What stocks to invest in –
This year has been market by a spate (like that word?) of mergers/acquisitions in the computer chip industry, the latest being the potential combination of stodgy Analog Devices with Maxim Integrated Products. Why is this happening now?
–cheap financing, even though not necessary in all cases, is still plentiful. This may not continue to be the case as interest rates in the US rise
–the cost of creating and fabricating new generations of products is becoming very expensive, to the point that some firms can no longer afford to stay independent and remain in the game
—most important, though, is the emergence of mega-customers like Apple and Samsung, or Acer and maybe even Asus, which has changed the competitive structure of the industry. The situation now is that these few large buyers of components can play one supplier off against another to get better prices. The only way suppliers can get any market clout is to combine.
One might think that this is evidence of the overall tech industry maturing, meaning that we’re entering a period of slower industry growth. While that may be true, maturity isn’t the sole, or even the main, reason for consolidation. When the EU was created, for example, cross-border mergers became feasible for the first time. Small national supermarket chains combined to become EU-wide powerhouses. For a while, food suppliers remained as small as before. But the mammoth size of EU-wide purchase orders from the big supermarket chains became so enticing that food suppliers offered unusually high discounts to get the business. These firms soon realized that they needed scale, both just to get the big supermarket orders and fulfill them and to streamline operations and lessen profit-destroying discounting. The large scale of the customers forced the suppliers to scale up as well.
The economics works in the other direction, too. Large scale on the suppliers’ part forces customers to scale up.
In the case of chip companies, I don’t see an easy way to make money right away from ongoing consolidation. Many of the actors remain unattractive on a stand-alone basis, in my view. Also, the general rule is that half of the combinations won’t work out, either because the principals can’t get along post-merger or an acquirer pays too much for a target. Better to let the dust clear and try to assess the combined firms, say, next Spring. Having said that, I do own Intel and Avago, two consolidators.