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Xilinx: Merger With AMD Is A Positive

Jan. 23, 2021 1:47 AM ETXilinx, Inc. (XLNX)AMD15 Comments13 Likes
Summary

 Xilinx is being acquired by Advanced Micro Devices as part of an all-stock

transaction.
 However, the market seems not to be looking at the deal with a positive eye with
some analysts affirming that AMD has over paid.
 Still, it is important to look at things from the changing dynamics perspective in
the semiconductor industry.
 Xilinx's financial results have been improving over the quarters and improved
metrics are expected for Q3-2021 during earnings announcement on January 26.
 It makes sense to purchase shares of the FPGA company based on current
valuations.
The takeover of Xilinx (NASDAQ: XLNX), the programmable chips giant, by Advanced
Micro Devices (NASDAQ:AMD), the CPU and GPU manufacturer, is now confirmed for
$35 billion, subject to the usual regulatory procedures. The all-stock transaction, carried
out exclusively in the form of shares with each Xilinx share giving right to 1.734 AMD
shares should be finalized before the end of 2021. After the transaction, the current
shareholders of AMD will hold 74% of the new group, while those of Xilinx will hold the
remaining 26%. Therefore, this has turned out to be more of a merger than a takeover.

Figure 1: Comparing total returns with the iShares PHLX Semiconductor ETF
(SOXX).
Data by YCharts
Unlike AMD, which has been outperforming the semiconductor industry, this has not
been the case for Xilinx, which for that matter started to relatively underperform in the
final week of July 2020.

This was despite the fact that analysts had included the company as a potential
beneficiary from Intel's (NASDAQ: INTC) woes in the 7 nanometer (nm) server CPU,
seen as comparable to Taiwan Semiconductor Manufacturer Corp's (NASDAQ: TSM)
5nm chip, which had already entered volume production.

Xilinx, just like AMD, relies on TSM for manufacturing.

However, this underperformance is to a lesser degree compared to more recent news,

which has the potential to shake up the whole chip market.

Changing market dynamics

It all started by Apple breaking up its partnership with Intel after having used the latter's
chips for 15 years and instead opting to utilize technology from ARM (Advanced RISC
Machines).

However, beyond this normal competition scenario whereby a customer would switch
suppliers, came a more radical shift with chip companies now facing competitive threat
from their biggest customers themselves. In this context, there was the decision by
Microsoft (NASDAQ: MSFT) to make tailor-made semiconductors for its cloud-
computing and artificial intelligence infrastructure.
Now, Microsoft just like Amazon (NASDAQ: AMZN) and Google (NASDAQ: GOOG) are
big cloud provider with their Azure, AWS and GCI suites respectively. These more
software-oriented companies now developing their own processors would spell havoc
for chip providers, unless they adapt.

Adaptation to new market dynamics could take many forms, with one of them being to
build more specialized chips for major cloud customers in their hunt to continuously
improve application performance to satisfy analytics, video and ultra-speed network
requirements, while at the same time being stingy on costs.

In this case to cater for higher network speeds, one of the trends has been the move to
SmartNICs which incorporate various additional computational resources beyond a
normal NIC or Network Interface card. Now, SmartNICs utilize specialized processors,
often field programmable gate arrays (FPGAs). Hence, in addition to producing CPUs,
GPUs and SoCs, the merger will ramp up FPGAs for SmartNICs.

Figure 2: Xilinx's third quarter sales, market share of the FPGA market and
operating cash flow.

Source: SeekingAlpha

Looking across the industry, the programmable gate arrays sector has been
consolidating mainly around Intel and NVIDIA (NASDAQ: NVDA) since a few years.

The first ventured into FPGAs by acquiring Altera in 2015, and from its OneAPI unified
programming model, simplifies development and deployment of data-centric workloads.
For its part, NVIDIA, in the process of acquiring ARM relies mainly on its GPUs, but has
also invested heavily in the network side and recently strengthened its positions in inter-
connectivity.

