Subsidizing 'Silicon Saxony': A Short-Term Fix?

A bailout gives Infineon's Qimonda unit breathing room. But the once-thriving chip industry in East Germany faces an uncertain future

Dresden is one of the great success stories of German reunification. After the fall of the Berlin Wall in 1989, the capital of the East German state of Saxony remade itself as the center of European semiconductor production, becoming home to major facilities operated by U.S. chipmaker Advanced Micro Devices (AMD) as well as Munich-based Infineon Technologies (IFX). When a 1998 Time magazine article dubbed the region "Silicon Saxony," locals embraced the label and even founded an organization by that name to promote industry interests.

But the mood in Silicon Saxony these days is anything but exuberant. On Dec. 21, Infineon's separately listed Qimonda (QI) unit, the region's largest private employer, narrowly escaped bankruptcy when it received a rescue package that could total more than $800 million. "We have achieved a breakthrough," Saxony's Economic Affairs & Labor Minister Thomas Jurk said in announcing the deal.

The bailout includes a $208 million loan from the Saxony state government as well as $104 million from Infineon, which holds 77% of Qimonda's shares. A further $140 million comes from an unidentified bank in Portugal, where Qimonda is expected to develop a research and development center. In addition, Germany's federal government and the Saxony state government are offering $390 million in loan guarantees.

Burning Through Cash

It's a major reprieve for Qimonda's 3,200 employees in the region and for thousands of other workers at nearby suppliers and research operations. Yet the long-term outlook for Dresden's high-tech industry remains cloudy. "This may give a chance for Qimonda to sail through the storm but not guarantee the outcome," Nicolas Gaudois, UBS's (UBS) London-based semiconductor analyst, wrote in a research note on Dec. 22.

Qimonda's New York-listed shares bounced more than 60% on the news, to about 49¢ apiece. But the stock is far below its price of more than $8 a year ago. Investors have good reasons to be spooked. In its most recent quarterly results, released on July 24, Qimonda posted a $558 million net loss on only $534 million in sales. It's burning through cash at a rate of as much as $420 million per quarter.

At least Qimonda has company. It's being buffeted by a global downturn in the semiconductor industry that has left almost all the players strapped.

Plunge in Memory Chips

Dresden's status as a chipmaking capital does not depend on Qimonda alone. AMD, based in Sunnyvale, Calif., is putting its manufacturing operations into a joint venture with Advanced Technology Investment, a vehicle owned by the emirate of Abu Dhabi. The venture, provisionally known as the Foundry Co., will have its manufacturing heart in Dresden, and is investing $2.9 billion to upgrade one of its two factories there. The company expects its 2,800-strong Dresden workforce to remain stable. Infineon employs about 2,000 people in Dresden, not counting Qimonda.

But if Qimonda doesn't survive, it would be a blow to Dresden's image as a high-tech center. And it would weaken the infrastructure that has grown up to serve the local semiconductor industry, including dozens of suppliers and research institutes as well as university programs to supply a qualified workforce. At the Technical University of Dresden alone, more than 5,000 students major in fields related to semiconductors or information technology. Without Qimonda, which also conducts R&D in Dresden, the area would have less legitimacy as a so-called cluster of semiconductor expertise.

All of the world's semiconductor makers are struggling amid a brutal downturn. Industry sales will plunge 16.3%, to $219.2 billion, in 2009 after a 4.4% decline in 2008, consultancy Gartner (IT) estimates. Never before have chip sales fallen for two consecutive years.

But Qimonda is among the hardest hit because it makes so-called DRAM memory chips, which have become so standardized that it is difficult for manufacturers to find a competitive advantage other than price. "The DRAM market is a straight commodity. It's all about getting your cost structure right," says Malcolm Penn, CEO of British semiconductor consultancy Future Horizons.

Handouts Necessary?

Parent company Infineon, meanwhile, has been clobbered by the downturn in the auto industry, one of its main customer groups. Slower growth in the mobile-phone industry is also hurting Infineon, which supplies chips for Apple's (AAPL) iPhone, among other handsets. Those factors and the negative effects of Qimonda bumped Infineon to sixth from fifth place among global chipmakers, according to Gartner's latest rankings.

Increasingly, Penn and other analysts say, a company's ability to compete on price hangs on the willingness of local governments to offer support. Virtually all chip factories are subsidized in one way or another. In Korea, a consortium of state-owned and private banks are expected to provide Hynix Semiconductor (HY9HQ) with about $600 million in new loans.

Now Qimonda is getting government help, too. But some local politicians fret that the bailout could set off a chain reaction of alms-seeking by local semiconductor suppliers and other industries. Neither government nor industry wants the region to become known as Subsidized Saxony.

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