Freescale Semiconductor: Successful spin

In its first months as a standalone company, Freescale Semiconductor appears to be on the right track.

By Erik Sherman -- Movers & Shakers, 11/1/2004

A year ago no one had ever heard of Freescale Semiconductor. So how did a leader in processors for communications, mobile, and transportation applications appear seemingly out of nowhere? Easy: It emerged earlier this year as a spinoff from Motorola. Actually, the Austin-based company is technically still a subsidiary, even though it is a separate public company. The parent company plans to formally sever all ties once its board and stockholders agree.

Michael Mayer, CEO, Freescale Semiconductor

That leaves the new entity in a precarious yet exciting position. Building a separate existence will be expensive, particularly when the company, formerly Motorola's Semiconductor Products Sector (SPS), no longer has captive customers. On the other hand, Freescale now has the freedom to move nimbly and become more efficient while using innovation to garner market share.

The primary difficulty Freescale faces is the cultural transition from being an in-company supplier to being a free-standing business that is ready to compete on the open market. But Freescale seems to be moving in the right direction.

"The third quarter was another quarter of profit improvement," CEO Michel Mayer stated during an October earnings call. Mayer, who joined the company after 20 years with IBM, most recently as general manager of IBM Microelectronics, is focusing on getting costs under better control while continuing to develop products that will help take Freescale to an indisputably competitive position.

By all accounts, spinning Freescale out became necessary because the relationship with the bigger company was stifling. "Freescale, when it was part of Motorola, was very focused on designing solutions for Motorola PCS, which was given directives to work closely with the semiconductor side and source most of its content from the semiconductor side," says Scott Smyser, an analyst with iSuppli. "If you look at it from a mobile-handset aspect, it wasn't a good relationship." The situation constrained the chip operation from exploring directions that might have better addressed the market while also preventing the handset unit from employing best-in-class technology that might have come from other companies.

Despite the split, Motorola is not cutting Freescale off cold turkey. The breakup process guarantees some amount of business over the next few years.

Freescale's financial history, although somewhat tricky to delineate, offers some perspective on what the company is doing now. In 2003, overall revenues for Motorola SPS were $4.86 billion, with gross margins of 29.1 percent, SG&A (sales, general, and administrative expenses) a very high 35.3 percent (which was at least better than 55 percent the previous year), a loss of $345 million, and 23,000 employees.

Comparing the most recent quarter against results from the same period last year reveals signs of significant improvement. In the third quarter, Freescale's revenues were $1.43 billion, up 16.7 percent from the roughly $1.23 billion that Motorola SPS brought in during the same period in 2003. Gross margins hit 39 percent, versus 30.3 percent, and net income went from a $106 million loss to a positive $57 million. Perhaps more importantly, Freescale's profit during its first quarter as a separate public company was $43 million on overall revenues of $1.46 billion. So the company's attempts to reduce costs and improve its finances seem to be working.

Furthermore, Freescale announced in October that it plans to continue streamlining its operations, eliminating approximately 1,000 jobs worldwide, primarily in positions that would impact SG&A. The move will lead to a $65 million hit next quarter because of restructuring charges but should also provide about $60 million a year in savings, much of which Mayer is planning to plow back into R&D. The CEO has been quoted as saying that the company spends more than 25 percent of its revenue on R&D.

Indeed, innovation is the lifeblood of the company, and staying ahead of users with attractive design solutions for the broad market is vital. It's also far from easy. "Other companies have not been tied in and have been servicing the broader market for a longer amount of time, so they're going to have to make sure they understand the users' requirements and come up with cost-effective solutions," Smyser says.

For example, handset OEMs may consider Freescale's lineup too inflexible for their needs, he says. In communications, Freescale inherited the title of inventor of the communications processor. Yet the company was also trying to satisfy the needs of more demanding equipment with a separate line of network processors.

So Freescale has expanded in some areas, sharpened its focus in others, and opened relatively new markets. The company won't continue to develop the network-processor line, although it's not being eliminated either (eliminating any revenue-generating products would probably not be wise at this point). Meanwhile, Freescale has announced a dual-processor addition to its PowerQUICC line of communications processors. "We don't want to be at the low end where it's so cutthroat that there's no margin, or at the high end where the margins are huge but the number of units is low," says Ferenc Koplyay, marketing manager for the product line. The company has also announced economical Ethernet switch controllers that will combine with the communications processors to form a central building block in gigabit-Ethernet devices.

In a different application area, Freescale is providing a reference design that engineers can use to deploy its i.MX21 processors in Windows Mobile-based Portable Media Centers. The company smartly partnered with graphics-chip leader Nvidia on the design. Freescale also has silicon for ZigBee, the short-range, low-data-rate wireless technology.

Meanwhile, the company's UWB (ultrawideband) wireless chip received FCC certification in August, making Freescale "the only chip supplier with commercial silicon for UWB," Mayer has said. The company has been smart about the IEEE certification process, rallying enough votes to keep a competing UWB technology from being established as the official standard, according to Smyser. That prevents an approach backed by Texas Instruments and Intel, among others, from locking up the market.

To top off a successful few months, Freescale and General Motors announced an agreement in which the automaker will use Freescale's microprocessors in its Powertrain engine-control systems.

Six months isn't a long time, but for all the difficulties facing Mayer and his management team, Freescale seems to be neatly carving out new niches while it defends the territory that it wants to hold onto. Imagine what the company might be able to do when it really gets going.