Source: FormFactor

Semiconductor probe card manufacturer FormFactor (FORM -2.75%) reported its fourth quarter earnings on Feb. 4, and while the company's overall results were in line with guidance, it caught investors off guard with the news that it was spending $352 million to acquire Cascade Microtech(NASDAQ: CSCD), its competitor in the semiconductor testing space.

FormFactor: the raw numbers

 MetricQ4 2015Q4 2014YoY Change
Revenue $71.8 million $71.3 million 1%
Non-GAAP Net Income  $5.8 million $6.5 million (11%)
Non-GAAP EPS $0.10 $0.11 (10%)

FormFactor revenue for the period came in at $71.8 million, which was toward the upper end of management's $68 million to $73 million guidance range. Non-GAAP net income for the quarter declined 11% year-over-year to $5.8 million, which translated to $0.10 in diluted earnings per share. This result was also within management's guidance range.

FormFactor generated $3.8 million in cash during the quarter after subtracting the $1.2 million that it spent on repurchasing shares -- this cash flow was down significantly from the $9.5 million that it generated in the same period last year.

For the full-year, total revenue grew 5% to $282 million and non-GAAP net income came in at $21.8 million, up 20% when compared to 2014. Earnings per share also rose a strong 19% to $0.38.

The big news
While the overall financial results looked good, investors focused their attention on the details of the Cascade Microtech acquisition. The $352 million deal represents a substantial bet for FormFactor, as the company's market cap at the time of the announcement was roughly $450 million.

The deal values Cascade Microtech's shares at $21.13 each, a 38% premium to its Feb. 3 closing price. FormFactor stated that it plans on funding the transaction with $270 million cash and $82 million in stock, so Cascade investors will receive $16 in cash and 0.6534 shares of FormFactor common stock for each share they own.

FormFactor has a rock solid balance sheet, but it can't fund the $270 million cash portion of the deal with what it has on hand. It plans on making up for the shortfall by issuing $150 million in new debt, which means its cash balance will take a $120 million hit. The deal is expected to close in mid-2016.

FormFactor's management team provided investors with a long list of reasons why it choose to pursue this transaction. First, it stated that the deal will give the combined company a leadership position in the semiconductor testing market, and its combined resources will allow it to push into new markets. All told, the company estimates that its addressable market opportunity will expand 40% to $1.4 billion. For perspective, the two companies had combined 2015 revenue of $426 million.

Second, the deal promises to bring more diversity to their revenue streams, as each company is currently overly reliant on a handful of big customers. Their top 10 customers respectively account for more than 83% of total sales, but after the transaction, that number is expected to fall to 62%.

The deal is also being billed as a quick win on the financial front, as FormFactor believes that the acquisition will be immediately accretive to its free cash flow and earnings per share. In addition, the companies have announced plans to realize at least $10 million in cost synergies over time. The merger will also allow for an accelerated use of the $300 million in net operating losses that FormFactor has racked up over the years.

What management had to say
FormFactor CEO Mike Slessor, who will retain the top seat at the combined company, stated:

The combination of our products, technologies, and addressable markets enables us to rapidly take the next step in achieving FormFactor's strategic growth objectives.  At the same time, we are able to realize significant financial synergies that the two companies would not be able to realize on their own.

Cascade CEO Mike Burger stated:

As a combined entity, FormFactor and Cascade will be the leader in the production probe card and engineering systems markets. The combination of Cascade and FormFactor creates a larger, stronger company that will drive long-term value for our customers, employees, partners, and shareholders.

Will it work?
While there are plenty of reasons to believe that this deal could be successful in the long run, it is certainly a risky move. Acquisitions are notoriously difficult to integrate properly: All too often, the benefits touted at the time of their announcements are not fully realized. This deal will also transform FormFactor's pristine balance sheet into one that's loaded with debt, which is a risky proposition for a company that is dependent on the gut-wrenchingly cyclical semiconductor industry.

The market doesn't appear enthusiastic about the deal: FormFactor's shares have shed about 20% since the news broke. Only time will tell if the long-term benefits of this transaction will outweigh its negatives.