June 4, 2019

Breakingviews: Transatlantic $10 bln chip deal does not compute

by Breakingviews.

Infineon Technologies’ 9 billion euro ($10.1 billion) acquisition of Cypress Semiconductor does not compute. Chief Executive Reinhard Ploss on Monday unveiled a deal that will make his $20 billion group the biggest supplier of microchips to the automotive industry. Delve into the financial circuitry, however, and the price looks too high.

Competitive bidding tension helps explain why Infineon is paying a 46% premium above the price of Cypress’ shares in the month before reports of the deal surfaced. Chief Marketing Officer Helmut Gassel told journalists on Monday that Infineon had been invited into discussions around five weeks ago, after another company had expressed interest in Cypress.

Infineon is counting on costs savings of roughly $200 million by 2022, mostly from “economies of scale”, and extra revenue of $1.7 billion in the long term. Revenue synergies will be generated by using the combined company’s broader suite of semiconductor products to win more business at customers like carmakers. However, Ploss has yet to spell out exactly how he plans to make this happen.

Even assuming he can meet his ambitious revenue goals, Infineon appears to be overpaying. Cypress is expected to generate $560 million of operating profit in 2021, according to Refinitiv estimates. Assume that rises 9%, in line with Ploss’ top-line growth target, to $610 million in 2022, and that the cost savings come through in full, pushing the total to around $810 million. Next add $386 million from the revenue synergies, assuming a 23% margin. Deduct tax at this year’s 16%, which is lower than the rate expected for the coming two years, and the resulting $1 billion return barely meets the semiconductor sector’s probable 10% cost of capital, using New York University estimates.

If even such optimistic assumptions struggle to create value, Infineon shareholders will be forgiven for wondering how successful the deal will be after integration costs are taken into account. There’s also a risk of culture clash between the Californian group and its new German engineering-focused parent. The idea of a rival buying Cypress may have motivated Ploss to pay top dollar. But fear of missing out is leading him into profligacy.

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