Wireless Industry Analyst

4. How does the energy company communicate with the user?

There are two main components that help the energy company achieve its objectives.

Smart energy gateway: This is typically connected to your broadband connection and serves as an access point for the energy companies to talk to you. In the future, we may have carriers providing zigbee-enabled gateways for the user to have a single device that provides broadband also communicates with your energy company.

In-house Display: This is essentially the smart-energy equivalent of a mobile phone. This wireless device can be a kitchen-top device or a device attached to your refrigerator. The gateway can communicate raw data to the device which can process and provide information for the consumer to assimilate. Examples of such information include peak hours, rates, usage, usage projections etc.

5. How are the devices controlled?

A rudimentary model would be to assume that once the information is provided, the user will use his discretion to manually turn off devices. A more advanced model would be to provide control features in the display either through buttons or touch-screens. The control information is the stimulus for the gateway to communicate with the intelligent or smart devices installed in your house.

6. That is in-house control. How about remote control?

This is where the usage model gets more interesting. The energy company may use the back-end platform it uses to communicate through the gateway to perform a multitude of other functions. The most logical thing to do is to provide a web interface through which the user can monitor the information passed on to the display. Additionally, he/she can also control the actions of the gateway. Hence you have a remote monitor and control mechanism in place.

Infineon states its strategic objectives clearly in its 2007 annual report. The company hopes to leverage its strength in energy efficiency and security to remain a semiconductor leader. It sees the growing need for mobility and communications as the drivers for its own growth. As the company is betting on mobile phones and broadband customer premises equipment markets, it recognizes the need to make strategic acquisitions to strengthen these segments.

The company also opts for a mixed manufacturing model. The German chipmaker wishes to retain control over process technologies for RF, power, embedded flash and others that it considers its traditional strengths. For standard CMOS processes, however, it will engage in long-term strategic partnerships with other companies while extensively using the services of silicon foundries.

I see a lot of positives in the company’s strategic plan. Its focus on strengths such as energy efficiency and its choice of an optimal manufacturing strategy are especially commendable. Given its portfolio, the mobile and the carrier markets are obvious growth drivers. Infineon, however, needs to take care as it is pitted against most other semiconductor leaders in these markets, including TI, Qualcomm, Broadcom and STM. Also, while it is certainly a leader in low-power technology and system integration, the competition is rapidly narrowing the gap given the increased thrust towards mobility and convergence.

It also appears that with Ziebart’s exit as CEO, Infineon’s strategy of making small but solid acquisitions may change. I am guessing that the company will now engage in larger M&A activities to gain scale, much along the lines of STM’s recent move to get NXP’s wireless business. The prime candidate being discussed is NXP. An Infineon-NXP merger would create an automobile and industrial semiconductor juggernaut.

With regards to wireless, Infineon’s acquisition of LSI’s mobility business was well motivated: LSI not only offered a sustained baseband program but also brought in substantial 3G IP from Agere to Infineon. Still, as I mentioned in the previous piece, Infineon lacks a full product portfolio to build a complete mobile platform.

This is where a merger with Freescale becomes a viable option. Freescale has its own baseband solutions for UMTS, EDGE and GSM/GPRS. More importantly, it not only has application processor capabilities, but it also delivered the industry’s first single-core modem architecture and has already embarked on long-term evolution (LTE) development. The complementary R&D that Freescale can add to Infineon’s low-power strength can, in my mind, create a powerful mobile wireless entity.

While these are good synergies, the two companies still do not have a complete connectivity portfolio between them. Infineon will probably need to follow a hybrid acquisition strategy, combining the merits of Ziebart’s philosophy while going for scale through Freescale and/or NXP. The company should perhaps go for small acquisitions or long-term strategic partnerships for connectivity solutions to secure and grow its mobile market share.

I also think that with its unique strengths in energy efficiency and low-power electronics, Infineon should look actively into Zigbee and smart energy systems as a diversification area. I believe that smart energy is a burgeoning industry and Infineon, among the semiconductor giants, is best positioned to exploit this growth.

In this post I have looked at various strategic directions and initiatives for Infineon. I have also put forth my vision for the company. With this thorough analysis behind us, we turn to the company’s valuation in the concluding part of this series.

1. What is energy management?

Energy management is the concept that allows residential and business consumers to monitor and control the way their electrical appliances are used. The control mechanism may be in-house or remote-platform based.

