Semiconductors’ increasing complexity and centrality to critical infrastructure and mission-critical applications has made the industry extremely sensitive to the strategic interests of individual countries. It is an understatement to say that this dynamic has greatly complicated M&A in the industry.
In this alert, we analyze the unique aspects of the semiconductor value chain, as well as recent trends in, and outcomes of, regulatory activity impacting semiconductor-related M&A in the U.S. and Europe. We identify resulting key risks in cross-border M&A in this space, which require careful navigation to obtain successful outcomes.
A market for global deals
Semiconductors are among the most strategic pieces of hardware in many markets today. Not only are they present in virtually every consumer electronic device, they also power technological advancement in industries such as telecommunications, healthcare, mobility, energy and defense.
Semiconductors are designed and manufactured in a highly interdependent global supply chain spanning many regions. According to Accenture, the average chip travels the world 2.5 times before reaching the final consumer. This EUR595 billion market has the U.S. and Europe spearheading most of its research and development, as well as the design of new semiconductor models. However, 75% of the global production of chips is concentrated in locations such as mainland China, Japan, South Korea and Taiwan.
This is a capital-intensive and vertically integrated supply chain. Building a modern chip manufacturing facility easily requires capital expenditure of USD10bn and more, and a three-year ramp-up period before it reaches full capacity. Setting up fabrication facilities requires close collaboration with an ecosystem of suppliers. Production of a single semiconductor device requires expertise on over 1,000 production steps.
The fragmented nature of the supply chain and the disruptions to it caused by the Covid-19 pandemic leading to critical shortfalls in supply, have combined to result in an industry which is rife with cross-border M&A opportunities, and the market has been accordingly active.
According to CB Insights data, 2021 saw over 800 M&A and private equity deals in the semiconductor space, with a deal value of over USD 16.5bn and 15% of the cross-border deal value targeting companies in the U.S. and the UK. According to Statista, the trend continued in the first six months of 2022, with M&A deals rising to an aggregate of USD20.6bn in valuation. In addition to acquisitions by strategics, SPAC buyers and private equity have been active in the semiconductor M&A market, with over USD7.8bn in venture capital funding being destined to semiconductor startups globally in 2022. We expect to see increasing M&A activity by non-semiconductor companies looking to bring chip design capabilities in-house.
Government scrutiny and protectionism on the rise
Disruptions in the semiconductor supply chain due to the Covid-19 pandemic are estimated to have caused losses to GDP amounting to USD240bn in the U.S. Accenture estimates that the Eurozone incurred losses in the region of EUR112.7bn. Vulnerabilities in the global supply chain for semiconductors were also exposed by rising international tensions between certain countries, leading to semiconductor R&D and manufacturing being at the cross-section of geopolitics, foreign policy initiatives and trade discussions.
Resulting concerns about the sensitive nature of the semiconductor supply chain have led many jurisdictions to seek to bolster their domestic or regional semiconductor industries, leading to legislation creating incentives for domestic investment in the sector.
In July 2022, the U.S. passed the Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act, which provides USD52bn of funding to support the expansion of semiconductor manufacturing, regional technology hubs, and research and development for semiconductors, among other initiatives. This is the largest five-year investment in public research and development in America’s history.
The CHIPS Act also places restrictions on grant recipients’ ability to invest in China and other countries of national concern for ten years. The Act empowers the government to review transactions in the semiconductor space and negotiate mitigation measures and direct special due diligence requirements applicable to beneficiary companies. Other jurisdictions tend to replicate this move as manufacturers direct their investments internationally to capture incentives.
The European Commission has proposed a similar Chips Act, spanning more than EUR43bn of public and private investment to strengthen the European Union’s semiconductor ecosystem and reduce external dependencies. Resources should be directed to double the EU share of global microchip production to 20% by 2030 and introduce a more active approach by the European single market to industrial and trade policy. The new act is expected to be passed soon.
In parallel with the growing focus on bolstering domestic semiconductor capability, regulatory scrutiny of semiconductor M&A has also been increasing. Governments are acting to prevent the concentration of the expertise or the technology deployed in semiconductor design and production in the hands of a few players and countries. Moreover, they are acting to prevent the transfer of intellectual property and know-how to countries seen as undesirable competitors or as threats to national security interests. Many jurisdictions are therefore using regulation of semiconductor transactions to advance their own interests in technological leadership and to prevent rivals from accessing valuable technology, but also as instruments of leverage and retaliation in trade policy.
