>>> Weekly Update

Weekly Market Update: Mixed Earnings Give Way to "October Surprise"

Equity markets drifted lower in the latter half of the week as quarterly earnings showed no strong overall trend. Then on an otherwise quiet Friday afternoon, FBI director Comey announced investigators had uncovered new emails that may be related to the Hillary Clinton private email server probe. Though the FBI did not give any specifics on the substance of the new investigation, markets immediately went into risk-off mode, repricing the odds of the election outcome. By the close on Friday, gold futures rose to the week's high at $1285/oz, and stocks had touched their lows of the week. For the week, the S&P500 fell 0.7%, the DJIA edged up 0.1%, and the Nasdaq dropped 1.3%. Treasuries did not react much to the FBI story, with the 10-year yield remaining near the weekly high around 1.85% on Friday.

Economic data was mostly upbeat. The German Ifo Business Climate index reached its highest level in a year and a half, and the Euro Zone reported its 40th straight month of manufacturing expansion. The UK announced Q3 advance GDP at 2.3% y/y, two-tenths higher than expectations. The advance reading on US Q3 GDP also came in at a hotter than expected 2.9%, beating expectations by three-tenths of a percent, solidifying expectations of a Fed rate hike in December. Elsewhere, OPEC technical discussions on an oil production deal appeared to make little progress, as Iran and Iraq reportedly refused to support a production cut or freeze with the semi-annual OPEC meeting just one month away. WTI crude futures ended the week at lows below $49/bbl.

A slew of earnings and M&A came down the pike in a busy corporate news week. On Sunday, rumors of an AT&T acquisition of Time Warner were confirmed when AT&T disclosed it entered into agreement to acquire Time Warner in a $107.50/share cash and stock deal, though some media names lagged the broader consumer discretionary sector on Monday as regulatory hurdles ahead dampened enthusiasm for the merger. Rockwell Collins announced it had agreed to acquire B/E Aerospace in a $6.4B cash and stock deal, which sent Boeing and other industrials up to start the week. On Tuesday, Materials and industrials led the indices lower, as Caterpillar reported mixed results and cut its full-year outlook, while 3M lowered the top end of its full-year expectations. Consumer discretionary also lagged after Sherwin Williams, Whirlpool and Under Armour disappointed and cut their outlooks. On Wednesday, investors analyzed another gusher of earnings reports which generally saw tech and deep cyclical names continue to outperform companies leveraged to the US consumer. Key tech giants reported Thursday afternoon, and while Google beat on top and bottom line, Amazon worried investors by coming up short on profits. On Friday, AB Inbev led losses in the Eurostoxx after releasing Q3 results which highlighted challenges in the Brazil market.

SUNDAY 10/23
TWX: AT&T confirms to acquire Time Warner in a stock-and-cash transaction valued at $107.50/shr; total transaction value $108.7B

MONDAY 10/24
PHIA.NL: Reports Q3 Net €383M v €324M y/y, adj EBITA €649M v €570M y/y; Rev €5.9B v €5.95Be
(DE) GERMANY OCT PRELIMINARY MANUFACTURING PMI: 55.1 V 54.4E (23rd month of expansion)
(EU) EURO ZONE OCT PRELIMINARY MANUFACTURING PMI: 53.3 V 52.7E (40th month of expansion)
(UK) OCT CBI TRENDS TOTAL ORDERS: -17 V -5E
(US) OCT PRELIMINARY MARKIT MANUFACTURING PMI: 53.2 V 51.5E (highest since Oct 2015)
V: Reports Q4 $0.78 v $0.73e, R$4.26B v $4.24Be
000660.KR: Reports Q3 net KRW597M v KRW498Be; Op KRW726B v KRW660Be; Rev KRW4.24T v KRW4.17Te