2. Why would we need to control electrical appliances?

There are several reasons we want to be able to do this. Firstly, as responsible citizens of this world, we ought to give Mother Earth the respect she duly deserves. As we strive to go ‘green’, we should collectively work towards energy efficiency. Where else to begin this but at your home? Like someone said, ‘Charity begins at your home.’

Secondly, the energy companies are perennially running out of capacity and we are hit by power outages. Not only is the population growing, but the per-capita consumption of energy is also increasing by the day. The power companies are trying to device a more efficient, graceful strategy. If they can have nominal electrical usage per household, then such outages can be avoided or at least reduced. One scheme that the power companies are toying with is the idea of differential rates during peak hours. If the energy company communicates peak hour information to the user, this will encourage him/her to turn off electrical appliances that are unnecessarily running during those times.

Thirdly, there is the luxury angle. How many of us would like to have our house temperature right when we step in after an exhaustive work day? Or would you not like the A/C or the heater to fall back to a nominal temperature when you are not around?

3. How is the intelligence built into electrical appliances?

The smartness can come from several short-range communication mechanisms. A good emerging example is the use of Zigbee which is a short-range radio communication standard being promoted for home networking. Once your thermostat is equipped with a zigbee radio, it can be controlled by a central device which will also be zigbee-enabled. Suppose you have set a timer in this central device to turn off you’re A/C at 8AM when you step out of the house, zigbee signals are sent out to the A/C at the right time to enable this automation.

Apart from the cellular ICs, Infineon has a low, non-negligible market share in the Bluetooth market. In collaboration with Global Locate (now Broadcom), Infineon also developed the Hammerhead II A-GPS solution for the cellular market. It also has a presence in the digital cordless and RF power markets.

While Infineon specializes in low-power chipsets and is looking to increase its wireless footprint across Europe and elsewhere, there are holes in its product portfolio. This is especially critical in the context of the global movement towards convergence devices. Firstly, the company does not have an application processor family that complements its rich and highly competitive baseband solutions. Secondly, it does not have a complete set of mobile connectivity products. With Global Locate getting acquired by Broadcom, Infineon’s future in GPS/A-GPS is unclear. Unlike the other leading cellular IC vendors, Infineon also does not have embedded WLAN solutions that will complete its current connectivity portfolio.

Infineon’s strategy seems to be to provide low-cost cellular platforms whose gaps can be filled by other vendors. The 2G iPhone platform is a good example. While its cellular ICs were from Infineon, the application processor was from Samsung, WLAN from Marvell and Bluetooth from CSR. This model will work fine as long as handset vendors are interested in picking the best-in-class components based on cost and performance. If, on the other hand, the trend drifts towards highly integrated single vendor solutions, the handicaps in Infineon’s mobile portfolio will result in the company losing its market share, potentially including iPhone designs 2009 and beyond. Infineon will not be in a position to compete with the likes of Qualcomm, Broadcom and STM, all of whom have a complete portfolio to build single-stop cellular platforms.

Given these loopholes in its mobile and wireless portfolio, mergers and acquisitions become viable paths for Infineon to stay competitive. In the sequel, we will discuss potential acquisition areas and targets before looking at its valuation.

The main products of this segment include power semiconductors, sensors and microcontrollers, silicon discretes, chip card and security ICs. Infineon’s ICs are used in power trains, body and convenience features such as air conditioning in your car, its safety features such as ABS, airbags and stability control, and its infotainment aspects. Industrial applications include power management and supplies, power generation and distribution, and industrial control. Customers include Avnet, Bosch and Siemens.

Market research firm Semicast reported that Infineon is the leader in the industrial segment ahead of STM and Renesas. Semicast estimates that Infineon has about 7.5% of the $20 billion industrial market. Further, this market is expected to grow to $33 billion in 2013 presenting Infineon with a good growth driver. Strategy Analytics ranks Infineon as the second largest supplier of ICs for automotive applications worldwide with about 9% market share. Additionally, Infineon is number one in the power semiconductors market with 6% share in 2006 according to an IMS research report.

Driven by the strong demand for energy efficient solutions, the industrial and automotive business will stay healthy. The company expects healthy growth rate in the industrial segment primarily based on its leadership position in power applications. It also hopes for roughly stable sales within its automotive business based on its ability to provide complete high quality semiconductor solutions integrating power, analog, mixed signal IC and sensor technology.

