Why Intel may be interested in spending over $13 billion on its biggest acquisition ever (INTC, ALTR)

Intel's in talks to acquire chipmaker Altera, in what could be its biggest acquisition ever, the Wall Street Journal reported Friday. Analysts say Intel will have to spend over $13 billion for this deal.

In terms of revenue, buying Altera isn’t going to move the needle for Intel, a massive company with over $55 billion in sales. Analysts estimate roughly $2.1 billion, or 4% of revenue, will be added to Intel’s top line following this deal.

So why would Intel want to dole out all that money on this particular company?

The simple answer is to grow its data center business.

More than 60% of Intel’s sales are tied to its PC unit, and it’s been trying for years to diversify its revenue stream, with mixed results. Last year, Intel's mobile business lost $4 billion, and the company shuttered mobile as a separate division and will stop breaking out its results.

But its data center business generated $11.2 billion in sales, or 25% of its total, last year, and it's been growing its footprint within Intel. Altera’s acquisition will only solidify Intel's lead in the space, and lessen its reliance on PC sales.

“We believe that Intel views [Altera’s] technology as strategic in the data center (where Intel holds 95%+ share),” Macquarie Capital wrote in a note.

Altera’s best known for its field programmable gate arrays, or FPGAs, a type of chip that can adjust its functionality after its manufactured. Regular chips are unable to reprogram its tasks once built. Demand for FPGAs are growing in data centers, as customers can reconfigure them for specific use cases.

Intel may be betting this market is going to grow even further. According to Altera’s annual report, the programmable logic device (PLD) market, where FPGAs are a part of, is estimated at about $5 billion. But when you include other segments the PLDs are competing with, such as application specific integrated circuits (ASICs) and application specific standard products (ASSPs), the total addressable market expands to over $50 billion, it says.

Plus, considering the high-barriers to entry and Altera’s high margins, the acquisition starts to make more sense.

“Due to the high barriers to entry of PLDs, Altera has long been known to have some of the highest margins in the semiconductor industry with 2014 gross margins of 66.4% and 2014 operating margins of 28.1%,” Citi Research said in a report.

Both companies declined to comment on the reported deal. Since the report first came out on Friday, Intel shares are up roughly 4.5%, while Altera’s jumped over 23%.

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