TUESDAY 10/25
NOVN.CH: Reports Q3 $1.23 v $1.18e, Core Op profit $3.38B v $3.49B y/y, R$12.1B v $12.3Be
ORA.FR: Reports Q3 Restated EBITDA €3.60B v €3.59Be, Rev €10.3B v €10.2Be
(DE) GERMANY OCT IFO BUSINESS CLIMATE: 110.5 (highest since Apr 2014) V 109.6E; CURRENT ASSESSMENT: 115.0 V 114.9E
MRK: Reports Q3 $1.07 v $0.98e, R$10.5B v $10.2Be
LMT: Reports Q3 $3.61 v $2.86e, R$11.6B v $11.4Be
GM: Reports Q3 $1.72 v $1.44e, R$42.8B v $40.1Be
S: Reports Q2 -$0.04 v -$0.07e, R$8.25B v $7.99Be
FCX: Reports Q3 $0.13 v $0.19e, R$3.88B v $3.86Be
(US) OCT RICHMOND FED MANUFACTURING INDEX: -4 V -4E
(US) OCT CONSUMER CONFIDENCE: 98.6 V 101.5E
AAPL: Reports Q4 $1.67 v $1.66e, R$46.9B v $46.8Be
TWTR: Disney rumored to have rekindled takeover interest; Closing in on deal after both companies agreed on takeover price "in high $20s/shr" last week - Betaville
(AU) AUSTRALIA Q3 CONSUMER PRICES (CPI) Q/Q: 0.7% (matches 5-quarter high) V 0.5%E; Y/Y: 1.3% V 1.1%E; TRIMMED MEAN Q/Q: 0.4% V 0.4%E ; Y/Y: 1.7% V 1.7%E

WEDNESDAY 10/26
AIR.FR: Reports 9-month Net €1.81B v €1.90B y/y, Adj EBIT €2.41B v €2.80B y/y, Rev €42.7B v €43.0B y/y
SAN.ES: Reports Q3 Net €1.7B v €1.54Be, Rev €11.1B v €10.9B q/q
BAYN.DE: Reports Q3 Net profit €1.19B v €1.10Be; adj EBITDA €2.68B v €2.52Be, Rev €11.6B v €11.27Be
(DE) GERMANY NOV GFK CONSUMER CONFIDENCE: 9.7 V 10.0E
LLOY.UK: Reports Q3 PBT £1.91B v £2.0Be, Rev £4.28B v £4.24B y/y
HEIA.NL: Reports Q3 Organic beer volume +2% v +1.4%e
(UK) SEPT BBA LOANS FOR HOUSE PURCHASE: 38.3K V 37.4KE
LUV: CEO: Sees increased competition in many more markets; Q4 rev trends unch - post earning comments
3988.HK: Reports Q3 Net CNY41.8B v CNY40.8B y/y
(US) OCT PRELIMINARY MARKIT SERVICES PMI: 54.8 V 52.5E (highest since Nov 2015)
(US) SEPT NEW HOME SALES: 593K V 600KE
TSLA: Reports Q3 $0.71 v $0.14e, R$2.30B v $2.13Be
TXN: Reports Q3 $0.94 v $0.86e, R$3.68B v $3.48Be; Raises dividend 32% to $0.50 (implied yield 2.8%)
(NZ) NEW ZEALAND SEPT TRADE BALANCE (NZ$): -1.44B V -1.15BE; 3rd straight and RECORD deficit
005930.KR: Reports Q3 final Net KRW4.41T, Op profit KRW5.2T v KRW5.2T prelim, Rev KRW47.82T v KRW47.0T prelim

