Though it's long been focused on organic growth, semiconductor maker Analog Devices (NASDAQ:ADI) recently announced its intention to make a big acquisition this quarter, buying fellow chip maker Hittite Microwave (NASDAQ:HITT). Let's take a look at the details of the deal, the rationale behind the acquisition, and what this might mean for ADI and Hittite down the line.

About the acquisition
ADI's offer price for Hittite is $78 per share, or about $2.45 billion, representing an enterprise value of approximately $2 billion. According to Bloomberg, this will be the largest acquisition of a U.S. chipmaker so far this year. The deal will be financed through a combination of cash and short-term debt, and is expected to close by the end of Analog Devices' current fiscal quarter. 

Analog Devices' offer price represents a 29% premium over the level at which Hittite shares were trading. Following the announcement, Hittite shares jumped predictably to around $78, and ADI's shares also rose 5%, suggesting the market's generally favorable view of this deal.

The rationale
Analog Devices makes a range of analog chips, such as data converters and amplifiers, including RF-integrated circuits. Hittite also provides RF chips, but it also has a strong portfolio of microwave and millimeter wave products. Analog Devices' management claims that the two companies have focused on different parts of the frequency spectrum, and that they have largely complementary offerings. As a result, there is not a lot of revenue overlap.

The Hittite acquisition is estimated to extend Analog Devices' amplifier and RF segment, which earned $682 million in 2013, by approximately 39%. In addition, thanks to Hittite's strong margin profile, the deal is expected to be immediately accretive to Analog Devices' already-high gross and operating margins by 40 and 70 basis points, respectively, as well as to earnings by 4%-6%.

What about cost savings?
In the short term, Analog Devices expects to achieve operational cost savings due to Hittite no longer being a public company. Also, it believes that it can bring down Hittite's effective tax rate, which is currently around 34%, drastically higher than Analog Devices' 17% tax rate in 2013. There do not appear to be any immediate plans for layoffs, with Analog Devices CEO Vincent Roche calling Hittite a "lean company."

As for production costs, Hittite is a fabless chipmaker and is likely to remain so. Although ADI sources around 50% of its production from its own fabs, there is not much overlap in the technology processes between Analog Devices and Hittite, as Analog Devices mostly makes silicon chips, while Hittite's products are made from gallium arsenide and materials other than silicon, according to The Wall Street Journal. While there might eventually be savings for common lab equipment and software, management expects that combined capital expenses will remain unchanged for the next two years.

Looking down the line
Roche stated that Rick Hess, Hittite's CEO, will run both businesses, presumably meaning Hittite and related parts of Analog Devices. The combined business is expected to outgrow the RF and microwave market (estimated at 5%-10% yearly growth) thanks to sales synergies and taking market share in the coming years. Analog Devices estimates that this will lead to an increase in earnings of around 15% by 2016. 

Analog Devices previously pledged to return 80% of free cash flow to shareholders through a combination of dividends and stock repurchases. Importantly, management said that this pledge remains unchanged following the sizable acquisition.

In conclusion
Analog Devices has made a large acquisition of fellow chipmaker Hittite Microwave. The two companies' products are complementary and should provide revenue growth and synergies, leading to an approximate 15% increase in earnings by 2016. In spite of the size of the acquisition, Analog Devices' policy of returning 80% of its free cash flow to shareholders remains unchanged, making this a thoroughly positive deal for ADI investors.

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Srdjan Bejakovic has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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