Therefore, AMD, facing potential revenue loss from hyperscalers could not stand idle,
continuing to assert that by offering high-performance computing ("HPC") products in an
open ecosystem and relying on partners.

It needed a more viable solution.

Thus, in addition to FPGAs for SmartNICs targeted for data center markets, the
acquisition of Xilinx which specializes in programmable logic devices represents a
natural evolution of HPC with adaptable logic.

More importantly, the acquisition should increase AMD's TAM (Total addressable
market) by $110 billion.

The financials
In the first quarter of its fiscal year 2021 (ended June 2020), Xilinx posted revenues of
$727 million, down 14% year on year, with operating profits of 176 million dollars, a
contraction of 30% and net profits of 94 million, down by 61%. The results were more
favorable for the second quarter, while still remaining in the red. Hence, revenues were
$767 million, a 7.9% year on year drop with operating income of $205 million, up by 1%.
Finally, the net results of 194 million were down by 15%.

Figure 3: Quarterly income statement.

Source: SeekingAlpha

The reasons for the downbeat results for Q1-2021 were first, the pandemic resulting in
the company seeing demand weakness, with its automotive business impacted the
most as car sales declined significantly in China and globally.
Second, the trade restrictions that the United States has imposed on China translated
into Xilinx's inability to supply hardware to Huawei resulting in an estimated 6-8% loss in
revenue.

Going forward, for the third quarter (October to December 2020), estimates are for sales
to be $776 million, more than both the previous quarter and Q3-2020. These should be
driven by continuous recovery in the auto sector and datacenter growth where the Xilinx
Alveo U50 accelerator cards provide optimized acceleration for workloads in financial
computing, machine learning, and analytics. There is also the RFSoC (Radio Frequency
System on Chip) deployments for 5G Commercial wireless communications.

Operating profit is forecasted to be about $192 million, more than the same quarter last
year as a result of lower expenses and better market mix.

Looking at the top-line since 2019, the company has been impacted by the intensifying
competition in the communications infrastructure market, not being able to push through
its products in the datacenter industry. However, FPGA, while not being a big growth
area benefits from considerable long-term growth potential with a partner like AMD.

Figure 4: Long term Datacenter, Embedded, Gaming opportunities.

Source: SeekingAlpha

Exploring further, given Xilinx's low growth, some analysts remain skeptical about the
merger and the price paid by AMD is viewed to be on the high side, as well as the ability
of the combined play to generate enough free cash flow to compete with the likes of
Intel and NVIDIA.
For the merger to outperform on a sustained basis, there should be consistent and
improving growth but other factors like profitability as well as cash provided by operating
activities should be considered.

Valuations and key takeaways

The merger transaction is based on a unit price of $143 for Xilinx's stock. That is a
premium of nearly 25% on the closing price of October 26. It values the FPGAs
specialist at 35 billion dollars, about $7 billion more than its $28 billion market cap on
that date.

Moreover, since AMD does not have amount of the cash of its peers, the company has
taken advantage of its position on the stock market to complete the all-in-stock
transaction.

Now the long term CAGR revenue is estimated to be about 20%. Therefore, based on
operating margins improving by 3% to 16% with the combined entity generating $11.6
billion at start, enough profits to cover for the premium paid will only be achieved in the
7th to 8th year of operation.

However, this simplistic mathematical computation ignores the COGS (Cost of Goods
Sold) and opex synergies which the combined AMD-Xilinx entity will generate as a
result of providing a set of coherent and unified solutions, namely through the use of the
same hardware and server in a datacenter for compressing video in a very precise and
efficient manner, at an important time for gaming and eCommerce.

In terms of figures, some $300 million in savings expected due to synergies within the
first 18 months of completing the transaction.

Figure 5: Metrics for the combined AMD-Xilinx entity.

Source: SeekingAlpha

Perusing further, Xilinx's recent acquisition of Falcon Computing Solutions, a privately-

held provider of compiler technology for hardware acceleration of software applications
makes it easier for developers to create custom high-performance accelerated
applications using FPGAs.

