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How ADI Determined Linear Technology Was Worth Buying

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ADI’s revised fiscal 3Q16 guidance

In the previous part of thi series, we saw that integration of Linear Technology (LLTC) would be immediately accretive to Analog Devices’s (ADI) earnings. So, ADI has revised its guidance for fiscal 3Q16.

ADI has raised its revenue estimates from $840 million to ~$865 million. It has also raised its non-GAAP[1. generally accepted accounting principles] EPS (earnings per share) estimate from $0.74 to $0.78. ADI’s guidance beats analysts’ estimate of $0.70 EPS on revenue of $817.9 million

Linear Technology would improve combined entity’s profit margins and FCF (free cash flows). However, it would also increase the combined company’s leverage as ADI would raise new debt to the tune of $7.3 billion.

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ADI’s balance sheet

On April 30, 2016, ADI’s cash reserves stood at ~$3.8 billion against long-term debt of ~$1.7 billion. The company would raise new long-term debt of $7.3 billion and use up to $3 billion in cash reserves to fund the acquisition of LLTC. This would increase ADI’s debt level to $9 billion and reduce cash reserves to ~$1 billion, which is the cash sitting in LLTC’s balance sheet.

However, the acquisition would increase ADI’s FCF from $750 million in fiscal 2015 to ~$1.7 billion post-merger, which would help it repay its debt faster.

The combined company would have a net debt-to-EBITDA[2. earnings before interest, tax, depreciation, and amortization] ratio of 4.4x. ADI is not alone. Acquisitions increased the leverage of many semiconductor companies. NXP Semiconductors (NXPI) and Broadcom (AVGO) have a net debt-to-EBITDA ratio of 4x and 7x, respectively.

Business synergies

ADI aims to achieve a non-GAAP EPS of $5.00 by the end of 2020. The synergies would come in three forms—cost, manufacturing, and revenue.

  • The combined company would achieve about $150 million in cost synergies within 18 months of the close of the transaction by 1H17.
  • ADI specializes in data converters and amplifiers, whereas Linear specializes in power-management chips. The two companies’ complementary product portfolios would almost double the combined entity’s total addressable market to $14 billion. This would help ADI optimize its manufacturing capacity and reduce its production cost.
  • Both companies cater to the industrial, automotive, consumer, and communication infrastructure markets. This would bring cross-selling opportunities for the combined entity, increasing its revenue growth rate.

Next, we will look at the businesses of ADI and LLTC and how their products complement each other.

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