This article first appeared in The Edge Malaysia Weekly on November 20, 2017 - November 26, 2017
ON Thursday, Nov 2, US President Donald Trump unveiled his signature tax reform plan in the Oval Office at the White House. He was flanked by Penang-born Tan Hock Eng, 65, CEO of Singapore-based, San Jose-run, communications chip firm Broadcom, which has a market capitalisation of US$106 billion. Broadcom, Tan told Trump and the White House audience, was ready to “make America home again” as it relocates from Singapore to Delaware.
“My mother could never have imagined that one day her son would be here in the Oval Office standing beside the president of the United States,” Tan said in a voice choked with emotion. Trump moved forward, put his arms around Tan and said: “And my mother too,” to roars of laughter. Tan and Trump were being chummy as they patted each other on the back. Each needed the other. Trump needed a CEO who was willing to say his tax reform proposals would do what they are supposed to and Tan needed the White House’s seal of approval for the next leg of his acquisition spree.
Tan who? And Broadcom? Most Malaysians and Singaporeans may not have heard of him until recently but Tan, who briefly ran mid-sized, Kuala Lumpur-based, construction materials firm Hume Industries in the mid-1980s, is CEO of one of the largest, fastest-growing and — because of its acquisitive ways — increasingly the most-feared technology companies in the world. Measured by market capitalisation, Broadcom is the largest Singapore company, though it is listed on Nasdaq. Tan was a long-time Singapore permanent resident and ran a venture capital firm here between 1988 and 1992 before he relocated to the US.
A key plank of Trump’s argument has been that tax reforms would bring back nearly three trillion dollars of profits that US companies have stashed overseas to avoid paying taxes, and end corporate inversion — the practice of relocating a company’s legal domicile to a lower-tax nation, or tax haven, while retaining its key operations in its higher-tax country of origin.
Tan’s Oval Office appearance was a prequel to many things. Within hours, news leaked out that Broadcom was mounting an unsolicited bid for Qualcomm at US$70 a share (US$60 in cash and US$10 in stock), a 28% premium, which values it at US$105.3 billion, the largest takeover deal in the history of technology.
Qualcomm’s board promptly rejected the offer, saying it “dramatically undervalues” the firm, whose stock was trading around US$80 last year before its long-standing legal tiff with one of its biggest clients, Apple, spilled over into the courtrooms. “It’s still early days in the high-stakes game,” says Amit Daryanani, analyst for RBC Capital Markets in San Francisco. He expects a proxy battle to ensue and Tan to eventually win, as long as he can sweeten his initial offer. Qualcomm’s board and shareholders may be holding out for 15% more than the original offer. Somewhere between US$115 billion and US$120 billion, or US$77 to US$82 a share, the deal gets done, say semiconductor analysts in New York and San Francisco who have spoken to The Edge Singapore in recent days.
Impact of tax reform bill
Broadcom is one of two Nasdaq-listed tech giants that have long maintained their legal headquarters in Singapore (contract manufacturer Flex, formerly Flextronics, being the other), partly for historic and partly for tax reasons, even though they have always been run from their Silicon Valley operational headquarters. But with tax reforms looming in the US, which will cut corporate taxes to just 20%, many CEOs, such as Broadcom’s Tan, believe there is little sense in maintaining a legal or tax presence in Singapore.
To be sure, multinational tech companies do not pay rack rates anywhere. Broadcom, for example, pays an effective tax rate of 4.5% in Singapore, notes Daryanani. If the tax reform bill is passed, Broadcom will pay a tax rate of 7% to 8% in the US. Even if the bill does not go through, the company may pay just under 12%. Sweeping US tax reforms have wide-ranging implications for Singapore as a financial centre. A number of other MNCs that have their regional or tax-related headquarters in Singapore are likely to rethink their strategy if the US tax reform bill becomes law.
Like the current Wall Street darling chipmaker Nvidia, Broadcom and Qualcomm are among a group of cutting-edge, new-age, “fabless” semiconductor firms that do not have their own “fabs”, or manufacturing plants. They basically just design chips and get them manufactured by independent chip foundries such as Taiwan Semiconductor Manufacturing Co, United Microelectronics Corp and Abu Dhabi-controlled GlobalFoundries, which took over Singapore’s Chartered Semiconductor eight years ago and still has plants in Woodlands.
Tan’s audacious bid for Qualcomm comes when the global semiconductor sector is in the midst of a stellar run on Wall Street as chips are increasingly being used in cars, home appliances and factory automation apart from their traditional applications in PCs, smartphones and data centres. Chipmakers have been some of the best-performing stocks in the world and have even outpaced the hot FAANG names — Facebook, Amazon.com, Apple, Netflix and Google’s parent, Alphabet. The Philadelphia Stock Exchange Semiconductor Sector Index, a chip bellwether, is up 46% this year compared with Nasdaq’s 22% rise since January.
