Answer the questions that immediately follow the case study.
Lam Research Buys Novellus Systems to Consolidate Industry.
Highly complex electronic devices such as smartphones anddigital cameras have become ubiquitous in our everyday lives. Thesedevices are powered by sets of instructions encoded on wafers ofsilicon called semiconductor chips(semiconductors). Consumer and business demands forincreasingly sophisticated functionality for smartphones and cloudcomputing technologies require the ongoing improvement of both thespeed and the capability of semiconductors. This, in turn, placeshuge demands on the makers of equipment used in thechip-manufacturing process.
To stay competitive, makers of equipment used to manufacturesemiconductor chips were compelled to increase R&D spendingsharply. Chip manufacturers resisted paying higher prices forequipment because their customers, such as PC and cellphone handsetmakers, were facing declining selling prices for their products.Chip equipment manufacturers were unable to recover the higherR&D spending through increased selling prices. The resultingerosion in profitability due to increasing R&D spending wascompounded by the onset of the 2008–2009 global recession.
The industry responded with increased consolidation in anattempt to cut costs, firm product pricing, and gain access to newtechnologies. Industry consolidation began among chip manufacturersand later spurred suppliers to combine. In February 2011, chipmakerTexas Instruments bought competitor National Semiconductor for $6.5billion. Three months later, Applied Materials, the largestsemiconductor chip equipment manufacturer, bought VarianSemiconductor Equipment Associates for $4.9 billion to gain accessto new technology. On December 21, 2011, Lam Research Corporation(Lam) agreed to buy rival Novellus Systems Inc. (Novellus) for $3.3billion. Lam anticipates annual cost savings of $100 million by theend of 2013 due to the elimination of overlapping overhead.
Under the terms of the deal, Lam agreed to acquire Novellus in ashare exchange in which Novellus shareholders would receive 1.125shares of Lam common stock for each Novellus share. The dealrepresented a 28% premium over the closing price of Novellus’sshares on the day prior to the deal’s public announcement. Atclosing, Lam shareholders owned about 51% of the combined firms,with Novellus shareholders controlling the rest.
In comparison to earlier industry buyouts, the purchase seemedlike a good deal for Lam’s shareholders. At 2.3 times Novellus’sannual revenue, the purchase price was almost one-half the 4.5multiple paid by industry leader Applied Materials for Variant inMay 2011. The purchase premium paid by Lam was one-half of thatpaid for comparable transactions between 2006 and 2010. Yet Lamshares closed down 4%, and Novellus’ shares closed up 28% on theannouncement date.
Lam and Novellus produce equipment that works at differentstages of the semiconductor-manufacturing process, making theirproducts complementary. After the merger, Lam’s product line wouldbe considerably broader, covering more of thesemiconductor-manufacturing process. Semiconductor-chipmanufacturers are inclined to buy equipment from the same supplierdue to the likelihood that the equipment will be compatible. Lamalso is seeking access to cutting-edge technology and improvedefficiency. Technology exchange between the two firms is expectedto help the combined firms to develop the equipment necessary tosupport the next generation of advanced semiconductors.
Customers of the two firms include such chip makers as Intel andSamsung. By selling complementary products, the firms havesignificant cross-selling opportunities as equipment suppliers toall 10 chip makers globally. Together, Lam and Novellus are able togain revenue faster than they could individually by packaging theirequipment and by developing their technologies in combination toensure they work together. Lam has greater penetration with Samsungand Novellus with Intel.
Lam also stated on the transaction announcement date that a $1.6billion share repurchase program would be implemented within 12months following closing. The buyback allows shareholders to sellsome of their shares for cash such that, following completion ofthe buyback, the deal could resemble a half-stock, half-cash deal,depending on how many shareholders tender their shares during thebuyback program. The share repurchase will be funded out of thefirms’ combined cash balances and cash flow. Structuring the dealas an all-stock purchase at closing allows Novellus shareholders tohave a tax-free deal.[1]
Discussion Questions:
1. Why did Lam’s shares close down 4 percent on the news? Whydid Novellus’ shares close up 28 percent?
2. Speculate why Lam used stock rather than some other form ofpayment?
3. Describe how market pressures on semiconductor manufacturers’impact chip equipment manufacturers and how this merger will helpLam and Novellus better serve their customers in the future.
4. How do the high fixed costs in the highly cyclical chipequipment manufacturing industry encourage consolidation?
5. Is this deal a merger or a consolidation from a legalstandpoint?
6. Is this deal a horizontal or vertical transaction? What isthe significance of this distinction?
7. What are the motives for the deal? Discuss the logicunderlying each motive you identify.
8. How are Lam and Novellus similar and how are they different?In what way will their similarities and differences help or hurtthe long-term success of the merger?
9. Speculate as to why Lam announced a $1.6 billion sharerepurchase program at the same time it announced the deal.
10. Do you believe this deal would help or hurt competitionamong semiconductor chip equipment manufacturers?