Like Semicast’s Colin Barnden notes, the challenge will be to hold on to the leadership position in the face of increased competition. The uncertain economy will make the stable industrial and automotive segment very attractive for semiconductor companies. The segment thus presents a good opportunity for Infineon subject to competitive risks. For the moment, I am willing to give Infineon the benefit of doubt that it will at least continue to maintain its market share here if not grow it modestly.

The picture below, taken from Infineon’s fiscal 2007 annual report, illustrates the root cause of Qimonda’s misery.

The DRAM prices dropped a whopping 29% in fiscal 2007 led by seasonal demand weakness, inventory build-up prior to the Windows Vista launch and capacity conversion from NAND to DRAM by the competition. The 44% increase in shipments and the continuing market diversification strategy were not enough to stave off these challenges leading to a net sales decrease of 207 million Euros in 2007.

Despite these issues, the DRAM business requires Qimonda to invest heavily in its research and manufacturing capabilities. In 2007, Qimonda announced plans to build new manufacturing facilities in Singapore and Malaysia. It also announced an agreement with SanDisk to jointly develop and manufacture Multi-chip Packages. Additionally, the company hopes to leverage its product and market diversification strategy to increase DRAM average selling prices (ASPs), profitability and return on capital.

Last week, Qimonda and Elpida, both top-5 DRAM suppliers, signed final contracts for a strategic technology partnership on joint development of DRAMs. Primarily a move to gain scale, this agreement encompasses a broad cross licensing of Intellectual Property that gives both companies higher design freedom while aligning their development interests. Elpida’s CEO is also quoted as saying that he was open to a share swap with Infineon.

Infineon wants to get out of the memory business. It announced recently that it wants to reduce its current 78% stake in Qimonda to below 50% by the 2009 Annual General Meeting. While not many will pay cash for this stake, share swaps with companies like Elpida may help constrict the supply and stem the free-fall in DRAM prices. With private equity unlikely to pick up Qimonda due to its unattractive cash flow, such share swaps may be the unfortunate reality that Infineon has to face today.

In summary, Infineon is unlikely to relieve itself of the memory business overnight. The huge write-off in the last quarter demonstrates that the company has realized this hard fact. It will have to swallow more losses despite its valuable R&D and manufacturing capabilities. From a valuation perspective, Qimonda will continue to have a considerable negative impact on Infineon’s share price.

For the fiscal year ending September 30, 2007, Infineon reported net revenues of 7682 million Euros at a gross margin of 20.7% and operating loss of about 3.5%. This is a decrease of 3% from the 2006 revenues of 7929 million Euros. The gross margin for 2006 was 26.2% while the corresponding operating loss was about 3.4%. Much like its European competitor STM, Infineon is also struggling well behind the industry average gross margin of 50.5% and operating margin of 18.6%.

The automotive and industrial business segment contributed 39% of the revenue while the communications segment accounted for about 14%. Qimonda, the struggling subsidiary producing memory chips, contributed close to 50% of Infineon’s 2007 revenues. Almost one third of Infineon’s products are consumed within Europe while Asia-Pacific accounts for another third.

Much of Infineon’s woes are tied to the struggling Qimonda. The commoditization of memory chips has caused their prices to fall considerably. While the cost of owning and operating memory fabs is high, the RoI is just not there due to unfavorable market conditions. Severely impaired in its ability to generate shareholder value, Infineon recently declared its interest in Qimonda as ‘assets held for sale.’ To give more clarity on its core business, the company will now report revenues only from its continuing operations. The potential gains or losses due to the change in the fair value of Qimonda will be reported as discontinued operations. In accordance with this practice, the company wrote off 1.3 billion Euros last quarter.

In the recent quarter that ended March 31, 2008, the company reported net revenues of 1049 million Euros from its core segments. This is an increase of 7% from the corresponding quarter in 2007. The gross margin for the quarter was 35% while the operating margin was about 4.5%.The Qimonda write-off in the balance sheet demonstrates the quandary that Infineon is in. It wants to dilute its stake in Qimonda and get out of the memory business. But apparently, the loss-making subsidiary does not have many takers. Infineon’s handling of Qimonda in the next few years will be an important component of any valuation analysis. It will hence be illustrative to take a look at this relationship in the sequel.