The stock of graphics chipmaker Nvidia, whose chips are used in gaming consoles such as Nintendo Co’s new Switch, for mining cryptocurrencies such as bitcoin and ether, as well as in data centres, is up 107% this year and over 1,009% since mid-2015; microprocessor maker Intel is up 35% since June and over 76% since July 2015; memory chipmaker Micron Technology is up 106% this year and 354% since its lows of May last year. Meanwhile, communications chipmaker Cypress Semiconductor is up 51% this year and 157% from the lows of last year, microcontroller maker Microchip Technology is up 43% this year and 126% since February last year, and power and signal chip firm ON Semiconductor is up 65% this year and 203% from the lows of last year.
The huge gains for chipmakers came in the wake of the US$15.3 billion takeover of Mobileye, which makes sensors for autonomous cars, by Intel; and SoftBank Group’s US$32 billion takeover of the UK-based mobile device processor maker ARM Holdings. “The rally in semiconductor stocks over the last two years has been broader and in many ways more powerful than the one we saw during the 2000 tech boom,” Mehdi Hosseini, veteran chip industry analyst at Susquehanna International Group, a boutique investment bank in San Francisco, tells The Edge Singapore.
Ironically, Broadcom and Qualcomm are both in the midst of their own takeovers. Announced a year ago, Broadcom’s US$5.9 billion purchase of Brocade Communications Systems, which makes switches and routers, is still awaiting regulatory approval from the Committee on Foreign Investment in the US. Analysts say approval could come within weeks. And Qualcomm’s US$38 billion takeover of NXP Semiconductors, which has been moving at snail’s pace, is now only likely to get antitrust approvals by early next year. NXP (formerly Freescale Semiconductor, which was once a Motorola unit), makes microcontrollers, processors and sensors for connected cars and the Internet of Things and still has extensive manufacturing facilities in Malaysia.
Merger’s implications
But what do Broadcom and Qualcomm really do? If you own a smartphone, you probably use three key features: access a cellular network to make phone calls, use the WiFi network to access data and employ the Bluetooth network to communicate with other nearby devices. Your smartphone has a host of other chips and sensors as well. Broadcom makes the WiFi and Bluetooth chips inside your phone as well as some motion sensors and other communications-related chips. Until a few years ago, WiFi and Bluetooth chips were separate.
A series of mergers in recent years that helped create the current Broadcom also allowed it to combine the functions of WiFi and Bluetooth chips. Qualcomm, on the other hand, makes the 4G or 3G cellular, or baseband, chips. There is one chip in your smartphone and another in the cellular tower nearby and your phone connects with the nearest cellular tower to make the phone call as you move around. Broadcom actually once tried to make its own baseband chip, but was not very successful at it. Moreover, Qualcomm, a global leader in cellular chips, began a series of lawsuits against Broadcom at the time. Now, years later, Tan has returned to gobble up the rival that dominates baseband chips.
What is happening in the smartphone world is that handsets are getting thinner and sleeker even as they pack in more functionalities. Our handsets are not just phones: They are also our mini-TV or video screens, music players as well as internet communication devices. Sophisticated cloud services and artificial intelligence (AI) will soon make them little robots in our pockets. To make handsets even lighter, manufacturers such as Apple, Samsung Electronics Co or China’s Huawei Technologies, the three big global players, are striving for fewer components that pack in a lot more functionalities.
What a merger of Broadcom and Qualcomm will do is that it will help the combined chip behemoth bring the functionalities of cellular chips and WiFi and Bluetooth chips together in a single chip. At the moment, because two companies make the chips separately, the handoff between cellular and WiFi can sometimes be problematic. In our homes, offices or public places such as shopping malls, we constantly switch from cellular network to broadband and back to cellular. Often, the result is jerky videos, suspended file downloads or cut-off calls despite all the hard work that software programmers put in to make the chips communicate seamlessly.
In the case of Apple, for example, Qualcomm and the Cupertino-based iPhone maker have been at loggerheads for nearly two years. A single chipmaker working closely with smartphone makers will dramatically transform the way we communicate on our devices. Broadcom provides all of Apple’s WiFi-Bluetooth chip needs and around 50% of Samsung’s needs for similar chips.
Workaholic Tan, who is said to regularly put in long hours at Broadcom’s San Jose operational headquarters, has a reputation of taking over unloved tech companies, selling off their non-core assets, wringing out operational efficiencies and charging on to his next acquisition target. He has built a global chip powerhouse from scratch, accumulating US$50 billion worth of companies over the past decade, building on his reputation as the semiconductor industry’s “arch-consolidator”.