THURSDAY 10/27
BAS.DE: Reports final Q3 Net €888M v €1.2B y/y, EBIT €1.5B v €1.50B prelim, Rev €14.0B v €14B prelim; affirms outlook
NOK1V.FI: Reports Q3 adj Op €556M v €492Me, Rev €6.0B v €5.85Be; Names Kristian Pullola CFO effective Jan 1st
DBK.DE: Reports Q3 Net profit €256M v loss €394Me, Pretax profit €619M v loss €379Me, Rev €7.49B v €7.19Be
SU.FR: Reports Q3 Rev €6.06B v €6.21B y/y; Lays out its Growth, Execution & Digital plans at its Investor Day
BARC.UK: Reports Q3 adj Net £509M v £486M y/y, PBT £837M v £619M y/y, Net Rev £5.45B v £5.48B y/y
066570.KR: Reports Q3 Net loss KRW62.0 v KRW83.7B y/y, op profit KRW283.2B v KRW283Be; Rev KRW13.22Tv KRW13.7Te
(SE) SWEDEN CENTRAL BANK (RIKSBANK) LEAVES REPO RATE UNCHANGED AT -0.50%; AS EXPECTED
(NO) NORWAY CENTRAL BANK (NORGES) LEAVES DEPOSIT RATES UNCHANGED AT 0.50%; AS EXPECTED
(EU) EURO ZONE SEPT M3 MONEY SUPPLY Y/Y: 5.0% V 5.1%E
(UK) Q3 ADVANCE GDP Q/Q: 0.5% V 0.3%E; Y/Y: 2.3% V 2.1%E
000002.CN: Reports Q3 Net CNY2.91B v CNY2.01B y/y, Rev CNY42.3B v CNY29.3B y/y
POT: Reports Q3 $0.10 v $0.09e, R$1.14B v $1.00Be
NXPI: Confirms to be acquired by Qualcomm for $110.00/shr in cash valued at ~$47B
DOW: Reports Q3 $0.91 v $0.80e, R$12.5B v $12.1Be; Sees steady growth in North America and Europe continuing
F: Reports Q3 $0.26 v $0.21e, R$35.9B v $32.0Be
TWTR: Reports Q3 $0.13 v $0.09e, R$616.0M v $611Me; Confirms to cut up to 9% of jobs
MO: Reports Q3 $0.82 v $0.81e, R$5.19B (ex-excise tax) v $5.12Be (update)
COP: Reports Q3 -$0.66 v -$0.69e, R$6.52B v $6.54Be (update)
UPS: Reports Q3 $1.44 v $1.43e, R$14.9B v $14.7Be
(US) INITIAL JOBLESS CLAIMS: 258K V 255KE; CONTINUING CLAIMS: 2.04M V 2.05ME
(US) SEPT PRELIMINARY DURABLE GOODS ORDERS: -0.1% V 0.0%E; DURABLES EX TRANSPORTATION: 0.2% V 0.2%E
F: Exec: confirms plan to cut production during Q4, cutting output of Focus, Fusion, and Escape models - earnings call comments
(US) SEPT PENDING HOME SALES M/M: 1.5% V 1.0%E; Y/Y: 2.0% V 4.0%E
ZTO: IPO opens for trade at $18.40
AMZN: Reports Q3 $0.52 v $0.85e, R$32.7B v $32.6Be
GOOGL: Reports Q3 $9.06 v $8.58e, R$22.5B (includes $ TAC) v $22.1Be; Approves $7B buyback of Class C shares (1.3% of market cap)
BIDU: Reports Q3 $1.28 v $0.87e (unclear if comp), R$2.74B v $2.59Be
BHI: GE said to be talks to buy Baker Hughes; BHI has market cap of $23B, GE may pay over $30B - financial press

