Intel's latest $5.4B takeover is a big bet a glut is not coming

With bosses named Gelsinger and Ellwanger, Intel and Tower Semiconductor sound like they were made to fit together. Investors must hope they do after Intel this week bid $5.4 billion for the Israeli foundry, a figure that represents about 36 times what it probably made last year in operating profit (it has yet to publish full-year results). At $53 per share, Intel's all-cash offer values Tower Semiconductor at a 61% premium to its share price on February 14.

Unsurprisingly, it shot up 42% on the Nasdaq yesterday following news of the bid, while Intel's rose just 1.8%. The rationale is that acquisition of the Israeli firm will help Intel beef up manufacturing and branch into contract chipmaking, a strategic shift Pat Gelsinger announced after joining Intel as CEO exactly one year ago. It also brings expertise in areas where Intel has looked relatively weak, with radio frequency among them.

Figure 2: Tower Semiconductor's share price on the Nasdaq ($) (Source: Google Finance)

It will do nothing, however, to make Intel more competitive against Taiwan's TSMC and South Korea's Samsung in the market for advanced chips – the kind whose transistors measure less than 10 nanometers (billionths of a meter). The strength of Tower, led by Russell Ellwanger, lies in more established processes. Its sites in Israel, Japan and the US crank out 150- or 200-nanometer chips, while a facility it shares with STMicroelectronics in Italy will be geared up for the 300-nanometer variety.

These are hugely important for a multitude of sectors, including consumer and industrial electronics, automotive, mobile, healthcare, aerospace and defense. Many have been crippled during the COVID-19 pandemic by a components shortage chipmakers including Intel are racing to address. Demand has soared. Even before Intel's offer, Tower's share price had doubled since March 2020, when countries began to impose restrictions. Sales for the first nine months of 2021 rose nearly a fifth year-on-year, to about $1.1 billion.

Spending splurge

This must all sound like a lucrative opportunity for Intel, but $5.4 billion is a lot to pay for a company with annual sales of $1.5 billion, even if Tower is growing fast. Intel's long-term debt of $33.5 billion does not look horrifying given the $22.2 billion it made in operating profit last year. But that profit number was 9% lower than Intel reported for 2020, and Intel is spending heavily to become a foundry.

Most of its planned investments are aimed at building new facilities in the US and Europe, where policymakers have been courting Intel and other chipmaking giants, desperate to wean themselves off chips made in Asia. Capital expenditure rose from just $14.3 billion in 2020 to $18.7 billion last year and Intel has committed to spending at least $22.3 billion in 2022 (it had made overall future commitments totaling $27 billion, it said in its last annual filing with the Securities and Exchange Commission).

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Whether this is a good idea depends largely on your vision of the future. The semiconductor industry has been cursed by boom-and-bust cyclicality in the past, with gluts succeeding shortages after waves of factory investment. Some think it is still trapped in this cycle – that Intel and others will struggle to sell a lot of very expensively produced chips in future. TSMC's investments are also rocketing. It plans to spend between $40 billion and $44 billion this year, up from $30 billion in 2021.

The alternative viewpoint is that demand will not drop off but continue to rise as technology spreads virus-like around the planet. The emergence of new connected gadgets, investment in data centers and 5G networks and the automation of industrial sites are just a few of the trends that could, in theory, break the boom-and-bust cycle for the next few years.

This forecast is usually peddled by the companies involved in making semiconductors or semiconductor equipment, however. The increasingly geopolitical nature of the chip industry is a further worry. Intel and TSMC are plowing money into fabs partly in response to government initiatives driven by protectionism and even fear of conflict.

Neither Europe nor the US, for instance, will be happy that about 85% of high-end chips come from Taiwan, a country China's rulers constantly threaten and claim as part of China. If the investments are merely about creating alternatives, oversupply could be a problem.

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— Iain Morris, International Editor, Light Reading