I am certainly not a finance professional, nor do I have any personal or economic interest in talking the Avago-Broadcom merger up or down. When that is said, I am very interested in understanding the mechanics of semiconductor mergers. They have become the preferred way of growing in the semiconductor industry, but nobody knows if they create value for other stakeholders than the two management teams that get rewarded handsomely. Companies become larger than the were, but that is not the same as becoming better than they were. Size does not equal value for every stakeholder.
M&A is the only game where the loser gets paid more than the winner
The only public information about a merger or acquisition is positive and talks about the upsides of the companies joining forces. Information about potential risks or losses is incomplete or omitted. If you ever have been part of a merger team, you will know how bloody and messy things can be on the inside at the same time as corporate communications send soothing music to the markets.
When M&A becomes your main growth engine you have your back to your customers.
Most people in the industry seems to assume that the finance team have done the math and approved the merger from a financial perspective. It is safe to assume that there has been plenty analysis before signing the deal. Much more interesting is it to identify what the analysis is based upon. In the Due Diligence process, the buying entity is allowed to review all financial material, and everything else deemed material from the selling entity.
It is also safe to assume that the selling entity will make sure they get a good deal or they will have to answer to rebel investors and potential lawsuits. It is much more difficult for shareholders of the buying entity to understand if they are getting a good deal or not.
Where lawsuits from shareholders of the selling entity in an acquisition are quite common, you rarely see lawsuits from shareholders of the buying entity.
To buy a good company, you are likely to have to pay more than its is worth in the market. The deal can be attractive if the acquired company can be made worth more by joining the buying company than it could alone. Synergies can be created by expanding the offerings to customers or by lowering costs by economies of scales. The problem with synergies is that they are based on assumptions and expectations of the future and have a lot of risks associated.
The merger balance sheet.
A way of getting additional information about a merger is to take a look at the merger balance sheet. This information alone is not sufficient to establish if the merger makes sense or not, but it can be used to highlight issues and risks associated with the acquisition. The merger balance sheet is what entering the buying company's balance sheet in return for the purchase price creating a new balance. You can see what you paid for.
For a mega merger like Avago-Broadcom we are talking big numbers - we are certainly in the closed area of the casino - and as Avago was the smallest company the merger is going to change the balance sheet dramatically.
All figures are from AVGO balance sheet and in B$
Price of acquisition
The first element of the merger balance sheet is the acquisition price, in this case, shown less cash. You can view the transaction to include the acquired company's cash or exclude it as you immediately use the money to fund the transaction.
The working capital involves the net value of all the assets that are in the cash cycle of the acquired company. This includes account receivables, account payables, and inventories. Also, assets held for sale and the short-term impact of debt is included. Working capital is a tangible asset, it has a very clear monetary value.
Property, Plant and Equipment
This asset group is also tangible. It is a group of physical assets with very clear accounting rules for establishing value. As Broadcom's business model was fabless, it is not surprising that this asset group is relatively modest in size.
The next two asset groups are non-physical and much more complex to evaluate. The part that is possible to identify and assign a value to is called intangible assets. As can be seen from the chart, this includes trade names, customer backlog and contracts and technology plus in development technology. Although there are rules for how to establish the value, there is a lot of interpretation possible. The last and maybe most interesting element of the balance sheet is Goodwill. It represents the intangible value of unidentifiable assets. Goodwill also represents the price the buying company is willing to pay for above and beyond what can be specified in the balance sheet. The long-term liability element is predominantly deferred tax as a result of the write-up of Broadcom's assets.
When seeing the deal as expressed in its balance sheet components, it becomes clear that a semiconductor merger involves a lot of estimations, assumptions and expectations. In short, there is plenty of risks involved as well. Even thought M&A is the preferred growth strategy in the Semiconductor industry presently, it also represents a danger to the companies involved. Synergies will be harder to unlock as manufacturing costs are equalised and the market dominated by fewer larger companies with wider product portfolios. During the merger, companies need to reassign a lot of their people away from operations and into integration related activity. Companies risk forgetting the customer in this phase.
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