Infineon Technologies: Time to Cash in Your Chips?

[pic 1]Infineon Technologies: Time to Cash in Your Chips?

Question 1. Infineon’s business

Infineon operates mainly in three segments. First one is the automotive sector, which accounts for 39% of sales. It mainly provides vehicle electronics, microcontrollers, power chips and sensors for engine, safety systems and transmission control. Second segment is industrial and multimarket (IMM) which generates 45% of sales. In IMM Infineon produces power chips to be used in efficient generation and transmission for industrial products or home appliances. Thirdly Chip Card & Security accounts for 11% of sales. Business in this sector mainly consists services and products for electronic security in chip cards and mobile devices.

There are new Asian markets and emerging players in the industry. Infineon could focus strongly on these new markets such as Asia or BRICS countries to strengthen its position in different steps. Firstly, Infineon produces their chips in the cleanrooms with extreme accuracy. Demand for cleaner and safer vehicles and renewable energy is increasing substantially in the BRICS parallel to the growth of middle class, so there will be more need for semiconductors, especially for power chips. It is already planned to set up a second clean room in Malaysia so setting up more cleanrooms or facilities in these countries would help Infineon to provide their technology and cost leader services faster than the competitors. Cheaper workforce and production in the emerging markets would create an advantage when setting up the new clean rooms. Secondly since the industry is very sensitive to new innovations more investment in the R&D projects is key to stay as the leader provider of newest technology. It is mentioned that lawsuits regarding intellectual property have been an issue in the sector. Therefore, another step would be to have licenses to protect their developed technology by avoiding possible litigations. This would strengthen the position in existing markets and provide important advantage in the new markets. Lastly the industry itself is known for long lead times for new technology and manufacturing capacity, intense rivalry and fast paced innovation. Hence pursuing strategic acquisition possibilities could give Infineon a competitive advantage and strengthen the position in the future.

Based on 2011 data, Infineon has been performing well with its €4bn record revenue, €6bn market capitalization and €2.4bn cash. According to the revenues it was ranked as 2nd in Europe and 12th in the world. It holds the largest market share in global power chips market with 11.2% in 2010. In the foreseeable future Infineon has a strong operational standpoint considering that it has size, technology and cost leadership compared to the rivals. Additionally it had improved its cash conversion cycle (CCC)^[1], which decreased from 98 days in 2009 to 7 days in 2011. This implies that Infineon is doing good from an operational standpoint. To improve operations Infineon got rid of its riskiest unit, which was more volatile than others. Even though it helped them to be safer and maintain long term customer relationships with set prices it wasn’t enough to get rid of highly cyclical pattern and risks of technology, competition and exchange rates.

Question 2. Capital Structure

As a consequence of the remarkable performance over the past years, Infineon has generated enough internal resources to finance its investments needs and secure its future liquidity without external sources. These results explain why the company decreased its debt, built a significant cash position and paid dividends for first time. Debt decreases have been followed by buybacks, dividends payment and repurchases of convertible bonds. For FY2010 the dividend payout ratio was 16.5% and total payout ratio was 47%. These transactions had had an impact on Infineon’s capital structure, which over the past 4 years showed a defined trend. Debt is decreasing and equity is growing. For FY 2011 the portion of equity over total capital employed was 95% compared to 72% in 2008. (Appendix 2). This capital structure had led to a WACC of 10-12%^[2].

Infineon’s main sources and uses of funds: Sources:  For 2011 the most important source was the company’s net income, which accounted for 1.119 million. Additionally, 490 million Euros were generated by the sale of assets. Based on the case, this sale probably corresponds to the divestiture of Infineon’s wireless unit.  For 2010, the net income continued to be the main source (659 million) along with other divestiture of assets, which generated 282 million. Uses: In 2011 the most significant use of funds was the property, plant and equipment investment (+505 million). In 2010, the payment of liabilities of 388 million represented the main use. However, these uses are lower than the total increase in cash reserves. This strong cash position will guarantee Infineon’s future liquidity needs and decrease under-investment risk.

Infineon’s sustainable growth rate: According to Higgins (1997) the sustainable growth rate is the highest growth a company can keep with the same capital structure. It is determined by the return on equity and the plowback ratio. This model has 4 main assumptions: “the company sells no new equity, wants to maintain its capital structure, has a target dividend policy and grows as rapidly as market conditions permit” (Platt, Platt, M. B., & Chen, 1995). In Infineon’s case there is not enough information to confirm these assumptions. First, the capital structure has changed every year and it might keep changing. Second, it has not a defined dividend policy since it has only distributed dividends once and Mr. Bauer’s statements only suggests Infineon will start paying regular dividends but not additional information is given. Third, Infineon’s asset turnover ratio has increased constantly over the past 4 years. If we assume that Infineon’s capital structure for 2011, the asset turnover and gross profit will remain constant and that the company will keep a dividend payout ratio of 16.54%, we get a sustainable growth rate of 15.37% (Appendix 3). This rate is lower than the 2011 asset growth rate (17.62%). If Infineon didn’t have debt and didn’t payout dividends, it could reinvest its earnings and the sustainable growth will be similar to its asset growth rate.

Infineon’s current capital structure: It is well known that companies with high financial distress costs should have less debt and hold a conservative approach. In Infineon’s case these distress costs include not only distress related to being unable to meet financial commitments but also investment needs.  Since Infineon is a knowledge-based company that operates in an extremely competitive industry, it is vital to be able to continue with the significant investments in R&D it had done in the past. In FY 2011, the company’s level of R&D expenses and total CAPEX investment was 11% and 22% of its revenue respectively^[3]. To do so Infineon is using its internal funds, which explains why the company is holding high levels of cash. This policy allows the firm to decrease the risk of under investment, which would be the same as the default risk. Additionally, according to the pecking order theory, a company should use first the internal funds before raising debt, since it is a positive signal to the market of its good financial position due to healthy cash flows. Another fact that can explain Infineon’s current capital structure is that by having a low debt portion it will be easier to acquire debt under favorable terms during crisis. This access to financial resources is key to Infineon since its main assets are intangible; therefore they are company dependent and cannot be hedge with financial instruments and don’t match company’s cash flows.