Don't mess with Texas Instruments' chip salespeople. Given the 78% premium at which TI is buying National Semiconductor, they have got their work cut out for them.
That is because TI will have to boost National's chip sales significantly for the $6.5 billion deal to pay off for shareholders. But as the market's growth rate is expected to slow, that may be difficult.
Often when a company buys another in the same industry, big cost-cutting opportunities are available from elimination of duplicate functions. Not so with this deal: TI plans to keep National's research department and sales staff, and estimates just $100 million of synergies in corporate overhead.
To achieve its target for return on investment, TI says it can boost National's revenue growth to a level that would be double the analog chip market's growth rate. TI won't say what its growth assumptions are. Gartner analyst Steve Ohr says the market's growth rate will slow. He pegs 2011 growth at 9%, falling to 6% next year and 3.5% in 2013.
TI is certainly paying up for the growth potential, valuing National at 21 times this year's earnings, says BMO Capital Markets. That compares with faster-growing analog peers such as Linear Technology, Maxim Integrated Products and Analog Devices, all trading at 14-15 times.
TI's rationale is that by plugging National's analog product line into its 10-times-larger sales force, it can goose growth. This is a common theme for tech deals. Dell acquired storage company EqualLogic for 10 times revenue in 2007. Three years later, EqualLogic revenue had increased by a factor of eight. International Business Machines' winning M&A recipe similarly calls for buying small companies that can benefit from being plugged into a larger sales force. And Hewlett-Packard justified the big premium paid for 3PAR on the same grounds.
Bernstein analyst Stacy Rasgon likes the strategic rationale, noting that, among chip stocks he covers, National's "incremental" gross margins of 80% trail only Intel's at 90%. That means for every additional dollar of National revenue generated by TI's sales force, about 80 cents will end up as gross profit.
The biggest risk could be timing. Given the hefty price paid, TI estimates it will take three to four years before the deal's returns exceed its costs, plenty of time for the cyclical chip business to go through another downturn.
TI's big investment in National leaves little room for error if its expectations prove too bullish. Last year it added considerable manufacturing capacity to meet the post-recession jump in demand. To that it will now add National's facilities as well.
It is said everything is bigger in Texas, including, apparently, M&A optimism.
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