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Which Way Forward for Infineon?

{complink 2565|Infineon Technologies AG} is profitable but only barely so, and current trends in the general economy and within several of its end markets point to major turbulence ahead for the German semiconductor company. After a series of turnaround programs executed over several years, Infineon is still in recovery mode, and it probably will be for at least the next several quarters.

On Tuesday, Infineon's share price and valuation fell more than 6 percent after it said it would report lower-than-expected results for its fiscal fourth quarter, which will end Sept. 30, including a slight decline in sales from the fiscal third quarter. For the first quarter of fiscal 2013, the company expects “a revenue decline of up to ten percent relative to the fourth quarter of the 2012 fiscal year.”

Infineon clearly remains in jeopardy, but this situation could be worsened by management missteps that, in my opinion, were inspired by an overexaggeration of the challenges it faces. First, the bad news: Though sales grew sequentially in the last two quarters, they are expected to decline for the next two. A decline of as much as 10 percent from a year earlier would be huge for a company that has been steadily ramping up its growth and initially appeared to be on an upward trend. Margin pressure is also expected to intensify, with operating margins dropping from a high of 13.6 percent in the fiscal first quarter of 2012 to as low as 5 percent a year later.

What does the company plan to do, and what actions must it avoid? Infineon says the management board “will define and implement measures to improve profitability beyond the first quarter of the 2013 fiscal year.” It did not specify further, but I expect it to squeeze savings out of selling, general, and administrative expenses, which have hovered at around 12 percent of sales for the last three quarters. It may also tamp down R&D costs and try to reduce the cost of goods sold to improve the gross profit margin, currently at around 36 percent. All these actions will invariably involve job cuts.

Investors and executives shouldn't underemphasize the company's strength, though. Yes, sales are weakening, and margin pressure is building, but the two are closely related. The company's cost structure isn't too high, and the drop it expects in the operating margin is only because sales will not be as robust as anticipated. Furthermore, Infineon is in the relatively strong position of having adequate cash to fund ongoing operations. With €2.1 billion (about $2.8 billion) in cash and short-term investments as of the end of the June quarter and only €192 million in long-term debt, Infineon isn't in danger of defaulting on anything or even running out of cash.

Therefore, Infineon shouldn't cut expenses so deeply it gets hobbled when the market turns around, as I expect it will in the second quarter of 2013. I believe the electronics industry will experience weak sales in the next two quarters but should see a reversal by the second half of 2013. Companies that aren't prepared for growth by that time or that have retrenched key employees will not benefit from the rebound.

It's important to note that Infineon has already done a lot of the reorganization it needs to improve. On an annual basis, its sales have grown strongly in the last couple of years and may only be slightly lower in fiscal 2012 from the prior year. For the restructuring actions it has already taken to yield the desired results, Infineon's management must take the longer-term view and use the sales lull to invigorate operations, fortify alliances with customers, and crank out new products.

Yes, margins are under pressure today, but others are feeling the pressure, too, and it's as important to plan for future growth as it is to safeguard profitability. Cutting R&D may help improve operating margins, but it will also decimate the product pipeline, and that's really what drives growth and long-term profitability.

18 comments on “Which Way Forward for Infineon?

  1. Nemos
    September 26, 2012

    “Therefore, Infineon shouldn't cut expenses so deeply it gets hobbled when the market turns around, as I expect it will in the second quarter of 2013.”

    You have to be very careful when you are trying to cut off expenses especially when this includes cut off  jobs of high quality and trained personnel.  

  2. bolaji ojo
    September 26, 2012

    Nemos, This is always a difficult choice for executives and this is even more so for public companies. The margin pressure is an ongoing concern for executives who have to make sure they have a profitable business and so often have to cut costs when sales decline. At the same time they still have to find ways to ensure revenue growth after a market decline. So, “to cut or not to cut” is a question firms must confront when sales decline.