FRIDAY 10/28
BNP.FR: Reports Q3 Net €1.89B v €1.69Be, Rev €10.6B v €10.3Be
ABI.BE: Reports Q3 $0.83 v $1.02e, Adj EBITDA $4.03B v $4.43Be, Rev $11.1B v $11.4Be
(FR) FRANCE Q3 ADVANCE GDP Q/Q: 0.2% V 0.3%E; Y/Y: 1.1% V 1.2%E
SAN.FR: Reports Q3 Net €2.30B v €2.0Be; Business Op €3.10B v €2.75Be; Rev €9.65B v €9.58Be; to buy back €3.5B in shares (3.9% of market cap)
RBS.UK: Reports Q3 Net loss £469M v loss £1.08B y/y, underlying pretax £1.33B v £776Me, Rev £3.31B v £3.18B y/y
ELUXB.SE: Reports Q3 Op SEK1.83B v SEK1.72Be, Rev SEK30.9B v SEK31.4Be
3328.HK: Reports Q3 Net CNY14.9B v CNY14.7B y/y, Net interest income CNY100.8B v CNY108.0B y/y
601398.CN: Reports Q3 Net CNY72.6B v CNY72.7B y/y, Op Income CNY155.0B v CNY167.1B y/y, Net Interest Income CNY117.1B v CNY127.9B y/y
(EU) EURO ZONE OCT BUSINESS CLIMATE INDICATOR: 0.55 V 0.46E; CONSUMER CONFIDENCE (FINAL): -8.0 V -8.0E
(IT) ITALY DEBT AGENCY (TESORO) SELLS TOTAL €5.25B VS. €4.25-5.25B INDICATED RANGE IN 5-YEAR AND 10-YEAR BTP BONDS
(RU) RUSSIA CENTRAL BANK (CBR) LEAVES 1-WEEK AUCTION RATE UNCHANGED AT 10.00%; AS EXPECTED
(DE) GERMANY OCT PRELIMINARY CPI M/M: 0.2% V 0.2%E; Y/Y: 0.8% V 0.8%E
(US) Q3 ADVANCE GDP PRICE INDEX: 1.5% V 1.4%E; CORE PCE Q/Q: 1.7% V 1.6%E
(US) Q3 ADVANCE GDP ANNUALIZED Q/Q: 2.9% V 2.6%E; PERSONAL CONSUMPTION: 2.1% V 2.6%E
(US) Q3 EMPLOYMENT COST INDEX (ECI): 0.6% V 0.6%E
(US) OCT FINAL MICHIGAN CONFIDENCE: 87.2 V 88.2E (lowest level since October 2014)

>>> US Close Dow -0.05% S&P -0.31% Nasdaq -0.50% Russell -0.20%

Closing Market Summary: Stocks End Lower as Political Uncertainty Rises

The stock market ended the Friday affair on a mixed note as political uncertainty ambushed participants at the end of another earnings-packed week. The Nasdaq Composite (-0.5%) extended its weekly loss to 1.3% while the S&P 500 (-0.3%; week-to-date: -0.7%) and the Dow Jones Industrial Average (-0.1%; week-to-date: +0.1%) finished closer to their flat lines.

Equity indices saw some slight selling in the opening minutes of the session, but climbed shortly thereafter as investors assessed some upbeat economic data and the latest raft of quarterly earnings reports.

The third quarter advance reading of U.S. GDP registered at 2.9%, exceeding the consensus of 2.5%. The data showed that real GDP accelerated in the third quarter, surpassing the 1.4% increase in the second quarter and the 0.8% increase in the first quarter. The average growth rate for the first three quarters of 2016 remains anemic, checking in at 1.7%.

On the earnings front, bellwether reports from Amazon (AMZN 776.32, -42.04, -5.1%) and Alphabet (GOOG 795.37, +0.02, 0.0%) came in on a mixed note. However, it was cautious commentary and disappointing results from the health care sector (-2.2%) that stole the show. McKesson (MCK 124.11, -36.39) plunged 22.7% after warning that price trends from pharmaceutical and biotechnology companies have resulted in lower profit contributions. The remarks took hold as investors continue to ruminate over the impact of this election cycle on the pharmaceutical industry's pricing practices. 

