The chips are down in battle for mobile profits
Broadcom’s rejected $130bn bid for Qualcomm reflects intense competition amid shrinking margins, reports James Titcomb
ualcomm’s chief executive Steve Mollenkopf isn’t used to being the underdog. The American microchip giant has been a key player in the world of semiconductors for the last two and a half decades, designing the technology for digital mobile networks in the early Nineties, and profiting handsomely from the lucrative royalties it receives on every mobile.
On top of this, it makes the processors used in many of the world’s mobiles, a position that has served it extraordinarily well over the smartphone explosion of the last decade. But over the last year, Mollenkopf could be forgiven for feeling a little bullied.
In January, America’s Federal Trade Commission charged the company with exploiting the monopoly it has over phone modems to squeeze customers. Days later, Apple followed, with the world’s most valuable company cutting off royalty payments to Qualcomm and suing it for overcharging customers.
Over the summer, the European Commission launched a full investigation into its $47bn (£36bn) takeover of NXP Semiconductors, imperilling the biggest deal in its history. And last week, Qualcomm found itself the subject of an unwanted $130bn takeover bid from Broadcom, one of the few chip makers big enough to swallow it. The deal would be the biggest in tech history.
Qualcomm rejected the deal yesterday, saying it “dramatically undervalues” the company. Broadcom is expected to return with a new bid, or potentially go hostile, a further unwelcome distraction. The company’s tumultuous year may look like a run of bad luck, but it also illustrates a wider upheaval in the colossal semiconductor market Qualcomm inhabits.
Semiconductors – the silicon components that create the microprocessors and transistors at the heart of all electronics – are expected to be a $411bn market this year, up 19.7pc from 2016. The proliferation of smartphones, modems and computers into our lives, as well as higher numbers of servers, data centres and manufacturing robots in the commercial world, has meant evergrowing demand for microchips and memory – the brains that power them.
The rise of connected cars and the “internet of things” – objects in homes and factories coming online – should only increase this. But while it might seem that this can only ever be a good thing, there is as much fear as there is opportunity. Smartphone sales – the chip market that has been so lucrative for many – have slowed down in recent years, and the profitable high end of the market has become dominated by Samsung and Apple, giving the two giants more leverage over their suppliers.
“A lot of the markets that have driven growth are consolidating,” says Stuart Carlaw of ABI Research. “There’s a massive amount of power in a small number of hands, so margins are going down.” As the smartphone market cools, the things that are replacing it, such as connected cars and the internet of things, offer immense scale but not the same profits. Whereas a phone might contain hundreds of pounds of electronics, connected machines can have less than £10. “Even if we’re generating far more types of machine, the growth profile still isn’t breaking even,” says Carlaw. This change does, however, require huge investments from the semiconductor firms, which not only have to calibrate themselves to new industries but also create ever more intricate designs.
Moore’s Law – the idea that the number of transistors one can fit in a circuit (which roughly equates to computing power) doubles every year – has been accurate for half a century, but has required ballooning research and development budgets to maintain, the type of budgets that exist only in mega companies.
This partly explains the wave of consolidation that has swept through the industry in recent years, of which Broadcom’s Qualcomm offer is merely the latest and biggest. The company’s own $47bn offer for NXP last year, which is currently being held up by the European Commission, was typical of the shift into new markets, with Qualcomm seeking to reduce its reliance on smartphones and break into NXP’s connected car market.
New capital has also swept into the industry, most notably in the case of ARM Holdings, the Cambridge-based company whose chip architecture powers almost every smartphone in the world. ARM was not bought by another chip maker, but by Japan’s SoftBank, which paid £24bn for the company last year.
China, which sees expertise in semiconductors as crucial, has plunged billions into catching up to other countries. A state-backed attempt by private equity firm Canyon Bridge to buy US firm Lattice Semiconductor failed, but it succeeded in recently taking over the UK’s Imagination Technologies.
But Broadcom, Qualcomm’s suitor, has been among the biggest buyers of all. Spun off from Hewlett Packard in 1999, Avago Technologies, as it was then known, was worth less than $5bn
‘There’s a massive amount of power in a small number of hands, so margins are going down’
when it went public in 2009, but has become a $109bn behemoth through a string of deals masterminded by its chief executive Hock Tan. When it paid $37bn for Broadcom, which makes radios for phones and other electronics, in 2015, it also adopted the name. Just days before its $130bn Qualcomm offer became public, Tan visited the Oval Office to announce that Broadcom’s legal base would move from Singapore to the US, a move that many see as an attempt to win regulatory support for the deal.
It still may not win it. Thomas Vinje, the head of antitrust at law firm Clifford Chance, says Qualcomm may seek to have any hostile takeover blocked by competition regulators, and that it may have a good chance. “If one looks at the interest the European Commission has shown in the deal with NCP, it indicates pretty clearly this broader deal between Broadcom and Qualcomm would attract in-depth scrutiny,” he says.
So if microchip mergers are now getting too big to be allowed, could this be the end of the great deal making boom? ABI’s Stuart Carlow thinks not, saying that tech giants like Google and Apple could simply turn into the acquirers. It seems that when it comes to chips, there is almost always a bigger fish.