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Thursday, 25 September 2014

Royal Philips NV pulled another rabbit out of the hat: the company is being split into two “baby Phil’s”, to become more profitable.

Yesterday, there was breaking news from the Dutch multinational giant in healthcare products, lighting and consumer electronics, Koninklijke (i.e. Royal) Philips NV ($PHG).

The company had a genuine bombshell for its investors, which made a large number of them very happy: Philips will be split up into two “baby Phil’s”:
  • Philips Healthcare + Consumer Electronics, using the label Philips HealthTech;
  • Philips Lighting.

In order to give you some valuable background information about this Dutch giant with approximately 115,000 employees worldwide, I refer to an older article: Does a new CEO in his rookie year always generate losses and dropping stockprices for Philips?

Philips (PHG) is a multinational company in lighting, healthcare and consumer electronics from The Netherlands, that you can best compare with a phoenix: every time you think the company is finished, it reinvents itself and returns from its ashes to grow bigger and stronger again.

The bad news is that the company is an investor’s worst nightmare. Cor Boonstra, CEO of the company from 1996-2001 called the organization structure in 1996: “a plate of spaghetti”. And that was after Operation Centurion, the worldwide reorganization of Philips, started by previous CEO Jan Timmer, had ‘finished’.  And also after the discharge of tens of thousands of ‘redundant’ employees and some drastic changes in the organization structure.

The problem was that the company was so big, versatile and sluggish, operated in so many countries and had an organization that was so complex, that it could be compared with a super tanker where the captain is frantically turning the steering rudder: nothing happens… Trying to change the company seems like pulling on a dead horse. If you look over the last 40 years, the numbers of reorganizations, strategic reorientations and buy-outs of company parts is truly countless. And for a few exceptions, nothing seems to have the desired effect.

But just when you think there is no strategy left, the product lines are hopeless, there is no subsidiary left to sell and the company has finally sung its swansong, other parts of the company become successful again and grow enormously, thus saving the company from bankruptcy.

Again this legend proved to be true for Philips. After a shaky start for Frans van Houten in 2011 and in spite of a series of scandals, regarding bribery, corruption and offending EU competition rules, the company saw its stock value rise again to values north of $37 dollar at the beginning of 2014.

5 year stock rate overview of Koninklijke Philips NV ($PHG)
Chart courtesy of Bloomberg
Click to enlarge
With this improved performance during the last three years, Philips proved once more the following statement that I made in the same aforementioned article from June, 2011.

In the last full working year of a Philips CEO, the company almost always shows good profits and a high stock price. In the first year of the new CEO the company often reports (record) losses and the stock price drops .

Of course there is no guarantee that this is a winning strategy. Especially after the crash of the dotcom bubble and in 2008, the stock got hammered. But it seems more than a coindicental pattern, that the last full year of the old CEO of Philips is always successful if you look at the stock price, while the next year is a year with reported losses and falling stock prices.

Of course CEO Frans van Houten is probably only in the middle of his stint as CEO of Philips and so he has still a few years left to work on his legacy for the company. 

Nevertheless, after the stock rates of Philips plummeted to $30 in August, 2014 from their $37 peak in January and the voices demanding a corporate split up of Philips became louder and louder, Van Houten decided to choose for the nuclear option indeed and split up the company.

The following snippets come from Het Financieele Dagblad:

Philips comes with a major intervention in the organisation. The company, with yet three divisions, will split itself up in two separate companies. The company will merge the Consumer Lifestyle division, which produces a.o. razors and coffeemachines, into the Healthcare division, operating under the label Philips HealthTech.

The Lighting division will be put into a new legal entity. This is the first step for a split up, after which other shareholders could enter into this division. Philips keeps several options open, concerning the future of this newly formed subsidiary. Still, it is the most intrusive step of Van Houten, Philips CEO since 2011, who already sold other subsidiaries of the company.

Both divisions will remain active under the Philips brand. However, putting the lighting division in a separate legal entity could mean that the stock-rated company wants to separate these company parts from the core organization. Philips already used this strategy a number of times before to outsource numerous other activities. The most famous split-offs are ASML (manufacturer of state-of-the-art lithography machines for the microprocessor industry) and NXP (microprocessor production).

