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Renesas saddled with $10bn in goodwill after acquiring Dialog

Investors skittish about Japanese chipmaker shares despite booming demand

Investors are wondering if the Dialog acquisition makes sense, as indicated by Renesas shares falling 7% on Feb. 8 after news of the takeover broke.

TOKYO -- Renesas Electronics has made another big acquisition, one that has analysts questioning whether the move will pay off.

The Japanese chipmaker announced on Feb. 8 that it will buy U.K. chip designer Dialog Semiconductor for 617.9 billion yen ($5.86 billion) in its third strategic purchase after two major acquisitions in 2017 and 2019, which cost the company about 1 trillion yen.

The announcement comes just as the previous two moves are starting to pay off. Renesas now has to make sure the assets pan out. Investors are concerned that potentially large goodwill impairment losses could dent the company's swelling bottom line, thanks to the current automobile memory chip shortage.

To convince investors to bet on its future, Renesas needs to start realizing the benefits of its acquisitions as soon as possible.

In a Feb. 8 news conference, Renesas President and CEO Hidetoshi Shibata stressed why acquiring Dialog, which has technologies crucial for 5G mobile communications, makes good strategic sense. The two companies are "mutually complementary in products, technologies and go-to-market potential, and we can expect a smooth creation of synergies," Shibata said.

Renesas forecasts the Dialog acquisition will increase profits by $200 million in four to five years and cut costs by $125 million in three years.

Dialog boasts a portfolio of technologies related to the Internet of Things (IoT), including power control chip technology. Renesas, which sells semiconductor devices mainly to automakers, is betting that acquiring Dialog will help expand its IoT lineup.

Few analysts say Renesas is overpaying for the British company, whose value to the earnings before interest, taxes, depreciation, and amortization ratio is around 15 to 20. By comparison, the ratio for Integrated Device Technology -- which Renesas bought in 2019 and is now called Renesas Electronics America -- is over 30, according to Refinitiv, a provider of financial market data.

But investors are not certain about how valuable Dialog is for Renesas, especially since shares in the Japanese company briefly fell 7% on Feb. 8 after news of the acquisition broke. Fueling skepticism is the financial burden. The two acquisitions in 2017 and 2019 that totaled 1 trillion yen have sharply increased debt and lowered capital-to-asset ratio to the 30% range.

The company once saw goodwill -- in other words, the portion of the purchase price that is higher than the net fair value of assets purchased and liabilities assumed -- surpass equity. Goodwill is an intangible asset that is difficult to quantify, such as customer loyalty and brand reputation.

Based on Dialog's financials, the acquisition will increase goodwill and other intangibles by 450 billion yen to about 1.4 trillion yen. Under international accounting standards adopted by Renesas, the company is not required to estimate and record goodwill costs regularly. CEO Shibata claims the Dialog business is likely to show medium- to long-term growth, as the acquisition lowers the British company's dependence on specific customers and improves its gross profit margin ratio.

But not all analysts are convinced. Richard Kaye of Comgest Asset Management of France says goodwill worth 1 trillion yen cannot be ignored, even though the latest acquisition is likely to generate technological synergies. Kaye intends to wait and see until he is convinced the investment produces returns that justify the purchase price.

Renesas was saddled with nearly 700 billion yen in interest-bearing debt as of December 2020. The company's debt to EBITDA ratio, which measures its ability to pay off debt, is projected to worsen to 3.5 at the end of December 2021, when the acquisition completes.

Meanwhile, Renesas plans to raise up to 270 billion yen in new capital in addition to borrowing from banks. That would result in a stock dilution of slightly over 10% based on the company's current value.

Investors are concerned the company will make more costly acquisitions involving new share issues, according to Takero Fujiwara, an analyst at Citigroup.

Still, Renesas is performing brilliantly. In addition to strong global demand for chips due to 5G rollouts, the positive effects of past acquisitions are now kicking in.

The company's operating profit in 2020 posted a whopping 10-fold jump from the previous year. Shibata is optimistic about the company's outlook, saying demand will grow further in the April-June quarter.

Amid a global shortage of automotive chips, Renesas has already told customers it will raise prices. The manufacturer is also marking up prices on other chips. The hikes will increase operating profit by as much as 10 billion yen in 2021 and 20 billion yen in 2022, according to one estimate.

Some analysts, however, are less bullish. Kenji Yasui, an analyst at UBS Securities Japan, warns that the chip shortage will peak in the next several months and then start easing. "Profit growth due to price increases has already been fully factored into the stock price, and there are not many stories about further profit growth remaining," Yasui says. He has downgraded Renesas from "buy" to "neutral."

A portfolio manager at a foreign asset management company investing in Japanese growth companies points out that Renesas has taken over unprofitable legacies, adding that the company is not one of his favorites.

Market attention is already shifting to how things will look after the party. Then, the real net effect of the acquisitions will become clear in the chip industry, where wild ups and downs are the norm.

Daiki Takayama, a managing director at Goldman Sachs Japan, says a company cannot keep raising prices. Growth requires boosting profitability by creating products with high value-added, he argues.

To win over skeptical investors, Renesas management needs to develop a formula to turn the three big acquisitions into a winning strategy.

An earthquake in northeastern Japan disrupted operations of some companies like Toyota Motor, but Renesas said on Tuesday it was resuming production in stages at its main Naka plant northeast of Tokyo, after confirming the condition of its clean room. The factory had been shut down as a precaution.

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