The increase in protectionism is not limited to investment regulation. In October 2021, the U.S. Commerce Department announced complex new controls on exports of advanced computing and semiconductor manufacturing items. The new set of rules includes new categories of chips, computer items containing chips, equipment to manufacture semiconductors, and items destined to be used in supercomputers located in or destined to China to the lists of items controlled by the Department. It further broadens the Department control over commerce with certain non-U.S. entities based on national security interests. The U.S. has been seeking to induce allies in the EU and Japan into imposing similar export restrictions. Indeed, in March 2023, the Netherlands joined the U.S. in imposing export restrictions on semiconductor technology to China, and Japan has also announced it is considering forms of export restriction.
In the U.S., the Committee on Foreign Investments in the United States (CFIUS) has been making use of its broadened jurisdiction under the 2018 Foreign Investment Risk Review Modernization Act as it reviews a record-breaking number of transactions. Following executive orders by the U.S. presidency in September 2022 instructing the committee to consider certain national security risks in reviewing transactions, CFIUS has published its first Enforcement and Penalty Guidelines in October. These facts may point to CFIUS becoming more aggressive in monitoring and sanctioning parties with regards to filing obligations, truthfulness of their statements to the committee, and compliance with mitigation obligations.
In the UK, the National Security and Investment Act (NSIA) has established a new framework for investment screening. While not aimed specifically at semiconductors, the regime allows the UK government to call in, analyze, impose conditions on and block acquisitions that pose a risk to UK national security, both for domestic and foreign investors. This new regime imposes mandatory notification for 17 areas of the UK economy spanning advanced materials, computing hardware, defense and critical suppliers to the UK government.
EU member states, such as France, Germany and Italy, have also moved to expand their toolkit for screening foreign investments in industries of strategic importance such as semiconductors. Semiconductor businesses have been the focus of a number of recent prohibition decisions in Germany and Italy. The Netherlands has adopted screening legislation with retroactive effect, enabling it to test current and recently done deals. Several other EU member states are planning to develop or amend their investment screening regimes which could further increase scrutiny of inbound investment.
What lessons so far? Takeaways from selected cases
Taking advantage of cross-border M&A opportunities in the semiconductor space therefore requires parties to navigate varied and complex regulatory regimes. Impending legislative action and case reviews by many governments make this a fast-moving environment. We believe, nonetheless, that some trends are apparent from a review of selected cases so far in the U.S. and Europe.
A. National Security Concerns
First, national security concerns play a material role in determining the success of a semiconductor transaction. Be it because chips themselves have multiple applications or because their technology may be deployed in certain sectors against national security interests, governments will not hesitate to intervene in those semiconductor deals they deem to raise national security concerns.
One such example was the blocking by the U.S. presidency of the proposed acquisition of Aixtron, Inc. by Grand Chip Investment GmbH in December 2016. The acquirer was controlled by Fujian Grand Chip Investment Fund LP and other investors, some of which were owned by the Chinese government. In that case, intervention by the American government was driven not only by concerns regarding entities linked to the Chinese government acquiring a semiconductor manufacturer but, according to reports at the time, by concerns that Aixtron’s technology uses gallium nitride, a rare, advanced semiconductor material with applications in power delivery, wireless communication and space exploration. The deal was therefore blocked on national security grounds.
Similarly, the U.S. intervened to block the acquisition of Lattice Semiconductor by Canyon Bridge, a U.S.-based group of investors that includes the state-controlled China Venture Capital Fund. Lattice’s expertise in manufacturing programmable silicon chips made their products particularly well suited for tasks such as deep learning, a technology that can be deployed in weapons and defense systems. The potential transfer of IP to China and the importance of maintaining the integrity of the semiconductor supply chain to the U.S. for such sectors meant the deal was blocked on national security grounds.
The frustrated acquisition of Qualcomm by Broadcom also illustrates this trend. Broadcom was then based in Singapore, so the deal was treated as a foreign takeover of an American company and regulators feared it would result in China being favored in the race to develop 5G telecommunication technologies. At a time of a so-called “trade war” between the two countries, the U.S. blocked the deal on national security grounds.
B. Increasing Regulatory Scrutiny
Second, national authorities such as CFIUS in the U.S. and the Investment Security Unit in the UK are broadening their scope of review. CFIUS’s latest annual report shows the committee reviewed a record-breaking number of transactions in 2021 and increased the number of investigations compared to 2020. A considerable part of that attention was devoted to semiconductors, with 20% of CFIUS interventions in the last five years involving companies in that sector.
In some cases, the government intervention has seemingly caught parties by surprise. In December 2021, Magnachip Corp., a U.S.-based designer and manufacturer of semiconductors operating primarily in South Korea, and Wise Road Capital, a Chinese private equity firm, abandoned their EUR1.4bn merger plan following an unexpected CFIUS intervention. The parties entered the transaction believing a CFIUS filing was not mandatory nor recommended, given that Magnachip had limited U.S. presence. CFIUS, however, held that the transaction posed risks to U.S. national security, requested that the parties file a formal notice, and blocked them from consummating the transaction before its review was complete. After a review process, almost three times as long as a standard CFIUS review, and in anticipation of the U.S. blocking the transaction, the parties voluntarily abandoned the merger.
