Avago to buy Broadcom

Avago Technologies agreed yesterday to buy Broadcom for $37 billion in the largest merger of chipmakers to date, turning a lesser known company run by a ferocious dealmaker into one of the biggest industry players.

Avago, which serves the wireless and industrial markets, is offering Broadcom shareholders $17 billion in cash and Avago shares valued at $20 billion.

Broadcom is best known for its connectivity chips, which are used widely in smartphones made by Apple and Samsung Electronics.

The deal is the biggest so far by Avago chief executive Hock Tan, who has developed a small chipmaker into a $36 billion company through acquisitions since taking the helm nine years ago.

Tan, a serial deal-maker, has trimmed Avago's portfolio by divesting units while bulking up in faster-growing areas.

The combined company, to be based in Singapore and known as Broadcom, will be the third-largest US semiconductor maker by revenue, behind Intel and Qualcomm. The merger is the industry's second megadeal this year and is unlikely to be the last, analysts said.

The $37 billion price represents a premium of about 28% over Broadcom's market value of $28.85 billion as of Tuesday's close, before the Wall Street Journal reported the companies were in talks.

Demand for cheaper chips and new products to power Internet-connected gadgets is driving consolidation in the industry.

The Avago-Broadcom deal follows NXP Semiconductors' $11.8 billion offer to buy Freescale Semiconductor in March. Avago had also bid for Freescale, people familiar with the matter said at the time.

Intel has also been in talks to buy chipmaker Altera in a deal that could top $10 billion.

Until Thursday, Avago's biggest deal was for chipmaker LSI, which it bought for $6.6 billion last year.

Tan's strategy has been to look at potential targets that do not necessarily have the best strategic fit but have cost-cutting potential to build value.

Avago and Broadcom first spoke about a potential merger in October 2014 but could not agree on a price, said people familiar with the matter who are unauthorised to speak publicly about it.

Talks heated up in April when Avago approached Broadcom again with higher offers, and negotiations continued until the two agreed on a deal.

Private equity firm Silver Lake Partners, which is an Avago investor and holds a board seat, worked closely with the company to help evaluate Broadcom and structure the deal, said two sources who are unauthorised to speak publicly about the deal.

The merger will help the companies improve their bargaining position with manufacturers.

Irvine, California-based Broadcom has been struggling to grow as competition in the mobile chip business intensifies. The company's revenue increased just 1.5% last year.

Broadcom's shares closed down 1.5% at $56.25 yesterday, while Avago's fell 0.62% to $142.38.

The companies said they expected to close the deal by the end of the first quarter of 2016 and save $750 million within 18 months. The deal has a breakup fee of $1 billion, one of the unidentified sources said.

The new Broadcom would have annual revenue of $15 billion and an enterprise value of $77 billion, the companies said in a statement.

Broadcom shareholders will own about 32% of the combined company. They would also have the option to choose between various combinations of cash and stock.

Avago, which is incorporated in Singapore and also has headquarters in San Jose, California, said it intended to fund the cash portion of the deal by using funds from the combined company and new debt of $9 billion.

The $37 billion deal creates new competitive challenges for Qualcomm and may force the world's largest mobile chipmaker to radically rethink its own strategy.

Qualcomm, which has dominated the market for connectivity chips on smartphones, has been looking to extend its reach into data centres and network infrastructure, but may find its way blocked by an enlarged competitor combining Avago's strength in storage and Broadcom's power in networking.

"Qualcomm has aspirations of moving into Intel's data centre processor incumbency that the Avago storage and now enterprise networking (from Broadcom) capability directly overlays," said Drexel Hamilton analyst Richard Whittington.

That could result in Qualcomm creating some sort of partnership with Intel, he said, to combat the reach of the new company.

Wall Street analysts generally cheered the deal yesterday, despite some fretting about price, saying Broadcom's strength in wireless networking, WiFi and Bluetooth chips is a good complement to Avago's presence in industrial and wired devices.

That presents a challenge to Qualcomm, which finds itself in a tough spot in the maturing microprocessor business, as smartphone makers such as Samsung, Apple and Huawei put more effort into producing their own chips.

Now a Avago/Broadcom tie-up - which will take the name of Broadcom - potentially gives handset makers another viable supplier, giving them more leverage and putting even more pressure on Qualcomm, said IDC analyst Mario Morales.

"The other material impact will come from the adjacencies that Qualcomm is trying to enter now, the data centre, infrastructure and the consumer area," he added. "We see a lot of synergy in the technology they [Avago] are buying."

Qualcomm has hinted it is looking at new areas.

"I think there's going to be a tremendous amount of growth in computing and resources dedicated to supporting the cloud," Qualcomm chief executive Steve Mollenkopf said at last year's Consumer Electronics Show. "We look at that as an opportunity for a company like ours."

The company did not immediately reply to a request for comment on its strategic plans in response to the Broadcom deal.

That backdrop of consolidation may force Qualcomm's hand.

"Either divest themselves of the business that they are in that is in direct competition with Broadcom - and now Avago - or find a way to grow their presence," said Chris Geier, partner-in-charge of Sikich Investment Banking, assessing Qualcomm's options. "They are going to have to do one or the other. The status quo for them at this point won't work."