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NOVEMBER 14, 2005
Hidden Value Let Loose Chipmaker Freescale, spun from Motorola, is a prime example of the power of spin-offs When Motorola Inc. (MOT ) moved to spin off its $5.7 bil- lion semiconductor business in July, 2004, the newly launched company, Freescale Semiconductor Inc. (FSL ), got no respect. Freescale shares made their debut at a limp $13, trading at less than 50% of the valuation accorded larger rival Texas Instruments Inc. Investors had lots of reasons to be skeptical. Freescale's business under Motorola had piled up hundreds of millions in losses in the early 2000s. Despite a massive restructuring, the unit was operating on razor-thin margins in hyper-competitive chip markets where it seemed to have lost its innovation edge. But those who didn't pay up for the stock were dead wrong. Just 15 months later, Freescale, which supplies embedded chips and software for wireless handsets, automobiles, and have thousands of other uses, is one hot tech company. Earnings jumped threefold in the latest quarter to $164 million on sales of $1.4 billion. Its stock, at $23, is up more than 70% from its starting point. How did the smart-money folks so badly underestimate Freescale? Given Motorola's troubled history, investors expected little from the spin-off. They also failed to appreciate the talents of Freescale's new CEO, Michel Mayer. And perhaps most important, they discounted the value that a properly executed spin-off can create. Of the 17 deals in 2003, 13 have beat the Standard & Poor's 500-stock index by a wide margin. The spin-off Class of '04 is performing equally well, says Joseph W. Cornell, principal of Chicago research firm Spin-Off Advisors. While disastrous spin-offs such as Delphi Corp. (DPHIQ ) and Visteon Corp. (VC ) may grab big headlines, many of the deals often result in far stronger businesses. That fact, in tandem with Wall Street's distaste for conglomerates, has a lot of CEOs becoming believers in the magic of spin-offs. American Express Co.'s (AXP ) Kenneth I. Chenault just set loose Ameriprise Financial Inc. (AMP ), its financial advisory business. Henry R. Silverman plans to divide Cendant Corp. (CD ) into four companies next summer. And Sumner M. Redstone is working on a scheme to split CBS (VIA ) and Viacom Inc. (VIA ) by the end of this year. "Spin-offs usually create huge value because a business goes from being the redheaded stepchild in a large company to a business being run for its own interests," says Cornell. The decision to send a division off on its own isn't an easy one for most companies, and it wasn't for Motorola. The unit had been part of the company for 50 years, and its 22,000 employees were "family," recalls one insider. Then there was the matter of a customer-supplier relationship -- Motorola accounts for about 25% of Freescale's revenues. Some execs worried that it would be a mistake to give up an integral part of the parent's innovation pipeline. Yet pressure grew from Wall Street and the board to delink so that Motorola could focus on its core markets. A team of top managers and directors considered the options, including the outright sale of its subsidiary or a carve-out that would sell just part of Freescale to the public. The final decision -- probably the most critical to Freescale's ability to prosper -- was to make a clean ownership break by distributing all Freescale shares to Motorola stockholders. That was key, because it meant Motorola was strongly motivated to craft a deal that would make Freescale totally independent and give it the resources to be a muscular player in its markets. Motorola needed Freescale to be strong so it could continue as a strategic supplier of parts for handsets and networking products. "This was about creating value by making Freescale a sustainable, independent company," says Donald F. McLellan, Motorola's vice-president of mergers and acquisitions. As a freestanding company, Freescale should be able to win new customers -- especially in the wireless arena, where giants like Nokia Corp. (NOK ) and Samsung Electronics could be reluctant to do business with a supplier owned by a rival. ACCOUNTABILITY RISING Motorola's next smart move was recruiting a strong CEO in veteran IBM (IBM ) executive Mayer. "My first question was, `Why were they doing this? Are they dumping a dog or trying to really unlock shareholder value?"' recalls the high-energy Frenchman. Mayer worried about Freescale's sickly earnings: Motorola had put the unit through a massive downsizing in the early 2000s, shuttering 11 of its 23 plants and slashing headcount by 13,000, almost a third. Still, the business had a gross margin of only 29% -- and lost $366 million, including writeoffs, in 2003. But after poring over Freescale's debt-light balance sheet, its $750 million in cash, and some 4,900 patent families that Motorola had ceded to it, Mayer took command in May, 2004. He quickly appointed a new executive team including outsiders from IBM and Dell Inc. (DELL ) To a greater degree than in the past, Mayer held employees, who were each issued stock, accountable for their performance. "It was a little like working for the government in the Motorola days," says one middle-level manager. "It was something extraordinary to get fired. And you could count on getting a 4% raise for strong performance and 2% for a passable rating." Now, he says, top performers get considerably bigger increases and there's no raise at all for many average performers. Workers' new sense of accountability has helped break down many of the silos that slowed decision-making and discouraged teamwork at Motorola. The idea is to give an engineering culture more customer focus. When working for a unit of Motorola, the managers at each fabrication plant tended to focus only on making their own monthly production goals. Now there's more flexibility. When a wireless customer urgently needed a rush order that would disrupt the Chandler (Ariz.) plant's monthly quota, its local managers decided to alert headquarters that they planned to make an exception to accommodate the rush order. The production target was revised and the customer got the parts. Mayer says that kind of customer focus is critical even as plants are pushed to be more efficient. Smarter manufacturing is a big reason Freescale has been able to boost efficiencies and get its gross margin to more than 43% in the third quarter, four percentage points better than the year-earlier quarter. Mayer is now targeting the product strategy process for radical change. He believes Freescale was losing the jump on developing timely new products because of an ultra-cautious approach to making commitments to next-generation technologies. "In an engineering culture, there's a feeling that you'd rather be slow and right than fast and wrong," he explains. "But in the markets we serve, you need to decide faster and accept that you'll be wrong a few times." A sour note in Freescale's turnaround is that revenues are flat while competitors are seeing modest growth. This is so even as Motorola, undergoing its own transformation under a new CEO, gains share with its Razr phone and other new products -- which means more business for Freescale. Mayer says Freescale is holding its own in overall market share. But while it claims to be getting much better access to Motorola's major competitors in an effort to drum up orders, Freescale can't claim any mega-wins. Analysts want to see if Freescale can leverage its strong position in supplying next-generation 3G cellular technology to customers other than Motorola. If Mayer can't deliver market share gains and faster growth, Freescale could lose the very independence it cherishes -- and perhaps become a takeover target itself.  By Mark Morrison
BW MALL
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