Intel Deal A Good Template For Chip Consolidation
A significant move of consolidation occurred in China’s fragmented microchip design sector last week, when global leader Intel (Nasdaq: INTC) purchased a strategic minority stake in a Chinese company formed through the recent combination of 2 midsized players. The step will bring together domestic smartphone chip designers RDA Microelectronics and Spreadtrum, with Intel’s huge financial resources, R&D muscle and global sales network.
The latest alliance is being driven most by Intel, which is trying to catch up in a booming smartphone chip space where it is now an insignificant player after badly misjudging the market. But the alliance was also nurtured by the government, in this case by a unit of the prestigious Tsinghua University, which forged the partnership in its bid to build a Chinese firm that could someday challenge current global leaders.
Beijing should encourage more of this kind of consolidation in not only its chip sector, but also other high-tech areas that are currently populated with too many small players. Such a strategy could build some true Chinese world-class tech firms. By focusing on such a strategy that emphasizes company development over heavy regulation, Beijing could also reduce criticisms of protectionism as it tries to control the dominance of foreign firms in some product categories.
Despite big potential, China’s chip design sector has become highly fragmented over the last decade, populated by a wide array of small- to mid-sized companies. Most such firms develop a wide range of products, most of which provide the “brains” for electronic devices from smartphones to televisions and washing machines.
Cellphone chips have become one of the biggest growth spaces, and 2 of the largest homegrown players, Spreadtrum and RDA, listed in New York in 2007 and 2010, respectively, in a bid to tap investor enthusiasm to fund their future development. But the companies failed to realize their potential due to their small size that put them at a disadvantage to big global names like US leader Qualcomm (Nasdaq: QCOM) and Taiwan’s Mediatek (Taipei: 2454).
As a result, Spreadtrum and RDA posted unimpressive growth and saw their stocks languish, setting the stage for buyouts over the past year by Tsinghua Unigroup. The buyer, affiliated with China’s most prestigious science and technology university, bought Spreadtrum for about $1.5 billion and RDA for $1 billion, producing a company worth just a fraction of Mediatek’s $27 billion and Qualcomm’s $125 billion.
But the newly formed Chinese chipmaker got a big boost last week when Intel announced it would pay $1.5 billion for 20 percent of the new company, instantly raising Tsinghua Unigroup’s value by a factor of 3 to about $7.5 billion. (company announcement) The high valuation reflects Intel’s confidence in Unigroup’s new scale, and also Intel’s desire to find a strong entry point into the lucrative smartphone microchip market.
The potent combination of Spreadtrum, RDA and Intel could mark just the first step in the creation of a major new Chinese player, following Intel’s May tie-up with Rockchip, a China-based maker of chips used in the related tablet PC space. That deal didn’t see Intel take an equity stake in Rockchip, but the US giant could use its growing presence to help bring together all 3 companies.
Tsinghua should be commended for successfully privatizing the laggard RDA and Spreadtrum, and then bringing in Intel to sharply boost the new company’s value. Other government agencies should continue this drive by taking additional steps, such as providing tax incentives and merger financing, to promote consolidation necessary to build future global industry leaders.
Other sectors that could benefit from such consolidation include contract chip makers, as well as consumer electronic sectors making products like smartphones and televisions. Such areas are often dominated by big global names like Samsung (Seoul: 005930) and Apple (Nasdaq: AAPL), which benefit from large size that gives them deep resources to devote to sales and product development.
Such a policy of promoting consolidation can sometimes be difficult due to the many stakeholders involved, complexities of M&A financing, and diverse geographies and product offerings of companies involved. But the potential rewards can also be big, as reflected by the early positive signs coming from Tsinghua’s efforts with Spreadtrum, RDA and now Intel.
Such an approach would also send a positive signal that China intends to challenge big global names like Qualcomm and Microsoft (Nasdaq: MSFT) through the transparent and commercial process of building its own homegrown rivals. That could help to quiet recent growing concerns from the foreign business community about protectionism by Beijing.
Bottom line: Intel’s new chip tie-up with 2 midsized players looks like a good template for consolidation, and could produce homegrown firms that can compete with global rivals.
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