Strategically, this will position the merged company to take better advantage of the
growing trend to offload packet processing workloads from the server cores in
performance-hungry datacenters in order to compensate for the limitation of traditional
CPUs. More specifically, with cloud providers in mind, this enables production of more
domain-specific accelerators to take on some of the larger and dynamic workloads.

Figure 6: Comparing the key metrics.

Source: SeekingAlpha
According to AMD, the merger will lead to a total of 13,000 engineers, with an overall
R&D investment of 2.7 billion dollars per year but the integration of Xilinx should
monopolize the attention of teams with one of the plus points being that they both
outsource production to TSM.

On a more positive note, the Hart-Scott-Rodino waiting period (related to the Antitrust
Improvements Act of 1976) concerning the acquisition has expired. That clears a
necessary hurdle in the deal.

With an aggregate revenue figures exceeding $11.6 billion and combined enterprise
value of approximately $138 billion, a rough estimate of the EV/Sales ratio is 11.9. This
is about half the figure for NVDIA, whose pending acquisition of Arm would provide it
with the means to become a platform company (covering a broad segment of computing
devices instead of just individual GPUs).

In the same way, Xilinx's adaptive platform in the form of ACAP [Adaptive Compute
Acceleration Platform] devices should help AMD to capture more market share in
adaptable and domain-specific accelerators.

Looking further, Xilinx specializes in the datacenter sector where AMD, as a producer of
chips for the PC, server and console segments, does not have a particularly strong
presence. Additionally, Xilinx chips are also present in other strategic sectors such as
5G telecommunications networks as well as in many other industries hence justifying
the hefty $35 billion price tag.

As for debt level, Xilinx has a Debt to Equity ratio of 83.38% compared to only 14.95%
for AMD.

Finally, knowing the ability of Lisa Su to engender a turnaround at a time when AMD
was losing market share to Intel and NVIDIA back in 2016, it makes sense to purchase
Xilinx with a lower valuation, bearing in mind that for each share of the FPGA company,
a shareholder will be entitled to more than 1.7 shares of the Radeon's processor
producer.

This said, current volatility due to COVID infection rates could bring the stock to the
$137-138 levels, constituting an opportunity to buy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate

any positions within the next 72 hours. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I
have no business relationship with any company whose stock is mentioned in this
article.

Additional disclosure: This is an investment thesis and is intended for informational

purposes. Investors are kindly requested to do additional research before investing.
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Comments (15)
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Rex Rode
23 Jan. 2021, 4:30 PM
Comments (204)
|
+ Follow
I have little doubt Lisa Su and her exceptional team have this all figured out. Provided
this merger occurs I can see AMD trading as high as $150 this year. On another note, I
continue to see real skepticism the ARM deal will actually go through for NVDA. I'm not
sure how this would affect AMD but I would guess it couldn't hurt them. As for Intel, they
are completely on the outside looking in now. After 3 unbelievable years of growth it will
be interesting to see how AMD does this year. I guess we'll find out on Tuesday if AMD
is finally ready to break $100.

ReplyLike(2)

Mindworker1970
23 Jan. 2021, 5:35 PM
Comments (181)
|
+ Follow
@Rex Rode To be honest, Nvidia would probably trade higher if the ARM deal goes
sour. They have the licence they need to make their own custom ARM chips, they have
plenty of other drivers to make money... and they would have plenty of financial
flexibility. For me, I see all the issues that keep popping up with Nvidia+ARM as being a
reason to modify the deal even more, but not kill it outright. But there are plenty of other
outside factors that are wildcards on trying to guess at an outcome. (USA trade war,
Brexit, China's high tech aspirations, customer's trust in Nvidia)
ReplyLike(1)

OldSchoolInvestor
24 Jan. 2021, 3:56 AM
Comments (106)
|
+ Follow
@Mindworker1970
NVDA wants to do far more than license ARM for their products. Rather NVDA wants to
license AI IP to the world, which opens up a whole new business other than selling
hardware.
License heterogenous AI cores for edge, ADAS, as well as datacenter, along with
CUDA, their frameworks and eco-system.
ReplyLike(3)

Richmondinvestor
23 Jan. 2021, 3:39 PM
Comments (447)
|
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Just wondering what the calculations show for a FEV when the merger is completed.