The major averages tumbled to session lows in the afternoon, responding to reports that FBI director James Comey may re-open a probe into Democratic Presidential nominee Hillary Clinton's emails. The reports were sparked by a tweet from Republican Congressman Jason Chaffetz, indicating that the FBI has "learned of the existence of emails that appear to be pertinent" to the previously completed investigation. Reports later indicated that the newly discovered e-mails were found on a new device and were not withheld from the previous investigation.

The benchmark index ebbed towards its low in the final hour as five sectors ended in the red. Health care (-2.2%), energy (-0.5%), and financials (-0.4%) rounded out the leaderboard while industrials (+0.6%), consumer staples (+0.5%), and real estate (+0.3%) outperformed. 

The health care sector (-2.2%) led the retreat as results and guidance from McKesson (MCK 124.11, -36.39, -22.7%) and Amgen (AMGN 145.18, -15.39, -9.6%) pressured the group. Dow component Merck (MRK 58.84, -2.45) finished at the bottom the price-weighted average, falling 4.0%. Meanwhile, the iShares Nasdaq Biotechnology ETF (IBB 260.49, -4.98) declined 1.9%, extending its October loss to 10.0%.

In the industrial space (+0.7%), Dow component General Electric (GE 29.22, +0.59, +2.1%) outperformed after announcing that it is exploring partnership opportunities with Baker Hughes (BHI 59.12, +4.57, +8.4%). The defense and aerospace sub-group was also able to extend its winning streak as United Technologies (UTX 101.84, +1.77, +1.8%) gained 3.2% this week. The broader sector moved higher by 0.2% over that period.

The influential technology group (UNCH) finished flat as top- and bottom-line beats from Alphabet (GOOG 795.37, +0.02, 0.0%) failed to rally the group. Facebook (FB 131.29, +1.60) managed a 1.2% gain ahead of next Wednesday's earnings report. Separately, the PHLX Semiconductor Index fell 0.6%, narrowing its weekly gain to 0.5%.

The Treasury complex settled on a mixed note with the short end of the curve outperforming. The yield on the 2-yr note slipped three basis points to 0.86% while the yield on the benchmark 10-yr note ended down one basis point (1.85%). The 30-yr bond ended little changed with its yield at 2.62%.

Today's trading volume was above the average of 850 million as 941 million shares changed hands at the NYSE floor.

Today's economic data included the advance estimate of Q3 GDP, the Q3 Employment Cost Index, and Michigan Sentiment:

  • Real GDP increased at a seasonally adjusted annual rate of 2.9% in the third quarter (consensus +2.5%), up from 1.4% in the second quarter and the highest rate since the third quarter of 2014.
    • The GDP Deflator rose 1.5% (consensus +1.4%) after a 2.3% increase in the second quarter.
  • On a seasonally adjusted basis, compensation costs for civilian workers increased 0.6% in the third quarter.
    • That was in-line with the consensus estimate and the third straight quarter the employment cost index has increased 0.6%.
  • The final reading for the University of Michigan Consumer Sentiment Index for October dipped to 87.2 in October from the preliminary reading of 87.9.
    • The final October reading also marked a downturn from the final reading of 91.2 for September and was the lowest reading since October 2014.

Monday's economic data will include the 8:30 ET release of Personal Income (consensus +0.4%), Personal Spending (consensus +0.5%), and Core PCE Prices (consensus +0.1%) for September. The day's data will be capped off with the release of Chicago PMI for October (consensus 54.0), which will be released at 9:45 ET. 

  • Russell 2000: +4.5% YTD
  • Dow Jones: +4.2% YTD
  • S&P 500: +4.0% YTD
  • Nasdaq: +3.7% YTD

