Why Texas Instruments Buying National Semi (TXN, NSM, ADI, MXIM, LLTC, ISIL)

   on April 05 2011 7:46 AM

Texas Instruments (TI) (NYSE:TXN) said Monday it agreed to buy National Semiconductor (NYSE:NSM) for $6.5 billion, or $25 per share, a deal that combines two industry leaders in analog semiconductors, each with unique strengths in delivering products to improve performance and efficiency and convert real-world signals in electronic systems.

The deal assumes significance as the market for analog semiconductors touched $42 billion in 2010 and the two companies will now have a combined market share of about 17 percent, meaningfully ahead of closest peers Analog Devices (NYSE:ADI) (6 percent), Maxim (NASDAQ:MXIM) (6 percent), Linear Technology (NASDAQ:LLTC) (4 percent), and Intersil (4 percent).

Upon close of the transaction, National becomes part of TI's analog segment, and sales of analog semiconductors will represent almost 50 percent of TI's revenue.

We think this deal makes sense, with TI the only likely bidder and the best strategic fit for National Semi, FBR analyst Craig Berger wrote in a note to clients.

Berger, who has an outperform rating and $40 price target on TI stock, said the deal is not inexpensive considering National Semi's growth rate, but likely not that expensive either considering the manufacturing synergies and cost reductions that TI is likely to achieve in coming years.

Net, TI's acquisitions of National Semi should be a solid opportunity for TI to build scale, grow its product offering, improve its manufacturing efficiencies, and accelerate EPS growth, all at a fair (but not inexpensive) price, the analyst said.

One main motivation for this deal is that it adds about 12,000 new parts to TI's analog product stable, allowing the thousands of TI salespeople to cross-sell these National Semi's parts to a wider swath of customers more quickly than National could on its own.

While there is likely some overlap in TI parts and National parts, the firms said their offerings are highly complementary with limited overlap.

While TI said that it is likely to keep using National's 150 millimeter (mm) and 200mm fabs given their mid-60 percent utilization rates and low manufacturing costs, we believe a real cost opportunity exists for TI to slowly move National's production out of those facilities and into TI's 300mm facilities, Berger said.

TI currently has equipped capacity to generate about $2 billion in annual revenues from its 300mm fabs, and has walled capacity to generate more than that. While not cited as an immediate synergy, he believes this is a key part of TI's acquisition of National, the analyst added.

Importantly, the deal provides the combined company with substantial margin leverage going forward should they be successful in boosting National Semi's revenue growth rate - or the ability to consolidate assets later if required, thus protecting the expected accretion.

With about 60 percent of revenues derived from traditional analog end-markets, National Semi provides sticky revenues that would have taken 5-7 years-plus for TI to grow organically, analysts at Oppenheimer said.

TI expects the deal to be immediately accretive (excluding deal costs) and intends to realize $100 million in annualized cost savings starting one year from the close, largely due to the reduction of corporate redundancies.

We expect accretion of roughly $30 cents per share in the first year of the deal, assuming no consolidation of manufacturing resources, which is a very conservative assumption in our view, analyst Chris Caso at Susquehanna Financial said.

Caso, who has a positive rating and $42 price target on TI stock, believes the deal provides TI with operating leverage - as the top line grows, he estimates the incremental fall through is in the 70 percent range.

In addition, the analyst believes the deal provides TI with downside flexibility if demand does not hold up, in that the company can consolidate fab assets, since National Semi's existing fabs currently are at utilization rates below 60 percent.

We estimate the National Semi acquisition adds about 100 bps of accretion to TI's corporate gross margin structure, Caso noted.

Meanwhile, Auriga analyst Daniel Berenbaum expressed surprise over the deal.

By the tone of the questions on the conference call, we were not the only ones surprised by the deal - National Semi has been viewed as a market share loser, and valuation is seemingly rich on a number of metrics, Berenbaum said.

Berenbaum, who has a sell rating $27 price target on TI stock, said given the monetary environment, the deal will likely be accretive in relatively short order, but TI seems to simply be buying customers - it's tough to get more positive on the stock with a deal this large on top of existing uncertainties.

Recently, TI's have had some trouble from the earthquakes in Japan, with several production facilities operating with reduced power.

However, the combined entity would boast about $7.42 billion in revenue, 34,000 employees, a 2,500-person sales force and 42,000 products. Also, given the size of the deal, the analysts see little chance of competing bids and expect the deal to clear antitrust hurdle without any major concerns.

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