  3. _hm
    September 27, 2012

    @Nemos:

    I agree with you. It is very difficult to get these highly trained people. Also, Infineon has very good leading products and they should be very healthy once market truns around. They need to have wait.

     

  4. _hm
    September 27, 2012

    @Bolaji:

    Saving very marginal money with cutting jobs is not prudent. This is high risk decision and it may hurt them in long run.

     

  5. Houngbo_Hospice
    September 27, 2012

    @Nemos,

    All good advice here. The company seems to be taking actions in order to be fully operational when the “market turns around”. As Bolaji said, the management needs to figure out how to balance R&D expenses and good profitability margins.

  6. Houngbo_Hospice
    September 27, 2012

    @Bolaji,

    “”to cut or not to cut” is a question firms must confront when sales decline.”

    Based on historical data what do you think executives usually do in such situation? I think there is a higher probability that they will cut costs in order to save their profit margins.

  7. Houngbo_Hospice
    September 27, 2012

    @_hm,

    It is sometimes tough for executives to come up with the good predictive analysis about the future. What is important here is first to save money so that you won't be out of cash when the market recovers.

  8. ahdand
    September 28, 2012

    Well In feel you need to take some risks here. If you try to be in the defensive mode all the time and save money it will do no good for you. Predective analysis is not accurate 100% but it can predict and throw you some suggestions which you can decide and take.

  9. FLYINGSCOT
    September 28, 2012

    Infineon is a strong company with real presence in the industrial and automotive markets.  With a large cash pile I would not worry too much about its future but I sure hope management get its act together soon.

  10. SemiMike
    September 28, 2012

    The devil is in the details, and in Infineon's case, its operational details and timing of strategic adventures, like the DRAM business fiasco that seem to plague them.

    German subsidies (like the one's given to AMD in Dresden for example) often lead to badly timed investments and subsequent fast obsolescence…..in my opinion.

    Its not just INVEST vs CUT based on macroeconomics or industry cycles.  Its WHAT, WHEN AND HOW that matters.,,,in my opinion.

  11. Taimoor Zubar
    September 30, 2012

    @Bolaji: What about the competition Infineon faces? Has that been one of the causes that has led to this situation faced by Infineon?

  12. Taimoor Zubar
    September 30, 2012

    “.. how to balance R&D expenses and good profitability margins.”

    @Hospice: That's one of the most critical decisions that any manufacturing company has to take. Either to cut expenses and show a healthy profit margin or to invest into R&D for better profits in future. Striking the right balance is very difficult and most companies struggle with it.

  13. hash.era
    September 30, 2012

    Taimoor competition is always a plus factor for any company. It may sound bitter for them but in long term it will do loads of good since because of compitition they have to make certain decisions which they might not have even thought about plus work hard and think differently to stay in the market

  14. hash.era
    September 30, 2012

    Very true flyingscot I too feel they have the financial backing plus resources to survive this kind of a situation but yes truly their management should act wisely here

  15. stochastic excursion
    October 1, 2012

    Like all businesses in an economic crunch, Infineon faces challenges in bringing cost-effective products to market.  Infineon chips often have the edge, though, in performance and reliability.  This suggests it will always have a foothold in the electronics market, and maybe even as an acquisition target.

  16. bolaji ojo
    October 1, 2012

    Stochastic, The semiconductor market is not one of the economic segments where large acquisitions are likely anymore. Few companies have the means to take on such a large acquisition (Infineon's market value as of Monday Oct 1 was $7.2 billion which means a potential buyer would have to pay a sizeable premium of 15 to 30 percent or more) and the ones who do may not have a good reason for doing it. So, an acquisition is unlikely, unless leverage buyout specialists get involved.

  17. bolaji ojo
    October 1, 2012

    Infineon executives will cut costs. They'll do it even if they believe it's not in the long term interest of the company. Managing a public company is a lot more complex than for a private company. They have to answer to investors who want short term results and that's often delivered with cuts!

  18. hash.era
    January 30, 2013

    Thats interesting stoachastic. I never thought about that part but yes you are right on it.

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