>>> Air Products watching for complementary buys; industrial gases in focus

Air Products watching for complementary buys; industrial gases in focus

Air Products (NYSE:APD) the Allentown, Pennsylvania-based industrial gases company, has the balance sheet strength to pursue acquisitions for its core industrial gases operations, according to executives.
On Thursday’s 4Q16 earnings call, CEO Seifi Ghasemi noted the company announced in September 2015 its plans to spin off its Material Technologies business by end fiscal 2016 and that the unit, now named Versum Materials, had been a listed standalone company since 1 October. Ghasemi added that Air Products was progressing with the sale of its performance and additive materials business, which was expected to close by calendar year end.
Later in his prepared remarks, the CEO said with its restructuring complete, Air Products would focus on profitable growth.
“We have the balance sheet capacity now to take advantage of the very exciting growth opportunities we see, including accretive and complementary acquisitions focused on our core Industrial Gases business,” Ghasemi added.
CFO Scott Crocco said in his prepared remarks that Air Products had USD 550m more cash and USD 425m less debt following the Versum spinoff.
In the Q&A session, Barclays analyst Duffy Fischer asked how Air Products planned to spend its cash pile in the next 18 months.
“Sitting on top of USD 3bn of cash is obviously not what we intend to do,” CEO Ghasemi replied. “We do have plans to deploy that cash properly, we are not in a hurry to do that, we are not going to do anything rash, but we feel very good about that.”
Later in the Q&A session, Citi's P.J. Juvekar asked if the company was interested in large M&A.
“I don't want to comment on what our competitors are doing, but we think pursuing big M&A among the four major industrial gas companies is a foolish idea and we are not going to pursue foolish ideas,” Ghasemi said. “We don't have any plans to participate, we'll sit back and if anything happens, there certainly will be a lot of pieces that comes out. We have a lot of cash that would be kind of Christmas for us if it happens.”
Air Products’ core Industrial Gases business provides atmospheric and process gases and related equipment to manufacturing markets, including refining and petrochemical, metals, electronics, and food and beverage. Air Products also supplies liquefied natural gas process technology and equipment. Its Performance Materials business serves the polyurethanes, cleaning and coatings, and adhesives industries.
The company has largely focused on disposals in the past few years, with its last notable acquisition in 2013.
Lazard acted as sole financial advisor with regard to the Versum separation. Skadden, Arps, Slate, Meagher & Flom acted as Air Products' lead counsel.

Other advisors used in the past decade include JPMorgan and Rothschild on the financial side, while McDermott, Will & Emery, White & Case, Hogan Lovells International and Freshfields Bruckhaus Deringer are among the law firms used, according to the Mergermarket M&A database.
Air Products has a market capitalization of USD 28.9bn.

>>> Sources Say Oracle In Final Stages Of Advanced Micro Devices Buyout, Seeks H

Sources Say Oracle In Final Stages Of Advanced Micro Devices Buyout, Seeks Hardware Play On VR/AR

Sources in Silicon Valley say ORACLE's brass has been meeting with AMD’s management, stating ORACLE is seeking a way to diversify offerings. The Redwood, CA software giant’s own hardware revenues and profits have contracted since 2010. To capture future value from VR/AR and to take on INTEL, ORACLE needs a separate brand that already has great products and a dedicated following.

AMD shares are trading at a level last seen in 2012. The company is gaining momentum, has great products, is in a field set to be the foundation for the next leg-up in technology advances, and the management is not exactly Grade-A (per the perceptions of various traders willing to pontificate when asked what AMD’s biggest weakness is).

The hardware game is strong and its future for VR/AR is bright. Analysts are bullish on not only PCs (which may be showing signs of demand from either channel-stuffing or end-users, still hard to tell) but also gaming consoles and potential VR/AR platforms. There is a whole new realm of mass-market potential for new hardware to operate VR/AR and Oracle's "difficult" past with hardware has left the firm seeking a way to position itself for these new opportunities

>>> Aixtron/FGC backlash reflects Chinese semiconductor buyers’ struggles

Aixtron/FGC backlash reflects Chinese semiconductor buyers’ struggles

  • Aixtron/FGC troubles mirror earlier CFIUS deal blocks
  • PE dominance of outbound bids undermines synergy benefits
  • IDMs and equipment makers as favored targets

