News Analysis: Out Shopping In Fab Land

When Philips Semiconductor CEO, Frans Van Houten revealed that the company
will move forward as NXP, a separate entity, it not only grabbed headlines but
also rewrote the company's 53 year long history books. Soon after, the market
was abuzz with the news of Freescale's acquisition by a private equity
consortium, for $17.6 bn.

Such moves in the semiconductor industry have opened the floodgate of
questions on the future of the industry and its impact on innovation, and cost
pressures.

The rechristening of Philips Semiconductors to NXP-Next Experience, follows
an agreement that gives a consortium of companies (including KKR, Bain Capital
and Silver Lake) an 80.1% stake in the semiconductor operation with Royal
Philips retaining 19.9%. On the other hand, Freescale, also a probable suitor of
Philips Semiconductor, gave up wooing after the sell-out and was in turn
acquired by a private equity consortium including The Blackstone Group, The
Carlyle Group, Permira Funds and Texas Pacific Group. Interestingly, Freescale
was spun off from Motorola not a long time ago.

Focus, Aim, Shoot

Way back in 2000, Richard McGinn, Lucent Technologies chairman and CEO had
stated: “The communications infrastructure and semiconductor markets have
become so big, so fast-moving and so competitive that it is time to divide in
order to accelerate growth.” Perhaps taking heed to these words, Philips
decided to take the plunge. Analysts profess that the best way to excel in these
markets is through two more focused and agile companies, each with a singular
mission, concentrated resources and an increased intensity. With this increased
focus, both companies will be able to grow even faster.

Hence the makeover was inevitable. Philip Brace, senior vice president,
Corporate Planning & Marketing, LSI Logic welcomes the move. “I wasn't
exactly surprised by the reformation of NXP. Looking at the trends, the
semiconductor companies are realizing the benefits of being focused to deliver
value to their customers. A company like Philips is much too diversified and
this spin off will help bring the focus of the group on semiconductors.”

The India Semiconductor Association (ISA) welcomes the changes in the
industry. Poornima Shenoy, president, ISA says, “The increasing number of such
deals indicates that there is a significant value-potential in the industry that
is waiting to be tapped into. This is a good sign. It also frees companies from
the stock market.”

LSI Logic, a leading designer and manufacturer of communications, consumer
and storage semiconductors also began a reformation last year. It has sold off
its manufacturing facility and realigned its strategy to focus on consumer
market semiconductor products. Texas Instrument, another leader in the market
sold off its sensors business to Bain Capital few years back. An official from
the company says, “The key to survival in the volume driven semiconductor
business is to have a concise focus on the strengths. Any dilution in the
objectives due to parent company's diverse business interests is harmful for
the semiconductor business.”

So clearly the name of the game is to be more focused on the product line,
one that is not possible in the case of an investor driven business. The
challenge faced by such companies is to see beyond the near-term period and
realize the goals.

Takes Two to Tango

While many like-minded companies (Intel, Infineon, and Freescale) waited in
the wings as probable suitors, NXP decided to dance along with a private equity
consortium. Freescale followed suit as it too found a new partnership in private
equity (PE). These recent moves may have signaled a new era of private equity in
the semiconductor industry-one where sizeable companies may well be the
targets.

Already rumors are that the next target of private equity could be Europe's
largest chip maker, STMicroelectronics NV. So the allure of going private seems
clear. Brace welcomes the entrance of private equity funds in the industry.
“There is a lot of PE fund sitting on the sidelines and in some cases what the
participation of such equity will do is to allow the semiconductor companies to
be more focused and take on some risk and try out new stuff out of the scrutiny
of the public market. This will fuel the market growth.”

Having shed off the Philips baggage, NXP has found the opportunity to expand
its clientele and attract those companies that stayed away so far due to a host
of legal, political and related reasons. The spin-offs can also raise capital
independently, thereby being able to create a real semiconductor powerhouse.

But serious doubts are only rising now. What happens to the few integrated
device manufacturers that have held on to their fabs? Will the buyout movement
lead to a situation where pure-play foundries such as TSMC will do all
manufacturing? Will it lead to pressure on cash reserves? Shenoy says, “Yes,
it might.” She says, “This could be since most leverage buyouts carry a
significant debt component which has to be serviced out of the cash flows of the
acquired companies. However, let us not forget that, historically speaking,
semiconductor companies carry very little debt on their books.” However, she
quickly adds that there may not be any direct correlation between the debt
servicing and prices that companies charge for their products.

But what happens to innovation in a maturing industry that is increasingly
owned by private investors? The buyout business model is seen to follow a simple
rule-to acquire companies, drive down running costs and resell the
more-profitable companies. As a result, there is a genuine fear that these
companies may have limited R&D and innovation. On the other hand, lack of
stock market pressure may fuel R&D growth in some areas.

On the brighter side, it could mean good news for India. As the investors
look to thin down running costs, it could trigger more design off-shoring to
India where the engineering cost is lower. Shenoy sees an increase in the
West-to-East movement, “We believe the PE-funded companies will sharpen and
deepen their India focus-to tap into not only our skills base, but also the
process maturity that Indian companies bring to the table.”

Nevertheless, ripples created now may soon turn into waves, one that we may
see in couple of years. Till then the bandwagon of private equity acquired
companies will only expand more speedily and the question better asked is: who
isn't joining the lineup?

Malovika Rao

malovikar@cybermedia.co.in