Intel Corp. (INTC) announced yesterday that it would be acquiring McAfee Inc. (MFE), one of the largest makers of security software for $7.68 billion ($6.8 billion net of cash acquired) in an all-cash transaction. The purchase price of $48 a share represents a 60% premium to McAfee’s closing price on Wednesday (after which the deal was announced). Shares surged 57% yesterday, dropping off .06% after hours.
This is overall a very good deal for existing McAfee shareholders, so they are expected to approve. Of course, regulatory approval will also be required, which may not be a problem, considering the fact that security software is not a market in which Intel competes.
Intel also announced that it would be retaining key management personnel and running McAfee as a separate unit, similar to WindRiver, which it acquired some time back. While some may point to Intel’s lack of success in dealing with non-core acquisitions in the past, we are more optimistic, given that Intel appears to be much better-focused right now.
Intel expects the acquisition to be slightly dilutive to GAAP earnings in the first year, with no impact in the second and accretive beyond that.
However, on a non GAAP basis, the acquisition would be slightly accretive in the first year and continue to improve beyond that.
Goldman Sachs & Co., an arm of Goldman Sachs Group Inc. (GS) and Morrison & Foerster llp advised Intel on the deal, while Morgan Stanley & Co. Inc., a division of Morgan Stanley (MS) and Wilson Sonsini Goodrich & Rosati did the honors for McAfee.
Key Considerations
Intel has discussed the importance of software in recent times, especially on emerging platforms, such as TVs, mobile phones and cars. It is true that these items are increasingly becoming smarter and getting connected. Intel would have us adding computing power here (where it has not succeeded already). However, it has not really gained much ground on the more portable devices because of the power-guzzling nature of its chips. On the other hand, ARM Holdings‘ (ARMH) more efficient architecture has been harnessed by the likes of Texas Instruments (TXN) and Qualcomm (QCOM) to gain share in these markets. Hence, Intel believes that its newer, more power-efficient and secure chips will increase chances of market share gains.
Another possible advantage that comes to mind is increased speeds of devices using Intel chips. Intel has already been working with McAfee over the past 18 months and has come up with a few joint solutions, such as the technology to protect data on a laptop, even when it was stolen. This association no doubt revealed material scope for Intel to increase the differentiation of its chips, which would be the reason for the huge premium it is paying.
Intel has stated that a device would be more secure and less prone to hacking if security was built into the hardware instead of third-party software. Additionally, it is expected that the closer integration of security would increase device speed.
And this is not all. McAfee is a highly profitable business, with gross margins in the 78-79% range on annualized revenues of around $2 billion. In comparison, Intel is expected to generate over $40 billion in revenue this year, with gross margins at around 67%.
The one thing that is pulling down sentiments is Intel’s historic lack of success in non-core areas. As a result, the shares fell over 3% after the deal was announced.
What Analysts are Saying
Barclays Capital – This is part of Intel’s push into the mobile wireless space and in furtherance of the strategic initiative to combine its chip-making technology with software (as in the case of the WindRiver acquisition).
Credit Suisse – The acquisition is consistent with Intel’s long term strategy of share increases in system bill of materials and is expected to gradually convert the company from a purely cyclical play. It would, therefore, enhance its ability to deliver complete platforms and improve growth prospects.
Deutsche Bank – The combination of Intel hardware and McAfee software will help the company take a systems approach to computing and improve the Atom line in 2011.
Jeffries & Co. – The Intel-McAfee combination should be positive in terms of product development, although the impact on Intel’s results or share price is likely to be minimal.
J.P.Morgan – Intel’s major problems in addressing the mobile segment are the high costs and power required by its chips. Therefore, although this could help the company expand beyond PCs, a better use of cash would have been a higher dividend.
Oppenheimer – The hardware-software combination will help Intel build a position in the embedded market, with no major impact on earnings over the next few years.
Raymond James – This is a bold move by Intel, although likely to be beneficial, since it is in-line with Intel’s long-term strategy.
RBC Capital Markets – The premium paid by Intel does not appear excessive. Intel is an unlikely suitor and companies such as Hewlett Packard Company (HPQ), Dell Inc. (DELL) and International Business Machines (IBM) would have been more obvious contenders. However, it is very unlikely that Intel will be overbid. A slight negative here – users in the mobile segment expect devices to come secured and are unlikely to pay extra for the added security.
Roth Capital Partners – The acquisition will help Intel expand beyond PCs to the enterprise segment, where security continues to grow in importance.
Stifel Nicolaus – This could indicate that Intel’s drive to push x86 into connected consumer devices is not meeting management expectations.
Consequently, the amount of resources the company is willing to devote for this purpose is something to watch out for.
Wells Fargo – The acquisition will bring security capabilities to Intel chips, thus giving it an edge over Advanced Micro Devices (AMD).
Our Stand
We believe the acquisition is an overall positive for Intel, with low interest on cash balances and incremental earnings from McAfee more or less balancing each other in the near term. However, integration expenses would likely lower GAAP numbers. Consequently, we do not expect any major change to consensus earnings, the reason for our short-term Hold recommendation (Zacks Rank #3) on the shares. We also see no momentum in the shares over the next 3–6 months. Consequently, we maintain our longer-term Neutral recommendation.
ADV MICRO DEV (AMD): Free Stock Analysis Report
ARM HOLDNGS ADR (ARMH): Free Stock Analysis Report
DELL INC (DELL): Free Stock Analysis Report
GOLDMAN SACHS (GS): Free Stock Analysis Report
HEWLETT PACKARD (HPQ): Free Stock Analysis Report
INTL BUS MACH (IBM): Free Stock Analysis Report
INTEL CORP (INTC): Free Stock Analysis Report
MCAFEE INC (MFE): Free Stock Analysis Report
MORGAN STANLEY (MS): Free Stock Analysis Report
QUALCOMM INC (QCOM): Free Stock Analysis Report
TEXAS INSTRS (TXN): Free Stock Analysis Report
Zacks Investment Research
