What's behind the wave of chip mergers

Dealmakers in the semiconductor industry probably have never been busier.

Not only did Intel (INTC) agree on Monday to buy Altera (ALTR) for $16.7 billion in a deal that had long been rumored, but last week came news that Avago (AVGO) agreed to acquire Broadcom (BRCM) for $37 billion, in the largest chip deal in history. The reasons for this acquisition spurt are many.

Let's take Intel. To most consumers, it's synonymous with computer chips, particularly those found in personal computers. That business, though, has faded in importance in recent years as PCs lost their position to smartphones and tablets, and as servers grew in importance.

That trend was evident in Intel's latest quarter, when operating income in its client computing group, which includes PC and tablet chips, plunged 24 percent while revenue in the data center group surged by 19 percent. Intel's server chip business is its most profitable.

"Growth is hard to come by a lot of these markets," Abhinav Davuluri, an analyst at Morningstar, told CBS MoneyWatch. "In the near term there isn't too much upside to be found. ... While the server chips have done well, it's probably the only segment that's shown significant growth in the past two quarters. If you also look at Altera, they have also had some tough times."

The combination would give the two companies some much-needed heft in the semiconductor sweepstakes. "The merged Intel-Altera would rank second, behind Texas Instruments, which is a leap from Intel's previous rank of fourth and Altera's previous rank of 29th," said IHS analyst Robbie Galoso in a statement.

The smaller company, though, didn't come cheap. According to The Wall Street Journal, Altera rejected an earlier buyout overture from Intel of $54 per share, angering some shareholders who didn't think the company would ever see deal as good. Talks broke off in April and resumed a month later. Today's acquisition price didn't change much from the earlier deal, and it represents a 56 percent premium over where Altera traded before news of the merger talks first broke.

Moreover, the companies have worked closely for years. Intel makes Altera's chips, but rumors were circulating that Altera was going to take its business to rival manufacturer Taiwan Semiconductor, according to Gartner analyst Mark Hung.

Intel is expected capitalize on Altera's strength in the communications market, where its programmable chips called field-programmable gate arrays, or FPGAs, are used in communications applications such as cellular base stations, routers and switches. FPGAs have been shown to be valuable to industries that require the rapid completion of complex calculations, such as financial services and web search.

"This is not ... a knee-jerk reaction" for Intel, said Richard Fichera, an analyst at Forrester Research, noting that one of Intel CEO Brian Krzanich's mandates from the board, was to "drive Intel into spaces other than their traditional server and laptop (areas). One of them is high-performance computing and mobile devices."

Added IHS analyst Tom Hackenberg in a statement: "Altera's position as a strong supplier of broadband, networking and telecommunications solutions was likely a crucial consideration for Intel."

Intel co-founder Gordon Moore famously wrote in a 1965 paper that the number of transistors on a dense integrated circuit doubled every two years, an observation that's been dubbed "Moore's Law." While these technological advances have contributed to the industry's rise, they've also greatly added to its costs, Gartner's Hung said.

"Moore's Law is a doubled-edged sword," he told CBS MoneyWatch. "Ten years ago, to get a chip out of production probably cost anywhere from $10 million to $50 million. Today it's in the hundreds of millions of dollars. All but a few of the largest semiconductor companies can support that kind of R&D cost. As a result we're seeing this wave of M&A."

  • Jonathan Berr On Twitter»
