removed.  Lattice is a clear example as China was going to buy it for almost double of its market value rather than a more normal typical M&A premium.  It also removes the fear factor and pressure of US companies to merge or run into the arms of a white knight to escape the clutches of China.  It also obviously means there is less rush and imperative to get deals done as this overhanging threat is gone.

The Toshiba Soap Opera

The plot thickens as Apple and Dell are two new characters added to a multifaceted love triangle Italian opera.  I have long ago lost track of who is on who's side and who loves whom, who is suing who etc;.  All I pay attention to is that the bid continues to go up to the current $19B and counting.  Its likely far from over and is just starting to get interesting.
We wonder what premium is being paid for Toshiba's chip business above the depreciated value of the fabs and equipment in them.  Our math says its a very high premium. You could probably build three large state of the art NAND fabs for the $19B being offered and at last count, Toshiba does not have three bleeding edge big NAND fabs.
This goes back to the point of the value of the technology/IP/know how that China wants and will have a hard time getting.  
We also finding it amazing that a few short years ago you probably couldn't give away assets in the memory space. Does anyone remember Inotera or Elpedia?  Micron has obviously done a good job of picking up assets on the cheap at the bottom of a cycle while the current Toshiba auction appears to be going on at the top of the cycle (are these buyers really as smart as they think they are???).
Investors in Abu Dhabi must be cheering from the sidelines as their stock in Global Foundries is obviously worth a whole lot more.
We do think Toshiba is more of an aberration rather than an example of current M&A demand. First off, its a shotgun sale as Toshiba is being forced to liquidate and second the memory market is obviously in a frenzy.

M&A getting smaller

Its clear that in the chip equipment space, smaller is better. After AMAT/TEL and KLAM both getting shot down everyone has been gun shy.  We sense that more companies are now talking about M&A in the space but the pickings are very slim.  You can't do a large deal without the blessings of the customers (think Intel) and small deals don't move the needle enough.  The industry unfortunately is like a barbell with a bunch of very big companies and a bunch of very small companies and not a lot of potential targets of the right size. Varian was one of the last good deals on the equipment side and MKS acquiring Newport was one of the last good deals on the supplier side.
The industry may be stuck doing a lot of smaller deals based on strategic technology rather than financials.  An example of this would be the recent purchase of Coventor by Lam which got $25M of revenues which isn't even a rounding error to Lam but did get some very key technology that will likely generate many times that revenue in helping its core etch and dep businesses sell more product and improve process. ASML clearly overpaid to get Hermes , but Hermes is clearly very strategically important to the larger EUV story of ASML.

The stocks

Given slowing M&A and China being barred from the market we think there is little reason to pay an M&A premium for a potential target company.  Valuations are already strong and we likely won't see huge premiums in M&A. Veeco buying UTEK was an example of this phenomenon as the premium was low because UTEK was already fully valued given its weak performance. 
Most all the low hanging fruit is gone and good deals will be harder to get past government and customer scrutiny. Record stock prices are further deterrents.
While we do expect M&A to continue, we think the pace will remain low along with premiums and would not place stock bets based on expectations of activity.





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