Yet, Broadcom has had a chequered history. US private-equity group Silver Lake Partners acquired the semiconductor division of Agilent Technologies, which had an old plant in Yishun Avenue 7, to form Avago Technologies in 2005. (Agilent was a spinoff of Hewlett-Packard.) Silver Lake hired Tan to lead Avago in 2006. He then shepherded it to its listing on Nasdaq in 2009. Avago bought Broadcom in 2015 for US$37 billion, at the time the biggest tech deal ever, and renamed itself after its target, but kept its Nasdaq ticker symbol AVGO.
Modus operandi
Those who have worked with Tan describe him as a no-nonsense guy, an aggressive cost-cutter and a value creator. Analysts who have followed him for years say he does not like to spend too much time, money or effort on sales, marketing, brand building, advertising or even R&D. Indeed, he does not like having a big staff and would rather outsource as much work as possible. His forte is operational efficiency. With previous acquisitions, he has wasted little time selling off non-core assets, trimming bloated executive ranks and going through the R&D budget with a fine-tooth comb. Yet, Tan sees cost-cutting not as a goal in itself but a means to an end. After every merger, he has been able to expand the combined company’s product lines, which leads to better economies of scale and increased operational efficiency. Broadcom shares are up 17-fold since Tan helped launch the firm’s IPO under the Avago banner in 2009 and 399% since January 2014.
The Broadcom-Qualcomm merger matters not just because it is the largest technology takeover in history. Chipmakers such as Broadcom and Qualcomm have become large oligopolists dominating their respective lucrative niches, which in turn has fired up their stocks as investors waking up to their growing earnings power have chased them to the sky. Given the increasing complexity and cost of next-generation semiconductor design and manufacturing, chip companies need scale as well as a diversified range of products for an array of end markets, says Susquehanna’s Hosseini. Tan is betting that Broadcom could benefit from the next wave of cellular technology, or 5G, that Qualcomm is set to dominate. 5G rollout is expected to start in the second half of next year in markets such as Korea and Japan, expanding to the rest of the world in 2019.
So, what’s next? Broadcom is likely to put up its own slate of directors for election to Qualcomm’s board in March. If that fails, sweetening the deal with a higher price offer will be Tan’s next move. “We believe there is a clear path to completion,” he said confidently on Nov 14. In the nine takeover bids that Tan has pursued so far, he has won in all of them, and he is not keen on losing in his 10th attempt. “Hock hates to lose,” says Daryanani, who believes Tan will do whatever it takes to win.
Still, Qualcomm could be Tan’s toughest battle yet. For one thing, chairman Paul Jacobs is the son of Qualcomm founder Irwin Jacobs, a much-revered chip industry veteran. For another, Qualcomm’s shareholding structure is such that the Jacobs family and their supporters may have more than enough votes to spurn even a fair-priced offer in their attempt to keep Qualcomm independent.
Qualcomm shareholders to decide
Susquehanna’s Hosseini notes that Nvidia, whose shares have risen tenfold in just over two years, has shown investors how focusing on new tech trends such as AI or data centres and investing heavily can pay handsomely. It remains to be seen whether shareholders will prefer Jacobs’ long-term R&D bet to Tan’s ruthless route to operational efficiency.
As it tries to fend off Broadcom, Qualcomm may need to work out a compromise with Apple over patent royalty fees. The ongoing litigation allows Apple to legally withhold billions in royalty payments that it owes Qualcomm until the courts finally rule on the case, which could take years. A quick out-of-court settlement would release those funds and boost its stock price, making Broadcom’s bid look even cheaper. Qualcomm’s stock could also benefit from an early close of its acquisition of NXP. Qualcomm could expedite that by talking with regulators and making concessions. The sooner the NXP deal closes, the sooner Qualcomm starts to reap the benefits of what has been billed as a hugely accretive deal.
Even if the Qualcomm board and shareholders do agree to sell to Broadcom, getting regulatory approval for the merger will not be easy. Sure, Tan now has a friend in Trump at the White House, but a merger such as Broadcom-Qualcomm will invite global scrutiny, particularly from European and Chinese antitrust regulators. Regulators in Beijing and Brussels increasingly have a stronger say on large deals involving global MNCs because of their impact across geographies. China sees semiconductors as a strategic industry and is trying to break free from dependence on foreign oligopolists such as Broadcom and Qualcomm. Beijing may not end up blocking the deal, but would likely squeeze a lot of concessions from Broadcom in exchange for its approval. And Tan, who has spent half a lifetime acquiring chip companies and hammering them into shape, may find that the bigger Broadcom becomes, the more regulators will try and slow its march.
If Tan thought bagging Qualcomm will enable him to secure other bigger deals, such as Micron in the memory chip space — or who knows, some day, even the behemoth Intel — the lesson he will take away from the deal is that while his operational efficiency model may benefit from scale, Broadcom’s sheer size may now force regulators to keep a watchful eye on it.
Assif Shameen is a technology writer based in North America
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