AMD's (NASDAQ:AMD) pending acquisition of Xilinx (NASDAQ:XLNX) is another reason AMD is a buy. Xilinx, the leading designer of field programmable gate arrays (FPGAs), recently reported its fiscal 2022 first-quarter results (for the three months ended July 3, 2021) showing the company is back in growth mode and generating plenty of profits. AMD is getting a great deal here and opening up a new front against longtime rival Intel (NASDAQ:INTC).

Xilinx goes for a reasonable selling price

On its last quarterly earnings call, AMD CEO Lisa Su said its takeover of Xilinx is still expected to be complete by the end of this year. As a reminder, each Xilinx shareholder will get 1.7234 shares of AMD for every share of Xilinx they own. As of this writing, Xilinx's market cap is at just over $36 billion (to AMD's nearly $128 billion). So what is AMD actually getting from this deal?

Someone in a lab suit holding a semiconductor.

Image source: Getty Images.

During its last quarter, Xilinx reported revenue of $879 million, up 21% from a year ago and putting the company on track to break its all-time high it last notched back in 2019. The company has been down in the dumps the last couple of years due to complications from the U.S.-China trade war followed by the coronavirus pandemic. But it's back on the rise as its data center, automaker, and broadcasting customers are in need of multipurpose and customizable chips like the FPGAs Xilinx specializes in.  

Xilinx also reported free cash flow of $373 million in the quarter, an incredible 42% free-cash-flow profit margin. This isn't just a one-off eventl Xilinx consistently generates high rates of profitability from its semiconductor designs. After the last report, Xilinx has reported $1.19 billion in free cash flow over the last 12 months. AMD's purchase price thus values Xilinx at about 30 times trailing 12-month free cash flow. Given the smaller company's growth and high rate of profitability, it's a pretty reasonable deal for AMD.

A great prize to add to the AMD ecosystem

Here's where things really get interesting, though. AMD of course expands the number of chips it can offer its customers with Xilinx, and takes on Intel on the FPGA front (Intel purchased FPGA companies Alterra in 2015 and Omnitek in 2019). But in spite of its relatively diminutive size, Xilinx is able to shell out lots of cash on research and development -- 28% of revenue on R&D in its last quarter alone. AMD spent 17% of its revenue on R&D in the comparable period.

For AMD, which has caught up with its peers on the technological front and is now in a leadership position on many counts, adding Xilinx to the mix will help it build on its efforts to design cutting edge semiconductors for consumer electronics and cloud computing. Xilinx's higher profit margins will elevate AMD's post-merger (AMD free cash flow margin was 23% according to its last report, to Xilinx's 42%), and along the way the two companies said they expect to be able to cut annual costs by an additional $300 million per year once the integration is complete.  

Put simply, the $36 billion AMD will pay out in new stock for Xilinx is a big price tag for the scrappy semiconductor company, but the reasoning pencils out. Besides helping it break into new markets in a splashy way, Xilinx will help AMD continue to elevate its development of chips all the while increasing profit margins over time. It's one of the reasons AMD stock looks like a buy to me right now, and a reason I'll also hold on to the new AMD shares received from the merger by the end of this year.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.