2015 saw more than $100 billion of M&A activity in the semiconductor industry, and this wave of consolidation shows no signs of slowing down, with Qualcomm, Inc. (NASDAQ:QCOM) in talks to purchase NXP Semiconductors NV (NASDAQ:NXPI).
Multiple forces are behind the semiconductor merger wave: low borrowing costs; slow growth and greater competition within this maturing industry; the need to cut costs and combine product lines; and the desire to capitalize on the emerging Internet of Things megatrend.
In addition to this, the Chinese government and other investors hope to invest $100 billion to $150 billion to develop a domestic semiconductor industry. China will likely continue trying to buy foreign chipmakers. Last year, a Chinese group tried to buy Micron Technology, Inc. (NASDAQ:MU), but Micron rejected the offer. In December, Fairchild Semiconductor also turned down Chinese buyers on the grounds that the United States government might not approve the sale.
Investors seem bullish on the sector. The exchange-traded fund SPDR S&P Semiconductor (ETF) (NYSEARCA:XSD) is up 16.6% year-to-date and nearing its 52-week highs. With all these factors encouraging M&A, more buyouts seem likely.
And don’t forget, chipmakers need not stay within their own segment. A group of consultants at McKinsey spelled it out earlier this year:
“When considering M&A, semiconductor players typically look for targets within their own segment, believing that their share price will not rise substantially if they buy a dissimilar company. But many unconventional alliances have produced substantial gains, since they allow players to offer more comprehensive products while simultaneously diversifying the customer base—changes that the market will perceive favorably.”
Which semiconductor stocks should investors buy in order to profit from a potential buyout?
Semiconductor Stocks Ripe for Buyout: Skyworks (SWKS)
Skywork Solutions Inc (NASDAQ:SWKS) provides analog semiconductors for firms such as Apple Inc. (NASDAQ:AAPL) and Samsung (OTCMKTS:SSNLF). With that market slowing, SWKS seeks growth in markets such as medical, wearables, connected home, industrial, smart energy and others.
Growth prospects look good, as analysts expect SWKS to grow earnings at a 17% CAGR over the next five years.
According to Finviz, SWKS commands a 50% gross margin and a 29.3% profit margin. Skyworks’s 28.5% return on equity shows efficient management. SWKS also has zero debt.
SWKS stock trades at less than 16 times earnings and 13 times forward earnings, yet is basically flat this year. Perhaps it will catch up.
Reasonable valuation, solid management, good growth prospects, zero debt and fat margins should make SWKS stock a strong buy.
Semiconductor Stocks Ripe for Buyout: ON Semiconductor (ON)
Phoenix-based ON Semiconductor Corp (NASDAQ:ON) makes a wide variety of semiconductor products, including sensors, microcontrollers, transceivers, power management units, signal processors, and memory. ON Semiconductor products can be found in everything from power banks to security cameras to automotive engines.
Analysts project that ON will grow earnings at a white-hot 49.1% CAGR over the next five years. ON trades at 3 times book value and with a 0.29 price-earnings-growth ratio.
Buy ON stock to benefit from industry consolidation.
Semiconductor Stocks Ripe for Buyout: Cypress Semiconductor (CY)
Cypress Semiconductor Corporation (NASDAQ:CY) produces chips in four divisions: programmable systems, data communication, memory products and emerging technology.
CY merged with Spansion in December 2014, which will bring CY $180 million in cost savings by the end of fiscal 2016. This merger made CY a major player in embedded systems used for things such as controlling car engines.
In July this year, CY acquired Broadcom Ltd’s (NASDAQ:AVGO) IoT division for $550 million in cash. Cypress will be able to supply IoT device makers with parts for wireless connectivity, memory, microcontrollers and sensors. This will give CY an advantage if device makers seek to cut the number of suppliers and purchase everything from one firm.
Talk of a potential buyout (again from China) boosted CY shares in July. Cypress took a loss in the first two quarters of 2016 but reported non-GAAP earnings of 7 cents and 12 cents for these quarters. Furthermore, CY had a positive operating cash flow of $22.503 million for the six months ending on July 3, 2016.
CY currently trades at 1.76 times book value, lower than the multiple of 2.8 for XSD.
As of this writing, Lucas Hahn did not hold a position in any of the aforementioned securities.