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Research Note: Analog Devices to acquire Linear Technology

Analog Devices announced on Tuesday, July 27, 2016 that it will acquire Linear Technology Corporation for USD 14.8 billion, continuing the trend of big consolidations within the semiconductor sector. ADI reported annual semiconductor revenue of USD 3.4 billion in 2015, while LLTC revenue was USD 1.4 billion.
After examining the potential margin improvement, product portfolio, and end market focuses of these two companies, the acquisition will increase the competitiveness of ADI in several end markets.

Margin improvements

Compared to the overall semiconductor industry, both ADI and LLTC boast decent gross margins and operating margins, which hover around 37 percent and 7 percent, respectively.

From 2010 through 2015, ADI posted an average gross margin of about 60 percent and an operating margin above 20 percent. LLTC exhibits even better gross margins and operating margins in the same time period: Gross margins for LLTC was 75 percent or more for most of 2010 to 2015. Its operating margin lingered around 45 percent, in the same time period.

If correctly executed, the acquisition of LLTC by ADI will help boost margin performance, from a gross margin and operating margin standpoint. The resulting company is expected to post gross margins in the high-60s and operating margins in the mid-30s. If integrated properly, the resulting figures provide a substantial margin improvement for a company with $4.8 billion dollars in annual revenue.

Competing yet complementary product portfolios

Over 80 percent of ADI’s products are general-purpose analog devices used in various end markets in the industry, including computing, communications, industrial, automotive, and consumer electronics. Within the analog products segment, ADI specializes in converters, amplifiers, radio frequency (RF), signal processing, and power management devices. It also invests in high volume manufacturing processes for both analog and digital products.

While some ADI products are created for the high performance market and compete directly with LLTC, most of their goods are general-purpose devices made for medium- to high-volume customers. ADI has a massive customer base with over 100'000 customers globally.

IHS Markit classifies high performance parts as those that exhibit low-noise, high-speed, high-precision, high-efficiency, lower power, or any other desirable performance specifications.

Similar to ADI, LLTC specializes in analog products. All of LLTC’s revenue was generated from the analog product segment, with specializations in voltage regulators, RF, data converters, and amplifiers/comparators. Contrary to ADI, LLTC typically focuses on high-margin, high-performance, and lower-volume products in emerging applications, to maximize its return on investment. Analog products typically have larger feature sizes and less dependence on cutting-edge process technologies, and capital investments in analog manufacturing facilities (fab) are typically magnitudes lower than their digital counterparts. As a result, LLTC invests less in manufacturing and achieves higher operating margins.

On paper, the product portfolios of ADI and LLTC both compete and complement each other, as they are targeted for slightly different customer sets. The combined company will be competitive in offering both high-performance and high-volume products to its customers. The primary competitors in this market segment are Texas Instruments, Maxim Integrated, and Infineon.

Harmonious target end markets

Over the last several years, both ADI and LLTC were fueled by the growth from the automotive and industrial end markets.

In the automotive market, ADI grew its automotive business from 12 percent of total revenue to nearly 16 percent in 2015. LLTC managed an even more impressive growth rate from the automotive industry. In 2010, automotive revenue comprised only 7 percent of total semiconductor revenue for LLTC; by 2015, automotive revenue tripled to 21 percent of total semiconductor revenue.

IHS expects the automotive industry to be an important growth segment of the semiconductor industry over the next five years. ADI’s decision to acquired LLTC is very timely, and is expected to create advantages in this market.

Automotive semiconductors have strict quality standards, high performance requirements, and firm device specifications. As a result, smaller semiconductor suppliers exited this market, leaving most of the pipeline to tier-one semiconductor suppliers competing for design wins in self-driving features, driver assists, electrification, electric motors, and hybrid drivetrains. ADI can benefit from a successful acquisition and integration of LLTC’s products into its manufacturing system, to capture additional revenue and accelerate growth in the automotive semiconductor market.

In the industrial market, both ADI and LLTC have been growing successfully. The integration of their product portfolios will provide additional weapons for the combined entity to sell more high-performance products into the industrial market at a higher volume.

In the other end markets, wireless communication started to slow down in early 2016, but will remain a growing market in the short term. Brazil, India and other emerging markets will be a critical factor in the overall health of the wireless communications market, especially for smartphones and tablets. Apple is ADI’s single largest customer, which has created risks for revenue fluctuation. By acquiring a company less dependent on smartphones and the wireless communication sector, ADI can now further diversify its customer base, to absorb the impact from forecasted sluggish smartphone sales.

A difficult short-term environment is expected in other end markets, especially for computing and consumer electronics. However, both ADI and LLTC were already transitioning away from these lower-growth end markets.

Better together

Overall, ADI will become a much stronger player in the analog market, with the acquisition of LLTC. This move will create a ripple effect for other large suppliers to re-evaluate their scaling strategies and may result in additional acquisitions.

ADI will now be able to offer the same high performance, high margin products from LLTC to the same market. If integrated correctly, ADI can use its high volume manufacturing for LLTC products and generate substantial growth from the automotive and industrial end markets, while growing quickly with improved gross margins.

Author: Jonathan Liao, senior analyst, power semiconductors, IHS Markit
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