If Fujian Grand Chip Investment Fund (FGC) abandons its agreed EUR 670m acquisition of Aixtron [ETR:AIXA] following the German economy ministry’s withdrawal of its approval it will result in a much tougher future regulatory environment for Chinese buyers who are already struggling to acquire and integrate state-of-art technology assets, said a senior executive at an industry association.
“If the deal fails it’s definitely bad news for other Chinese IC buyers,” said the executive who acknowledged outbound M&A is key to China’s goal to build a semiconductor industry. “Aixtron has solid strength in essential MOCVD [metal-organic chemical vapour deposition technologies] which would greatly boost China’s growth in this field if the ongoing takeover offer can be successfully completed,” said the executive.
Shares in Aixtron have fallen 13% since 25 October when it said the German ministry’s u-turn was due to it becoming aware that the company’s technological know-how extended into the defence sector. One report said US intelligence had tipped off its German counterparts that the deal could give Beijing access to technology that could be used for military purposes. The deal is also undergoing a review from the Committee on Foreign Investment in the United States (CFIUS).
The executive said the US always holds sway over such deals that involve cutting-edge assets essential to maintain its own competence in areas such as defense and aeronautics. Its scrutiny is less strict in sectors like consumer electronics, the executive added. The Aixtron setback further highlights the extent to which CFIUS’ tentacles stretch beyond US shores and comes nine months after the US agency effectively blocked a Chinese private equity consortium’s bid for an 80% stake in Dutch company Philips’[AMS:PHIA] lighting businesses for similar reasons. The perception of CFIUS risk played a key role in derailing Chinese bids for numerous US semiconductor companies, namely Pericom Semiconductor, Fairchild Semiconductor and Affymetrix. CFIUS was also prominent in thwarting an agreed USD 3.8bn equity investment byUnisplendor Corporation [SHE:000938], a business unit of Tsinghua Holdings, in Western Digital [NASDAQ:WDC], a US manufacturer of computer and information storage solutions, as reported.
Notably, these failed Chinese bid attempts were largely led by Chinese private equity players or state affiliated investors. Indeed, eight of the last ten Chinese outbound semiconductor deals above USD 300m in value have been led by private equity investors with the two exceptions including the troubled STATS ChipPAC sale to China’s Jiangsu Changjiang Electronics Technology (JCET) [SHE:600584], according to Mergermarket records. STATS ChipPAC is suffering from considerable losses and there is still some way to go before the expected synergies can be realized, according to a recent JCET announcement.

