Infineon - Valuation

Sunday, July 27, 2008

[Originally for Sramana Mitra's site]

Last month, we discussed in detail the various businesses of Infineon and also peeked into its strategy. We noted that Qimonda was the cause of most of its miseries. We also suggested acquisition and growth possibilities for the German company. Against this background, it is time for us to look at its valuation.

I value Infineon at $9.30 per share. This valuation accounts for the recent Qimonda write-offs as well as potential future losses due to the memory manufacturer. The two successive write-offs, totaling 1.411 billion euro, demonstrate Infineon’s firm commitment to leave the loss-making Qimonda behind as it creates a strategy for its future.A further upside of my valuation is the wireless communications segment. Given the competition and Infineon’s relative unpreparedness for the convergence movement, I have assumed a modest growth rate for Infineon’s communications segment. The situation can change if the company addresses the lack of connectivity solutions in its portfolio, either through long-term partnerships or acquisitions. With the company vigorously shaking off Qimonda, watch out for more activity on the wireless front.

The biggest downside is expense management. The analysis assumes that the company will execute on its promised cost-cutting measures. Its non-Qimonda operating margin of around 5% is far below the industry average. Thus, CEO Peter Bauer’s objective of reducing costs by around $300 million a year becomes a critical metric for the company’s success. It remains to be seen how successful the company will be in cutting 10% of its workforce in the face of Europe’s tough labor laws. If it continues to have low margins, Infineon’s valuation will drop to about $6 per share.

Infineon has its task cut out for it since the company has to strike a fair balance between its expenses and the need to embark on an aggressive strategy to grow its mobile wireless market share. It has the 3G iPhone now, but all bets are off for the mobile chipset supplier for next year’s refresh. It hopes to retain Apple with the newer 3G chip and reference designs it announced recently. But beyond that, Infineon may find the going tough on the baseband front. With Nokia and EMP looking away from TI in the recent years, STM and Broadcom seem poised to better exploit this situation. Infineon will have to embark on an aggressive all-inclusive platform development strategy. But this involves high development costs. With the current turmoil due to Qimonda and its string of poor quarterly results, the company will find it tough to justify such a strategy.

In summary, the $9.30 valuation assumes that Infineon will successfully get over Qimonda and execute on its expense management plans. This valuation has the potential to go up if the company overcomes competition to aggressively grow its wireless communications business. The stock is trading around $8 today after its recent quarterly results. I will perhaps not buy Infineon shares now. I would prefer to see the company deliver on its cost-cutting measures. But will I buy it at $7? Yes, since the upsides outweigh the downsides on this stock at that price.

Posted by Vijay Nagarajan at 3:41 PM  

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