ReplyLike(1)

Harley Dude
23 Jan. 2021, 12:31 PM
Comments (38)
|
+ Follow
It seems like these chips could be an alternative to nVidia's Tensor cores. Will be
interesting to see how they are integrated with CPUs and GPUs.

ReplyLike(1)

Sighcopath
23 Jan. 2021, 10:33 AM
Comments (2.75K)
|
+ Follow
XLNX pays a dividend. AMD does not pay a dividend. With XLNX shareholders
transitioning to AMD shareholders it would be the perfect time for AMD to start paying a
dividend. The reason is that there are funds that can only own dividend paying stocks
and would have to divest their AMD position after the completion of merger. Older XLNX
investors may be relying on the XLNX dividend for their income. Were AMD to start
paying a dividend it would be affirmation by the AMD management that the company
can not only pay the dividend now but also pay the dividend for many years out of free
cash flow! Quite a change from AMD having to issue shares (dilution) to raise cash to
stay solvent! Nice little reward for long term holders of AMD

ReplyLike(8)

OldSchoolInvestor
24 Jan. 2021, 3:51 AM
Comments (106)
|
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@Sighcopath
Since this deal was announced, Xilinx shareholders are benefitting in capital gains far
more than dividend.
Xilinx slow growth was causing its stock price to stagnate around $100. If those
shareholders insist on dividends, let them sell, take their gains and buy something else.
IBM gives a nice dividend.
AMD has alot better things to spend their cash on, and competitors Intel and NVDA
have alot more cash flow. I would be disappointed if AMD announces any dividend in
next few years.
ReplyLike(8)

Jamjack
24 Jan. 2021, 10:29 AM
Comments (6.71K)
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@Sighcopath,

Agree, just a token is all that is needed.

ReplyLike(1)

Julian Beatty
24 Jan. 2021, 11:33 AM
Comments (983)
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@OldSchoolInvestor
Yes I agree. Now isn't the time for amd to issue dividends.
ReplyLike(5)
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me2020
23 Jan. 2021, 2:53 AM
Comments (515)
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Generational change coming with AMD/XILINX. Programmable cores changes a lot and
when everyone realises the quantum change, AMD will double....again. Buy now, put
the shares in the drawer and enjoy some amazing profits in 2-3 years. I have. 15,000
@$28 average.

ReplyLike(9)

CL73
23 Jan. 2021, 7:04 AM
Comments (734)
|
+ Follow
@me2020 I feel the same way. I wanted to diversify and invest in XLNX, but this merger
has saved me a lot of effort. I currently have 24,000 AMD shares. AMD will be triple
digits soon, so there's no way anyone can buy XLNX for $137-138 !
ReplyLike(1)

Chetan Woodun
23 Jan. 2021, 7:34 AM
ContributorPremium
Comments (523)
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yes, for an AMD holder, but ASML makes sense for new investors looking for
transformational change

ReplyLike

Chetan Woodun
23 Jan. 2021, 7:37 AM
ContributorPremium
Comments (523)
|
+ Follow
Yes, generational change. Wanted to write more on that but it would have become too
tecchy.

The potential to have one device/system for both of the two companies functionalities
esp in GPU/FPGA is tremendous.
ReplyLike(1)
CeEstMoi
23 Jan. 2021, 2:24 AM
Comments (153)
|
+ Follow
After AMD managed to keep secrets, I'm curious to see what Lisa Su's plans will be.

So far, Intel has been in control of its partners, on which AMD also depends. That will
change... and completely new areas can open up.
I am glad to have bought AMD shares again cheaply the last days
ReplyLike(6)
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