July 27, 2000 SMARTMONEY.COM
Freedom to Compete
By Alec Appelbaum
HISTORICALLY, A SPINOFF was a tech reporter's best chance at predicting the future: When a company split a fast-growing business from a slow-growing one, the fast-growing company's stock tended to take off — at least for a while.
Microchips Off the Old Block
PARENT
COMPANY BUSINESS
SPUN OFF NEW COMPANY DATE OF
COMPLETION
Orckit Semiconductors Tioga Technologies Summer 2000
3Com Hand-held devices Palm July 28, 2000
Lucent Office equipment Avaya September 2000
Lucent Microelectronics Not yet named Late 2000
Qualcomm Semiconductors SpinCo (temporary) August 2001
Lucent Technologies (LU) gained 99% in a year once it won independence from AT&T (T). Since Rockwell International (ROK) spun off its chip business as Conexant Systems (CNXT) in January 1999, the spinoff's stock has gained 329% while Rockwell's has lost 32% of its value. According to a study by McKinsey and Co., from 1989 to 1999, spinoffs delivered an average 26% return over their first two years of trading, compared to a 17% average biannual gain for the S&P 500 index.
Over the past week, there have been two more technology business spinoffs. Lucent announced a spinoff of its chip business on July 20 and Qualcomm (QCOM) followed up with similar news on Tuesday. At first, it looked like the same old thing. Two large telecommunications companies looking to unlock the value of fast-growing businesses. But when I peered closer, I saw something different.
For telecom-equipment companies in particular, and tech companies in general, spinoffs have become more of a marketing exercise than a financial one. The idea is to free up the newly independent units so they can try to sell wares to their parents' former rivals. That strengthens the new company's business and helps the parent company devote its operations to the remaining business. That, in turn, makes both the parent and the spinoff easier to value for investors.
Lucent and Qualcomm are spinning off businesses that sell components — chips used in telecom equipment. Lucent uses its own chips and currently tries to sell those chips to Cisco Systems (CSCO) and Nortel Networks (NT). Likewise, Qualcomm tries to sell its chips to Nokia (NOK) and Motorola (MOT).
The trouble is that Lucent competes with Cisco and Nortel for orders of big telecom switches and wireless hardware from phone companies. Likewise, Qualcomm competes with Nokia and Motorola for orders of wireless software. Why would the competition want to buy anything from its enemy? By spinning off their chip units, Qualcomm and Lucent can free those units to compete on the merits of their products, not corporate politics. By the same token, the parent companies can buy chips from whomever they choose without suffering interdivisional squabbles.
It's sort of an enlightened idea, as well as a capitalist one. "You don't want to be competing against your customers," says Elliot Hamilton of the Strategis Group, a market-research firm.
Wit SoundView analyst Matt Hoffman, who used to work for Qualcomm rival Ericsson (ERICY), says Qualcomm had to separate its software-licensing business from its chip business for either to realize its potential. When deciding whose chips to buy, Hoffman says, Nokia certainly realized that any money it gave to Qualcomm would fund Qualcomm's efforts to beat Nokia. After the spinoff, that issue will largely evaporate.
Qualcomm expects demand for its chips and its licenses to surge in a couple of years once the majority of cell phones are Web-enabled. As of now, cell phone networks aren't robust enough to handle heavy Web traffic, but when they are, Qualcomm President Paul Jacobs says he expects to license more of his patents for more devices.
Lucent, meanwhile, is racing to meet pent-up demand for high-speed optical-networking gear — equipment that uses light waves to send information over fiber-optic lines. Both companies recognize they can't afford to house businesses that tie up their spending or worry potential customers.
And they're not alone. As technology advances, many companies have begun spinning off their manufacturing divisions so that Wall Street will value them as solutions companies or software companies or idea-generating companies. For many, this means getting rid of chip businesses, which can be more like manufacturing shops than research labs. Hence, we see Orckit Communications (ORCT), a maker of software for high-speed phone lines, spinning off its chip business as Tioga Technologies (TIGA). When it announced the spin in February, Orckit predicted it would "expand opportunities for strategic partnering." Silicon Graphics (SGI), the struggling animation and graphics company, meanwhile got rid of its interest in chip maker MIPS Technologies (MIPS) earlier this year.
Will the spinoffs fly on Wall Street? That's a tough call. Though MIPS is up 44% from the time it became independent, Tioga is down 33% since it began trading. As for Lucent and Qualcomm, the spinoffs should help the stocks of both companies become less volatile as analysts have an easier time evaluating the direction of one business instead of three.
This trend runs counter to the rush of consolidation we've seen among telecom-service companies. While AT&T, Verizon Communications (VZ) and others offer more and more services over a larger territory, equipment companies are finding they can build bigger customer lists with a high degree of specialization. A rumored combination of Nortel and Corning (GLW), which makes optical gear, ended up dead after analysts expressed fear the two companies would make so many things that any possible customer might have a conflict with the joined company.
So consider this spinoff saga as an alternative to the winner-eats-loser logic we're used to in the telecom world. As the telecom-equipment business gets more competitive, it's a dangerous thing to look too big. |
