1 + 1 + 1 Does Not Equal 3
Obviously any such merger is characterized in its best light, and the public relations people always have a propensity to overdo it. However, when you start out in your press release stating that the venture will have "the industry's strongest product offering in semiconductors and platforms for mobile applications" it raises the question: Where's the evidence of that? This would seem to be another of those delicate areas where size doesn't matter.
First a little background. The new joint venture is actually the merger with another joint venture comprising the wireless assets from STMicroelectronics and NXP, which was announced last April. STMicro held 80 percent control of that entity and is exercising its option with NXP to acquire the remaining 20 percent interest.
When the STMicro-NXP deal was announced, the companies indicated that, on a pro forma basis, they would have had about $3 billion in revenue in 2007 and about $200 million in operating profit. The revenue was said to be about a 50-50 contribution or about 75 percent of STMicro's Mobile, Multimedia & Communications (MMC) unit and about 75 percent of NXP's Mobile & Personal unit. The combined entity would include more than 3,500 patent families, have approximately 9,000 employees, and management had identified more than $250 million in annual cost savings. Sounds impressive, huh?
At the time of the STMicro-NXP announcement (4/10/08), NXP was characterized as being a leading supplier to Samsung Corp. , and that was in part due to the company's prior acquisition of the wireless business from Silicon Labs. However, the term "leading" supplier can itself be misleading, particularly in light of the company's recent results. In the first half of 2008, NXP's Mobile & Personal unit experienced a revenue decline of 3 percent year-to-year and an operating loss. However, during this same period, Samsung's handset revenue growth was 24 percent and unit growth 27 percent. So just what does "leading supplier" really mean?
At the same time, STMicro billed itself as a "Leading 3G ASIC supplier to Nokia and EMP." Here I think they were careful to use the acronym ASIC (application specific integrated circuit). I could certainly be wrong. but the last I heard at the time of this announcement, STMicro was largely selling power management, some audio codecs, and RF parts to Nokia Corp. (NYSE: NOK). The all-important digital baseband and/or applications processors were still being supplied by others.
Granted, STMicro did enter into an agreement with Nokia last August whereby STMicro licensed Nokia's 3G platform, but that is not expected to enter production until 2010. Consequently, it would appear that the claim is a little short on substance at this point, and what happens two years down the road remains to be seen. The bottom line on STMicro's Nokia business is that it was actually down 3 percent in 2007 versus the prior year, and for the first half of 2008 it delivered "growth" of less than 1 percent. Maybe more importantly, the Applications Specific Group, of which MMC is the largest entity, is struggling with low single-digit operating margins. Maybe someone thinks this is golf where low score wins?
Let's fast-forward now to the August 20 announcement that the aforementioned ST-NXP JV will now team up with Ericsson Mobile Phone (EMP) to create a "world leader in semiconductors and platforms for mobile applications." This 50-50 joint venture is now declared to have the industry's strongest product offering, will have about 8,000 employees (that's 1,000 less than the entities had separately four months ago), and on a pro forma basis generated $3.6 billion in 2007 revenue. That implies that EMP was about $600 million last year.
What was most interesting on the conference call was that, unlike the April 10 call where the management suggested the pro forma operating income for 2007 was $200 million (an anemic number to begin with), the additional $600 million in revenue resulted in a "no comment" response to the operating income question. Despite that, the CEO of Ericsson assured the listeners that EMP was profitable.
I think we've seen from the STMicro-NXP venture, that a few of the claims are a bit of a stretch, to say the least. Now they go one better and crown themselves as the technology leader with a clear scale advantage. Having a part that's being evaluated or even a design win doesn't make anyone the "leader." When it starts translating to revenue, preferably more revenue than your competition, maybe then you have something to talk about; until then it's little more than hyperbole accompanied by slideware.
Aside from that point, there are bigger questions that this venture raises regarding managerial decisions. Of the 8,000 employees, approximately 6,500 are in research and development. That's a staggering 80 percent, and the respective CEOs characterized it as if it were something to be proud of. What's wrong with this picture? If operating expense categories function as a rough proxy for headcount (and they do), Qualcomm Inc. (Nasdaq: QCOM) has slightly less than one-third of its headcount in R&D, and they're about as R&D intensive as anyone.
What possible justification can exist for having 80 percent of your staff in R&D? The quick answer is "none." Granted, the joint venture's multiple commitments to different mobile platforms will be a bear to negotiate, but this makes no sense.
With the bulk of its operations in the Eurozone and its restrictive employment policies, will this JV be stuck with this contingent? Exactly how high does revenue have to grow for this bloated blimp to become profitable? And how is that going to take place without the appropriate level of sales and marketing?
At best, this is an entity with low double-digit top-line growth and, right now, will be lucky to be profitable at the operating line. Compare that to Qualcomm's chip business growing 28 percent year-to-year with 28 percent operating margin. It's not all coming from their CDMA operations, as the JV's managers suggested, nor is Texas Instruments Inc. (NYSE: TXN) just a "2G" company. Who do they think was supplying Nokia with all its 3G parts until late last year?
This entity defies logic but it was not without the usual array of fawning comments from the sell-side in the days following. We'll see how many hold those same warm and fuzzy opinions 12 months from now. This merger has all the attractiveness of Alcatel-Lucent (NYSE: ALU).
— Bob Faulkner, Special to Unstrung