More recently, the UK government announced that it will require Chinese-owned technology company Nexperia BV to sell the 86% shareholding it acquired in July 2021 in the UK’s largest semiconductor plant, Newport Wafer Fab (since re-named Nexperia Newport Limited). It is the first deal to be blocked by the UK government on national security grounds using its powers to retrospectively review deals completed before the NSIA entered into force.
The UK government considered that the completed deal raised national security concerns that could only be resolved by unwinding the deal. The government identified risks to national security stemming from “technology and know-how that could result from a potential reintroduction of compound semiconductor activities at the Newport site”. The government also identified a separate concern that “the location of the site could facilitate access to technological expertise and know-how in the South Wales Cluster […] and the links between the site and the Cluster may prevent the Cluster being engaged in future projects relevant to national security”. A previous acquisition by Nexperia dating from November 2021, of the Dutch semiconductor company Nowi, has caught the Dutch regulator’s attention and is now being screened after-the-fact.
C. Broadening Antitrust Review
Third, semiconductor deals are likely to be subject to heightened antitrust scrutiny. Where historically enforcers were focused more on deals that combined competitors, the trend over the past few years has been to also consider potential harms that flow from vertical or complementary deals involving market leaders.
This trend has been apparent for some time now. In 2015, North America-based Applied Materials Inc. abandoned its planned USD7.09bn acquisition of Japanese Tokyo Electron Ltd. following 18 months of discussions regarding antitrust concerns with the U.S. Department of Justice. The transaction, which would have combined the first and the third-largest makers of semiconductor tool manufacturers, became unviable when the regulator’s antitrust concerns could not be addressed through divestitures. The following year, Lam Research Corp.’s plan to acquire competitor KLA-Tencor Corp. fell through after the Department of Justice expressed concerns about its impact on competition in the market for wafer fabrication equipment. The transaction, between two U.S. parties, would have created a combined entity controlling 42% of the wafer fabrication equipment market.
In some cases, antitrust concerns arise from the impact of M&A on downstream participants in the semiconductor industry. The acquisition of Arm by Nvidia is one such case. Following the opening of in-depth reviews by authorities in the U.S., the UK, and the European Union, it became clear that the real issue in the deal was not a reduction of competition between the merging parties, but the potential harm to downstream competition. Arm was a key technology licensor to Nvidia’s competitors, and the authorities were concerned that the merger would allow Nvidia to foreclose its competitors by withholding or degrading access to Arm’s products that are vital to Nvidia’s rivals. Authorities were additionally concerned that the acquisition would prevent licensees from sharing sensitive information with Nvidia-owned Arm, thus discouraging downstream integration and innovation for the entire sector. In face of such global scrutiny, as well as national security and trade concerns, particularly in the UK, the parties eventually abandoned the deal.
Another deal facing an ongoing investigation and raising vertical effects concerns is the U.S. Foreign Trade Commission’s ongoing investigation on Broadcom’s USD61bn proposed acquisition of VMWare. Although Broadcom is a large microchip maker with no direct overlap with VMWare’s virtual management solutions, the relative competitive strength of both companies in their respective segments and related areas seems to have spiked the agency’s attention.
Steps for successful deal making
The recent introduction of incentives to encourage bolstering of the semiconductor industries in the U.S. and EU created by their respective CHIPS Acts will drive increasing focus on developing more independent domestic and regional semiconductor markets.
In parallel, the proliferation of national security screening regimes across the globe will facilitate the desire of governments to protect these domestic and regional markets. Governments in the U.S., the EU and many other developed economies are expected to continue devoting significant attention to cross-border M&A deals in the semiconductor industry, and dealmakers can expect the regulatory landscape to evolve in the direction of more monitoring and more intervention.
Dealmakers should be extra cautious in evaluating which notification requirements are triggered by transactions. Companies who have assets with defense, telecommunications and energy applications, for instance, are significantly more likely to pique the interest of national security regulators. Where transactions involve market leaders or, by the relative positions of the parties in the relevant market, may create negative incentives to competition further along the productive chain, detailed antitrust analysis will be necessary.
Dealmakers are therefore advised to monitor regulatory developments and prepare early and accordingly. Legal and technical due diligence, as well as review and analysis of precedent regulatory cases, are key to identifying potential red flags early on. Parties should assess the chances of regulatory intervention jointly and negotiate with them in mind. In particularly sensitive cases, parties will benefit from pre-emptively considering remedies for potentially extended review periods and any onerous mitigating measures that may be imposed by governments. Together with exercising careful judgment of the current geopolitical landscape, this will allow parties to prepare successful deals and unlock the immense value potential of M&A in this sector.
