Philips: In The Chips

Will the Dutch giant sell its star unit?

Boasting is not quite the thing in staid Eindhoven, the Dutch town Royal Philips Electronics has dominated for a century. But Arthur van der Poel, the 51-year-old chief executive of Philips Semiconductors, can barely restrain himself. His division is outshining the rest of the company. Fueled by explosive demand for cell phones, the $5 billion division is racing ahead at 40% growth. Van der Poel is spending $2 billion to boost capacity on three continents. For Philips Chairman Cor Boonstra, the chip business is an answered prayer. Chips account for just 16% of group sales--but nearly half of Philips' earnings.

While Boonstra is eager to hang onto this gem, he's under mounting pressure to put Philips Semi on the market. Philips executives and board members are debating the merits of a sell-off. A listed chip company would delight analysts and investors. More than that, it would instantly enable Philips Semi to shore up its talent pool with offers of stock options to top engineers. A stand-alone semiconductor company also could use its stock to finance acquisitions. As to the core Philips group, its holding in the new company would probably push up the parent's stock. "The discussion is ongoing," says van der Poel, a member of the Philips board.

ECHOES. Boonstra declined to comment on this debate. But echoes of it resound throughout Europe, as large companies adapt to the New Economy. Financial forces, blind to borders and history, are pushing them to take valuable assets to the market. Europe's phone giants are spinning off Internet and mobile-phone divisions. Companies such as France's Vivendi and Germany's Mannesmann are riding on new divisions and casting off old ones. If the U.S. is a haven of startups, Europe is raising its New Economy from the dismembered limbs of former national champions.

Van der Poel and Boonstra have a template of sorts. In March, Siemens spun off its chip division, Infineon Technologies, creating a quoted company with a market capitalization of $37 billion. Shares of the German giant, which still holds a majority of Infineon stock, have jumped 15% since the spin-off--a point not lost on many Philips investors and analysts. A separate Philips chip division would be valued at roughly Infineon's level--about half of the Philips group's value. "Philips' pieces are worth a lot more than the whole," says Philips investor Michael Kraland, president of Trinity Capital Partners in Paris.

Regardless of his division's corporate fate, van der Poel is building fast. In the last year, he has paid $1.27 billion for California chipmaker VLSI Technologies and begun spending $1.6 billion to expand other plants, including a newly acquired IBM facility in New York. A new joint venture with Taiwan Semiconductor Manufacturing in Singapore should open later this year. Van der Poel hopes to move the business up from its No. 10 ranking. "We have dreams of being in the top five," he says, "but that's possible only with M&A."

Talk of a spin-off, though, begs the question of whether the rest of the group--lighting, medical technology, electronics--has much reason to hang together. Boonstra, brought in from Sara Lee six years ago to fix Philips, has already sold more than 40 companies and divisions. If he lets chips go, he could be remembered as the man who took the Dutch icon apart.

This, say Philips sources, is a path 62-year-old Boonstra is determined to avoid in the year before his scheduled retirement. Indeed, the chip division is at the center of his plan to keep the company whole. Boonstra wants Philips to move from old-line TVs, stereos, and lightbulbs to Internet devices: set-top boxes that turn TVs into Web machines, palm-top surfing devices, and even clothing wired for mobile music downloads and instant chat. The brains in all this, naturally, are to be Philips chips.

SPOTTY HISTORY. A Net triumph would be a huge boost for the consumer-electronics division, which has had a very spotty history. Here the company must build a global brand name, especially in the U.S., and produce scads of slick machines that define new categories. Philips has made inroads, especially in cell phones and in set-top boxes, where it just inked a key contract with AT&T. It has also recovered from a disastrous cell-phone venture with Lucent Technologies Inc. But these are brutal markets, in which top competitors from three continents--Sony, Motorola, and Nokia, to name three--are targeting many of the same opportunities.

Still, Boonstra's slimmed-down Philips is turning skeptical investors into believers. The company, which used to stock inventory for ages, now moves it as fast as competitors. Philips is also benefiting from free-spending European consumers and the cheap euro, which is boosting exports. Commerzbank analyst Peter Knox predicts sales growth of 22% this year, to $34.6 billion. Earnings should rise 75%, to $2.8 billion. "Philips is continuing to find ways of doing more with less," says Knox. Philips' stock has doubled on the Amsterdam exchange in the last 10 months, to 47 on Aug. 23.

Impressive. But Philips would deliver even bigger gains, analysts say, if Boonstra followed Siemens' CEO Heinrich von Pierer and sold chips off. Philips Semi is even a better bet than Infineon, which still makes commodity chips, a business Philips left long ago to focus on high-margin specialty chips. And since Philips Semi already sells to other companies, it would easily weather the separation. Maybe Boonstra's Internet strategy will click. But if it comes up short, look for him or a successor--perhaps van der Poel--to spin off the chip division while the market is still raging.

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