By Reiji Murai and Supantha Mukherjee
(Reuters) - Applied Materials Inc will buy rival Tokyo Electron Ltd in an all-stock deal valued at more than $7 billion, combining the No.1 and No.3 makers of chip-making gear as demand for their products slows and it gets tougher to turn a profit.
The deal, which analysts expect to hold up under scrutiny from antitrust regulators, will create a company valued at about $29 billion that would be 68 percent owned by Applied Materials shareholders, the companies said on Tuesday.
The deal is the second-largest foreign purchase of a Japanese company, according to Thomson Reuters data and is worth $7.06 billion including net debt and excluding cash. That follows Citigroup Inc's purchase of Nikko Cordial Corp for $7.9 billion in 2007.
Applied Materials shares finished 9 percent higher on the Nasdaq at $17.45. The announcement came after the close of trading in Tokyo, where Tokyo Electron shares ended 0.4 percent higher.
Applied, Tokyo Electron and Dutch chip equipment maker ASML Holding NV are the three largest players in an industry that has consolidated as the rising cost of developing cutting-edge chips and slowing semiconductor demand forced alliances and acquisitions.
Most U.S. chipmakers have sold off or mothballed capacity and outsourced manufacturing to Asian foundries such as Taiwan Semiconductor Manufacturing Co Ltd, further eroding Applied's customer base.
The American company's net income has fallen steadily over the past two years and it posted losses in two quarters during that period. Tokyo Electron reported a 23 percent drop in quarterly sales in July.
ASML bought U.S.-based Cymer last year for about $2.5 billion, while Lam Research Corp bought smaller rival Novellus Systems Inc for $3.3 billion.
"When you look at the buyers of semiconductor equipment; when you look at the people who are really making very advanced chips these days, it's a very small number," Mike Splinter, Applied Materials' executive chairman, told Reuters. "Technology changes are getting more difficult and complex."
Despite their global reach and scale, few of their products overlap, analysts said.
RBC analyst Mahesh Sanganeri said both companies sell etching equipment, used to carve circuits onto silicon, but Applied Materials is a relatively small player in that market compared with rival Lam Research.
"There isn't that much overlap at the product level. I think it will be looked at closely, but I think it will go through," Sanganeri added.
Close competitors of the new company would include Lam Research, KLA-Tencor Corp and Hitachi Ltd subsidiaries Hitachi High-Technologies Corp and Hitachi Kokusai Electric Inc.
"We've looked at this in a lot of detail and we think the overlaps are very, very small," Splinter said.
NEXT BIG WAVE
Should the acquisition win the okay of regulators, the combined company might be able to ride the next big wave of capital investment from chipmakers.
Intel Corp, Samsung Electronics Co Ltd and TSMC are planning a new generation of mega-factories - a major shift that will require tens of billions of dollars. Within a decade, there could be just a handful of plants around the world producing the most cutting-edge microchips.
"Applied Materials is going to be the biggest beneficiary from this deal, given that they're going to be a large company and I think their customer exposure also improves following this deal," Stifel Nicolaus & Co analyst Patrick Ho said.
The deal is the biggest-ever for Applied Materials, whose last big acquisition was Varian Semiconductor Equipment Associates for $4.9 billion in 2011. The companies expect the deal to close in the middle to the second half of next year.
For every existing share, Tokyo Electron shareholders will receive 3.25 shares of the as-yet unnamed new company and Applied Materials shareholders will receive 1 share.
Applied Materials CEO Gary Dickerson will be chief executive of the new company and Tokyo Electron chief executive Tetsuro Higashi will become chairman. The companies will maintain dual listings on Nasdaq and the Tokyo Stock Exchange.
Dickerson told analysts he would move to Japan to lead a company whose board will comprise 11 directors - 5 appointed by each company and another they both agree upon.
The companies said they expected to achieve $250 million of savings by the end of the first fiscal year of operation. The new company will also buy back $3 billion of its shares within 12 months of the combination, they said.
Analysts and bankers said the deal took them by surprise, although Tokyo Electron's stock price has surged 14 percent over the past week, compared with only a 2 percent rise in Tokyo's Nikkei share average. Applied Materials' shares have risen 0.5 percent over the same period.
Goldman, Sachs and Co acted as Applied Materials' financial adviser, while Tokyo Electron was advised by Mitsubishi UFJ Morgan Stanley Securities Co.
Jones Day and Nishimura & Asahi represented Tokyo Electron. Weil, Gotshal & Manges LLP, Mori Hamada & Matsumoto, and De Brauw Blackstone Westbroek advised Applied Materials.
"They have the highest profit margins, they have the best balance sheets, they make money through thick and thin," said David Rubenstein, senior analyst at Advanced Research Japan. "So they are not desperate, but they are hungry for earnings growth and this is one way they can do it."
(Additional reporting by Nathan Layne and Maki Shiraki in Tokyo and Chandni Doulatramani in Bangalore, and by Noel Randewich in San Francisco; Editing by Edmund Klamann, David Holmes, Pravin Char, Ted Kerr and Andre Grenon)