Philips Under the Knife?

It will likely shed cell phones, but that may not be enough

It was billed as a growth story. After years of pruning poorly performing and peripheral businesses, Dutch giant Royal Philips Electronics was supposed to be ready for takeoff under a new leader, Gerard J. Kleisterlee, who took over last month. Instead, Philips, which has $32 billion in annual sales, was forced to issue a profits warning on June 15. Philips will now take a charge of $374 million to slash production of semiconductors and personal computer parts, and report its first quarterly loss since 1996. "The telecom and PC environments were worse than we expected," explained Chief Financial Officer Jan Hommen.

Kleisterlee knows there's a problem. So he plans either to sell the money-losing mobile-phone business to an Asian manufacturer or shut it down altogether. Despite a revamp of its product line, the company sold only 1.5 million handsets in the first quarter of this year, half the total of a year ago. Exiting handsets would free Philips up to focus on profitable components such as flat-screen displays and optical storage devices rather than flashier, but harder to market, consumer electronics. First, though, comes more pain: Marco Schram, an analyst at Delta Lloyd Bank in Amsterdam, figures that getting out of cell phones will trigger a $900 million write-off. The company says it will announce a decision in June.

This mobile phone fiasco raises the larger question of the future of Philips' entire $15 billion consumer electronics business, which suffered losses of $85 million in the first quarter. The company does boast fancy technology. For example, it plans to launch a voice-controlled widescreen TV by the end of the year. But Philips' ability to market gizmos to households has been spotty. Besides, the consumer electronics industry is growing at only about 4% a year, and low-cost Asian producers pose a constant threat to margins.

SUFFERING. The 54-year old Kleisterlee, a Philips lifer, proved he was CEO material by turning around the components business, which makes everything from DVD drives for PCs to displays for mobile phones. He also created a global leader in fast-growth areas such as flat-panel displays and computer monitors. And while Philips struggles to sell its own mobile phones, it has become the key supplier of chips and displays to market leader Nokia Corp.

The global tech downturn has momentarily clobbered these businesses. After earning $80 million last year, the components division lost $65 million in the first quarter. Suffering even more are semiconductors, which last year were the company's single biggest earner. On June 15, the unit's chief, Arthur van der Poel, announced that second-quarter sales would be as much as 25% lower than in the first quarter, resulting in an operational loss of $150 million. "We see no signs of recovery even in the third quarter," admits van der Poel. But analysts say that despite the current tech slowdown, demand for components and chips should average annual gains of 15%.

Is Kleisterlee strong enough to cope with the crisis? He has refused all interview requests and won't reveal his full strategy until August. Even before taking over, Kleisterlee said little during his few appearances, feeding the impression of a dull technocrat, not a visionary. "He's not going to be a radical," worries Rene Verhoef of Fortis Bank in Amsterdam.

If Philips was broken up into five separate companies--semiconductors, components, consumer electronics, lighting, and medical systems--Verhoef figures that shares in the separate entities would generate at least a 30% premium over the present $24 stock price. The company counters by saying a split-up would destroy the synergies between components and consumer electronics. Philips, for example, is the largest customer of its own semiconductor division. True, synergies are nice. But the company is bleeding. Radical surgery may be in order.

By William Echikson in Brussels

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