Israeli Chip Makers Mellanox and EZchip Reach Pact for Giant $811 Million Merger

Move will create a company with annual revenue of $670 million and a wider range of products to address burgeoning market for faster Internet. EZchip shares rally on news.

Ofer Vaknin

Two Israeli chip makers are on their way to a giant $811 million merger after Mellanox Technologies said yesterday that it agreed to acquire network communications chip maker EZchip Semiconductor to expand its portfolio for high-performance computing products.

Mellanox said it would pay $25.50 a share, a premium of 16% to EZchip’s closing price on Tuesday. EZchip shares, whose trading was suspended all day on the Tel Aviv Stock Exchange after the Calcalist daily leaked the news, jumped 14.4% in Nasdaq trading to $25.16 late in the day New York time.

Mellanox shares were down 5.8% at $34.47, but Nomura analyst Sanjay Chaurasia said he was keen on the deal. Mellanox has very little overlap with EZchip’s customers, which creates a business opportunity for the combined company over the next few years, Chaurasia said in a research note.

“We do not think that this acquisition is a defensive move. We believe that Mellanox could continue to grow in its core markets,” he said, keeping a Buy rating on Mellanox stock.

Mellanox said the acquisition was in line with its strategy to become the leading global supplier of interconnect solutions for software-defined data centers.

CEO Eyal Waldman said merging with EZchip would increase the combined company’s total addressable market by $2.2 billion to $14.5 billion in 2017 and enable it to better excploit the massive opportunity created by the emergence of “big data.”

“The synergies between EZchip and Mellanox create attractive opportunities. We expect our combined technologies, and product portfolios to deliver leading end-to-end intelligent interconnect and processing solutions to data centers and wide area networks,” Waldman said.

Both companies offer solutions in the area of data transfer. Mellanox InfiniBand products enable databases, servers and computers to communicate with each other. By buying EZchip, the company adds Ethernet network processors to the list.

Waldman said EZchip customers that Mellanox “can grow into” include China’s Huawei and ZTE, as well as Ericsson and Avaya. However, there are gaps in the two companies’ technology and the first integrated solutions probably won’t be introduced until well into next year.

Like others in the business, Mellanox and EZchip are rising on the wave of change taking place in the world of the Internet, including the growing use of smartphones, video and big data. Coming next is the so-called Internet of things, which will create a giant class of devices such as electricity meters that are connected to the web.

Cloud computing and the emergence of huge network-server farms also present opportunities.

EZchip faced obstacles in exploiting the favorable market conditions. Lead time for developing processors is long and then it takes times for customers to move to a new generation of processor, although that also has the advantage of prolonging the life of a product up to a decade.

In addition, EZchip has been reliant on a small number of customers. That risk was evidenced when Juniper Networks, which once accounted for half its sales, broke off with EZchip after it learned that its archrival Cisco had begun buying EZchip technology.

In May, Cisco said it would develop an in-house chip instead of using EZchip’s next-generation product, which caused EZchip shares to plummet 25% in a single day. Nevertheless, given the long product cycles, the impact of Cisco’s exit won’t be felt for a few more years and EZchip’s share price was recovering.

The two companies, both based in the northern town of Yokeneam and both led by two dominant CEOs, had held merger discussions in the past but they were snagged by issues of EZchip’s pricey market valuation — at its peak it was worth $1.3 billion — and by concerns about losing customers.

Waldman and EZchip CEO Eli Fruchtman started the latest attempt at a merger in May when EZchip was trading at $15. The shares’ climb in the next months forced Mellanox to increase its offer.

The deal, which has been approved by the boards of the two companies, is expected to close in the first quarter of 2016 and be immediately accretive to adjusted earnings. The combined businesses will have 2,400 employees, and revenue of $668 million for the year ended June 30.

Mellanox, with a market value of $1.7 billion versus EZchip’s $760 million, said it would fund the transaction mostly with cash and the remaining $300 million with debt financing provided by JPMorgan.

With reporting from Reuters.