PE dominance in M&A bids reflects trade players’ weakness
The dominance of private equity bidders and lack of strategic acquirers for overseas semiconductor assets is causing two key problems for China, said industry sources.
Firstly, large Chinese companies with international reputations would have more chances in winning national security clearances than those bidders that have opaque backgrounds such as FGC, said the executive.
The extent to which the first part of this statement is true is debatable as regulatory opposition to most of China’s failed semiconductor deals does not appear to have been linked to the particular nature or identity of the Chinese buyer. But certainly, the background and motives of FGC, a Chinese investment fund, has come under scrutiny due to suspicion, as first reported by this news service, that it is linked to San’an Optoelectronics [SHA:600703] - a Xiamen-based customer of Aixtron that sent the German company’s shares into free fall by cancelling an MOCVD order in December. San’an has not responded to this suspicion, which has since been reported elsewhere.
Secondly, the dominance of private equity acquirers over strategic buyers is hampering integration and synergy extraction efforts, said industry sources speaking at the recent 2016 China IC Industry Development Forum in Xiamen.
Wenwu Ding, president of China Integrated Circuit Industry Investment Fund (CICF) said that although China is becoming more experienced in outbound deal-making, its semiconductor industry is still lacking Chinese bidders with strong financial resources, technologies and global operational capability. Chinese outbound buyers need to focus on achieving reasonable valuations, effective control, and integrating targets with China’s own industry to realize concrete synergies from China’s outbound M&A deals, he added.
Haijun Zhao, COO of China’s largest foundry SMIC [NYSE:SMI; SEHK:981], agreed with Ding and stressed the need for Chinese industry players to take the lead in overseas deals. Private equity funds, which are currently in the driver’s seat in China’s outbound M&A activities, are at a disadvantage in achieving expected post-deal synergies when compared with strategic buyers, he said.
As part of the “Made in China 2025” plan, Beijing wants 40% of the country’s chip consumption manufactured locally by 2020, and to further increase this ratio to 70% by 2025. Last year only 27% of China’s chip consumption was made locally, according to China State Council's statistics. Some research firms consider this number is over stated and project the real number is around 20%.
While independent R&D remains the core theme of long term industry growth, M&As can fast-track China’s IC industry strategic goals and address mounting R&D and manufacturing costs in capital-intensive sectors like memories where market concentration has left only three key global players, said Xiekang Yu, deputy director and secretary general, IC Branch of China Semiconductor Industry Association (CSIA).
He added that cross-border deals would enable Chinese industry players to catch up with global giants by minimizing time to market and making strides in overall competence, while domestic deals would help create globally competitive players by streamlining local industry chain of the world’s biggest IC market, Yu said.
However, Mergermarket data shows that this domestic deal activity does not appear to be creating the powerhouses needed. While the number and combined value of agreed or completed Chinese outbound semiconductor deals has steadily climbed for the past three years - from six deals worth USD 3.1bn in 2014 to 13 deals worth USD 5.1bn in the first nine months of 2016 – domestic deal activity has, in fact, slipped. The first nine months of 2015 saw 21 domestic Chinese deals worth an average of USD 114m. The comparable period this year has seen 17 deals worth a combined USD 105m, based on Mergermarket data.

Chinese strategics need to target niche businesses
Feasible overseas targets for Chinese strategic buyers could be small-to-medium sized Integrated Device Manufacturers (IDMs) that operate in niche sectors and face succession issues. Such potential targets have proprietary technologies and manufacturing capacity, and might consider a sale to a Chinese bidder as they tend to have meager prospect of IPOs or other strategic opportunities, said Nasa Tsai, general manager of China-based IDM Changsha Innovation Semiconductor and a veteran industry executive running various large IC companies in Taiwan and mainland China since 1980s.
These IDMs could be attractive targets for higher rate of deal completion and easier post-deal integration - in certain circumstances their fabrication facilities could even be relocated to China, noted Tsai, who added that regulatory hurdles mean Chinese buyers have little chance in acquiring assets from global sector giants.
Cunzhong Jin, secretary general, China Electronic Production Equipment Industry Association (CEPEA) told this news service that the Association wants to see more M&A driven growth in China’s IC equipment sector. But he also concedes feasible overseas targets are hard to find, as IC equipment giants like ASML [AMS:ASML], LAM Research [NASDAQ:LRCX] and KLA Tencor [NASDAQ:KLAC], which have been consolidating or trying to, are unlikely to consider selling to Chinese buyers. Jin also thought it unworkable for Chinese buyers to target international component providers to meet China’s need for certain key components (the country now relies on imports) used in the country’s own IC equipment. This is because on top of the regulatory headwinds and post-deal integration difficulties such a deal would have, these providers are too big to consider interest from potential Chinese bidders.
Sevenstar Electronics [SHE:002371], a China-based IC equipment provider that recently completed its CNY 924m (USD 139m) acquisition of its Chinese peer North Microelectronics, is one strategic that does not rule out the possibility of considering more M&A opportunities, said a source familiar with the company. The source added that acquisitions are important to accelerate China’s industry growth, but successful buyers need to run the gamut of finance, technology, market, intellectual property factors to achieve significant synergies, the source acknowledged.
The executive cautioned that Chinese buyers risk creating new competitors if they fail to retain core assets of target companies.