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Merger of Equals Should Draw Skepticism

Mobile connections are forecast to grow by 25% globally over the next six years. One company set to benefit from that growth is Applied Materials (NASDAQ: AMAT  ) , which supplies manufacturing equipment, services, and software to create mobile components like processors. Still, investors should approach Applied Materials with caution and look closely at the news coming out about the proposed merger of equals with Tokyo Electron.

The near future looks bright
Applied's annual earnings shot up from $109 million to $256 million in fiscal 2013 despite a 14% decline in revenue. This decline in revenue is disappointing, but the company appears to have firmed up its position, and revenue increased in the fourth quarter.

But the real story going forward for Applied is that its top three customers, Intel (NASDAQ: INTC  ) Samsung (NASDAQOTH: SSNLF  ) , and TSMC, have announced strong capital investment plans for the coming year.

Intel is a relative late-comer to the mobile market, and some feel its efforts to be a major player in the sector are too late. But the company has announced plans to quadruple its tablet-chip production in 2014. The shift toward mobile technology is a big change for Intel, but it is necessary as the personal computing business is shrinking.

Intel is hoping that its advantage of scale in the component manufacturing market can guide the company through the difficult transition. Investors should monitor this transition very carefully.

Samsung has long been a dominant player in mobile, but the company believes the market may be saturated. As a result it is looking at expanding its component manufacturing, which is seeing increased profitability due largely to a limited supply. Component manufacturing will help ease the tightening margins in the smartphone market as Samsung will be relying more on mid-priced and discount phones in its portfolio.

With the expected growth of mobile devices over the next half-decade, and the investment being made by Applied's largest customers, the next few years should see solid and sustained growth from the company.  

Merger of equals                                                                                   
Applied Materials is the market leader in the semiconductor fabrication market, while Tokyo Electron is third. The fabrication market is shrinking, and in such an environment a merger looks attractive.Sharing resources can lead to considerable savings. In addition, analysts note that while Applied Materials and Tokyo Electron are competitors, their strengths in the sector rarely overlap. These reasons make the merger appear very attractive.

But such a merger of equals has a track record of many failures. Investors should be very skeptical of such deals. Alcatel-Lucent, Daimler-Chrysler, and AOL-TimeWarner are just a few examples of failures of this type.  

One problem with these mergers of equals is that when combining two different companies with different management styles, different philosophies, different goals, etc., a highly specific plan and vision for the new company is necessary. This is far easier to say than to do.

What further complicates this merger is that the two companies have different cultural styles. A merger of equals is difficult enough, but merging two companies with different cultures is even more difficult. While American and Japanese businesses have long proven their success in working together, it is an entirely different matter to meld the two under a single management team.

The outlook in the near term looks bright for Applied Materials. Mobile devices continue to see solid growth, and Applied's biggest customers are investing to take further advantage of this growth. 

But the upcoming merger news should draw caution. Investors should monitor the details of this merger going forward. If it appears that the companies are serious about creating a detailed plan containing the goals of the new company, answering questions about the management team and style, and a strategy as to what direction the new company will take, then that should go a long way toward mitigating the skepticism of the merger.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 25, 2013, at 5:09 PM, ALLWIN wrote:

    A similar sentiment was recently shared on Seeking Alpha

    However, the merger have caused many others to express bullish sentiments1

    Oh Dear..Oh action...but diverging / contradictory sentiments.

    It begs the question:- Is the concept of reality, just a VERY BIG illusion?

    so amny .

  • Report this Comment On January 12, 2014, at 10:32 AM, GirlsUnder30 wrote:

    From my estimates, AMAT will be adding over $2.50 in cash in 2014 and even more the next. On the fundamentals, that's about a 7x multiple at this price. There will also be some pressure for the short interest in this stock to start covering so it's not unlikely to see a $24 price in 2014. The stacked chip equipment purchases should help Intel make a competitive product but that doesn't necessarily make it a market success. Read this:

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