Slowing growth to spur analog semiconductor deals

SAN FRANCISCO (Reuters) - Analog chip makers, faced with slowing industry growth and looking to put their piles of cash to use, are likely to spur deal-making in coming months.

The pace of deal-making among analog semiconductor companies had lagged behind the overall technology sector because of strong growth opportunities within the industry.

The analog semiconductor industry grew at about 25 percent annually from the mid-1990s until about five years ago, driven by exponentially increasing demand for these chips from industries as far-ranging as housing and communications.

Analog chips receive continuous signals and are used in products that involve sound waves or pressure, which cannot be broken into ones and zeros -- the stuff of digital signals. Cell phones, computers, planes, cars and radios all use analog chips.

But the industry is now maturing, with the rate of growth dropping to about 10 percent annually. Analysts expect that rate to decline slightly in the next few years.

"Growth isn't as explosive anymore," said Wedbush Morgan analyst Patrick Wang. "The industry is ripe for consolidation."

Analog chip makers are also smarting from the economic downturn, which has shrunk demand for handsets, consumer electronics and other products that use analog components. Last month, Texas Instruments Inc (TXN.N), the largest U.S. cell phone chip maker, lowered its first-quarter earnings forecast, citing a weaker market for chips used in high-end phones.

These factors are likely to spur companies that have the cash to look for alliances designed to lead them to new markets and plug holes in their product portfolios, analysts said.

Wang said he expects a handful of acquisitions over the next 12 months, as companies seek to scale up by combining products, cross-promoting them and bundling sales.

HAVE CASH, WILL BUY

Although analysts said consolidation may not be the cure-all for declining industry growth, many see it as inevitable.

"Analog companies are flush with cash," Lehman Brothers analyst Romit Shah said. "Buybacks and dividends are not enough."

Sustainable profits from high-margin products and low capital expenditure have helped pad the wallets of analog companies, analysts said.

Given the current market uncertainty, many cash-rich companies are also likely to prefer to use their money for acquisitions, expecting better returns than from investments in securities. Depressed stock prices of many potential targets make opportunistic buys more attractive.

Traditionally, companies have hesitated to combine proprietary engineering processes, but acquisitions are no longer taboo, Shah said.

In a research note, Shah credited companies like Texas Instruments, Intersil Corp (ISIL.O) and Microchip Technology Inc (MCHP.O), which have made acquisitions in the past year, for stepping up the pace of deals.

Microchip, which has been hurt by the U.S. housing market downturn because it sells microcontrollers for use in home construction, is looking to expand its presence in the analog space, analysts said.

National Semiconductor Corp (NSM.N) and Analog Devices Inc (ADI.N) could also be potential acquirers, analysts said.

Earlier this year, On Semiconductor Corp (ONNN.O) bought Amis Holdings Inc, parent of AMI Semiconductor, for $613 million.

On Semi, which has a market value of $2.7 billion, also held discussions last year about a potential business combination with Micrel Inc (MCRL.O), a small analog chipmaker for cellphones, according to two people with knowledge of the discussions.

An On Semi spokeswoman did not return a call seeking comment. A Micrel spokesman declined to comment.

Micrel is currently battling an activist investor who wants the company to sell itself.

Obrem Capital Management, an investment firm that owns 15 percent of Micrel, which earned $258 million in 2007 annual revenue, said the company has underperformed and would provide better value to shareholders through a sale.

Some analysts have echoed the idea that small and mid-size analog semiconductor companies would benefit from selling themselves or merging with competitors.

"Small and low-growth companies that entertain M&A as an exit strategy might salvage value for investors, rather than holding on and facing potential erosion of equity over time," Goldman Sachs analyst Craig Hettenbach wrote in a recent research note.

Hettenbach identified four companies as potential acquisition targets: Volterra Semiconductor Corp (VLTR.O), which makes components for notebooks and servers; International Rectifier Corp (IRF.N), a maker of power semiconductors; Monolithic Power Systems Inc (MPWR.O), which sells to network equipment makers; and Micrel.

Many of these small and medium-sized companies, with market values of between $200 million and $1 billion, have engineering expertise or proprietary technologies, making them attractive buys for big companies looking to expand their businesses.

(Editing by Gerald E. McCormick)