Coverage: Avago buys Broadcom for $37 Billion

There are a lot of deals lately, but Thursday brought a huge one. Avago is purchasing rival chip maker Broadcom for $37 billion to create a $77 billion company. The

The USA Today story by Kevin McCoy and Mike Snider said the deal was one of the largest in tech history:

Chipmaker Avago Technologies (AVGO) Thursday announced plans to buy rival Broadcom (BRCM) in a $37 billion cash and stock deal marking the latest consolidation of firms that supply parts for smartphones and other tech products.

The deal, one of the largest tech acquisitions in history, values the combined companies at $77 billion in enterprise value.

Avago and Broadcom predicted the combined firm would have “the most diversified communications platform in the semiconductor industry, with combined annual revenues of approximately $15 billion.”

This deal could mark the start of a new string of megamergers in the tech industry, says Christopher Rolland, an analyst with investment bank firm FBR & Co. “We have seen a slowdown in top buying growth rates. So one of your options to at least generate growth on the bottom line is to do accretive deals,” he said. “There is actually very little strategic overlap between the two companies. What they will get out of it is size.”

The Wall Street Journal story by Dan Gallagher said that Avago’s recent success is giving it the confidence to try such a large transaction:

Consider that the chip maker’s market value has tripled since December of 2013, when it announced its $6.6 billion purchase of LSI Corp. That was Avago’s largest deal by far at the time, and meant the company had to take on significant leverage, given that the purchase price was more than six times Avago’s cash on hand.

That big bet worked. Avago’s revenue base has roughly doubled, and its gross margin has climbed to 61% for the fiscal second quarter ended May 3. That was up from 54% in the same period last year. And the debt load the company took on to do the deal has proved manageable; Avago succeeded in bringing its current ratio of debt to earnings before interest, taxes, depreciation and amortization to 1.8 times now from 3.8 times when it bought LSI.

So it is little wonder that the company feels it can jump back into the deep end of the pool. Avago confirmed Thursday it is buying Broadcom, using its valuable stock to cover about 54% of the purchase price. The rest will come in cash, about $9 billion of which will be financed with debt.

The Los Angeles Times story by Dean Starkman had a question-and-answer piece about the details of the deals and said the timing was favorable:

While the semiconductor business remains highly profitable, annual growth in recent years has slowed to single digits. Big companies, which have high capital costs, find they are able to boost profitability through economies of scale.

Plus, technology stocks have been rising for more than year, increasing the value of shares that the companies use as currency in such transactions. Companies tend to do deals while the stock is high.

Stacy Higginbotham had this background about Avago in a story for Fortune:

Avago was created when private equity firms Silver Lake and Kohlberg Kravis Roberts & Co.  KKR 0.09%  purchased the Agilent chip assets in 2005 to create a new rollup in the semiconductor market. It has since acquired other companies like LSI, and was reportedly looking to spend about $10 billion buying another chipmaker like Xilinx  XLNX 0.28% , Renesas Electronics or Maxim Integrated Products  MXIM 0.81% . Avago makes a variety of analog and mixed-signal chips used in automotive, industrial and communications applications. It also makes custom-designed chips known as ASICS that are used in networking.

Broadcom would be a large company to swallow, but the industry is consolidating.

CNET’s Ben Fox Rubin and Don Reisinger said that chip companies may need to merge in order to survive:

Still, the new deal points to a big trend in chips, in which companies need to find new partners or acquisition targets to stay alive in their rapidly changing and capital-intensive market. Another major impetus for these deals is the so-called Internet of Things, a concept of bringing online billions of new objects — from lampposts to clothing — which chipmakers see as the next big market for their processors and radio chips. For now, no one company has a broad enough portfolio to serve the young Internet of Things space, so these firms are all trying to partner or acquire their way there.

For consumers, all this consolidation may result in just a handful of companies taking control of bigger chunks of the chips market, potentially resulting in fewer options and higher prices. As a potential benefit, the combinations could help make the Internet of Things a reality more quickly.

With the rise of the Internet of Things, the key for many companies will be innovation and adaptation by companies. Big deals like this can be hard to integrate and manage, so the trick will be finding some synergies and getting a handle on the size of the new company.