Billionaire Investors Are Pouring Money into These Stocks

The technology industry saw a nice uptick in mergers and acquisitions activity in 2010. The total transaction amount doubled from the previous year to $107.1 billion, while the number of deals increased by 73% to 165, according to a recent report from PwC’s Transaction Services group.

One of the hot areas for deals was semiconductors. From 2009 to 2010, M&A activity increased from $5.6 billion to $7.6 billion.

It looks like the momentum will continue. Already this year, Qualcomm (Nasdaq: QCOM) has agreed to purchase Atheros (Nasdaq: ATHR) for $3.1 billion and Texas Instruments (NYSE: TXN) has announced a $6.5 billion deal for National Semiconductor (NYSE: NSM).

Why should investors care?  The main reason is that takeover targets often get nice premiums, generating a quick return for shareholders. A typical deal can see a premium of anywhere from 20% to 30%. In the case of the Texas Instruments deal, it was a juicy 70%. 

The good news is that there  are several strong drivers for the deal making. First of all, global scale is vitally important for being competitive — especially when dealing with low-cost providers in places like China. Next, there is tremendous growth in mobile and tablets, which will require next-generation chips.

Another factor is that the major players in the industry — such as Intel (Nasdaq: INTC), Broadcom (Nasdaq: BRCM) and Samsung — have huge cash hoards, so M&A can be an effective way to find growth. Besides, with cash earning virtually nothing in this market environment, the hurdle for transactions is quite low.

So what semiconductor companies are likely to be targets of takeover offers? A good way to filter things is to look at some of the companies where top investors are looking. Top investors looking into the semiconductor space include Carl Icahn, George Soros, Appaloosa Management’s David Tepper, CGM’s Ken Heebner and Gotham Capital’s Joel Greenblatt.

Here’s a look at some of the positions…

1. Mentor Graphics (Nasdaq: MENT): Launched in 1981, the company now has a market cap of about $1.6 billion. Mentor is a top company in electronic design automation (EDA). Basically, this technology allows other companies to develop semiconductors, circuit boards and embedded software. It’s a critical service and has high barriers to entry.

In February, Icahn took a 15% stake in Mentor  — valued at $242 million — and wasted little time in taking shots at the company. He even made a $17 bid for all the shares, which was rejected (that would value the company at $1.9 billion). The current stock price is $14.

If history is any indicator, Icahn will likely not give up. Over the years, he has aggressively pursued many companies such as BEA Systems, Yahoo! (Nasdaq: YHOO) and Lions Gate (NYSE: LGF). And he has made some nice returns in the process, which according to Forbes, gives him a net worth about $11 billion.

In the case of Mentor, Icahn is pursing a proxy fight. This uses the corporate voting process to gain board seats and other powers.  If Icahn gets his way, he may push for a sale to a rival like Cadence Design Systems (Nasdaq: CDNS) or Synopsys (SNPS).

2. KLA-Tencor (Nasdaq: KLAC): David Tepper has purchased roughly 1.8 million shares of this company, with a current value of about $77 million. Founded 1997, KLA-Tencor has a market cap of about $7.3 billion.

The company develops solutions to help semiconductor companies to increase the efficiency and yield from their products. The tools also help to minimize product defects.

KLA-Tencor has a market share of more than 50%, along with more than 20,000 customers. Because of its scale, the company can plow more money into research & development to maintain its competitive advantage. The result is that KLA-Tencor has strong pricing power and margins.

Moreover, KLA-Tencor should see increased demand. As semiconductor chips get smaller and more powerful, there will certainly be a need for quality-control solutions. Such qualities should be attractive for a potential acquirer that is looking for growth.

3. SanDisk (SNDK): Ken Heebner, Joel Greenblatt and George Soros all have taken a position in this stock (in all, more than 3.5 million shares). The total value of their stakes is about $165 million.

While these investors are not actively pushing for a sale, they definitely see strong value. Often, these are the kinds of companies that are attractive to buyers.

SanDisk develops flash memory devices, which retain data when the power to devices like smartphones, digital cameras, laptops and tablets are switched off. Founded in the late 1980s, SanDisk now has a market cap of about $11.3 billion. While it has a strong engineering team, the company has also been effective in partnering with companies such as Toshiba, Panasonic and Sony (NYSE: SNE) to build cutting-edge technologies.

As a testament to the strength of its intellectual property portfolio, SanDisk has generated $1.28 billion in license and royalty revenue in the past three years. The company has more than 1,700 U.S. patents and more than 1,100 foreign patents. The company also has another 1,100 patent applications pending.

Action To Take –> All three companies are quality operators, however, my favorite is SanDisk. Its fundamentals are strong and the company would make for a nice buyout from a player like Intel or Broadcom.

SanDisk’s product line could benefit from three powerful megatrends: the growth in smartphones, tablets and Internet television. Gartner recently published a forecast on these markets, estimating that by 2014, there will be as many as 2.2 billion mobile phones, 208 million tablets and 274 million Internet TVs. No doubt, this means there will be tremendous demand for flash memory.

But even in the short-run, SanDisk has lots of momentum. In the past year, revenue increased 35% to $4.83 billion.  During this time, net income increased from $340 million to $485 million.

The price-to-earnings (P/E) ratio is also fairly low at 8. This compares to 14 and 55 for KLA-Tencor and Mentor, respectively. In other words, as SanDisk continues to grow, investors will start to push up the valuation. And in light of the discount to other players, the valuation is attractive.

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