Van Houten reckons that these interventions will make the company more “lean and mean”, enabling it to battle the competition. By merging Consumer Electronics into Healthcare, he thinks that Philips can become a front-runner in the development and sales of medical products all over the world. And by separating Lighting, this division is better able to expand its strong market position in the world, according to CEO Van Houten.

This morning, the FD came with a further analysis with respect to this corporate split up of Royal Philips NV:

Is it a briljant move or will it prove to be the end of Philips as independent company?! It is impossible to answer this question yet, but CEO Van Houten made a bold move, by announcing the split up of Philips.

A split up was high on the wishlists, which circulated among investors and analysts who follow Philips. Yet, the announcement came unexpected. 

Analysts initially reckoned that Van Houten would first solve the various problems at the Healthcare and Lighting divisions. This is yet possible. The timebox for the transformation is 12 to 18 months, enabling Philips to guide this process thoroughly. It is a major operation, which will undoubtedly be very intrusive for the 115,000 employees of the corporation.

The corporation also takes a risky step. Such transformations offer opportunities to competitors, as well as financials, to perform an ‘air assault’ on these new companies, as the value of the new companies is only €15 billion (HealtTech) and €7 billion (Lighting) respectively.

Van Houten acknowledged yesterday that Philips has been put “under possible jeopardy” with this action: Both companies are leaders in their respective markets. We think that when we act rapidly and create proper value, we don’t have to worry about forms of activism (among shareholders) and takeovers”.

Suffice it to say that CEO Frans van Houten of Philips had his hand firmly on the “chicken switch”, when he made this announcement to split up the company:
  • This split up had been high on the wishlist of the shareholders (first red and bold text);
  • Probably the activist investors (TCI and its likes) had been banging on the door of Philips for some time now, and Van Houten decided to make a flight forward under their pressure (second red and bold text).

Perhaps the split up might be a sensible step after all for Philips, in order to avoid either a hostile take-over by a stronger competitor or a revolt under the (activist) shareholders, as a consequence of Philips’ poor performance in 2014.

Still, I don’t see it as a particularly brave step: it could be the end for the Lighting division as an inseparable part of the Philips legacy, which started in 1891 with this very division. 

In The Netherlands, Philips has been famous for ages under the moniker “the light bulb factory in the south of the country”. Lighting was just as an inseparable part of Philips, as the city of its establishment Eindhoven was. 

That this Lighting division will now be put on its own two feet is something that will sadden many (former) workers of Philips and will send shockwaves among numerous inhabitants of Eindhoven.

On top of that, I have serious doubts whether this step will make Philips-as-a-whole more successful!

In the past, Philips was as close to the famous A.C.M.E. company (i.e. American Company Manufacturing Everything) from the Looney Tunes cartoons, as could be: 

They. Made. Litterally. Everything...

However, that was 25 years ago. Since then, the company went through dozens and dozens of outsourcings, shut-downs, overhauls and moves of whole factories to the low wage countries.

The Philips company, infamous from the ‘Plate of Spaghetti’ methaphor and established in the hundred years before Cor Boonstra, has changed to an ever leaner and meaner company, focusing at only three successful divisions (even if they had their ups and downs in the recent past). In these years, world-famous institutions like Philips NatLab (i.e. Physical Lab) and the Philips television department have been abandoned or sold.

There comes, however, a time when famous large companies stop being viable, after too many divisions or company parts have been sold or outsourced. 

In the second FD article (see the aforementioned further analysis link), Frans van Houten refered to Nokia, as a company which waited too long with changing their main strategy and product lines.

The sad truth is in fact, that Nokia (once a part of ITT) was the Finnish cousin of Philips, specializing in all kinds of consumer electronics. That was before it started to focus on mobile phones exclusively. 

From a healthy, quite successful, company with a broad product range and sufficient cash cows, Nokia changed into a one-trick pony, which burned up like a flare. The company finally 'perished' (or would you call the take-over by Microsoft differently?!) when their telephones fell from grace with the consumers, under pressure from the competition.

Of course it is impossible to say whether Nokia would have survived as a broad producer of consumer electronics, or that it would have disappeared just like the German companies ‘Grundig’ and ‘Telefunken’ did earlier. We will never know…

Still, I have fears that this latest overhaul will turn Philips from a healthy, innovative company with (unfortunately) cyclical stock rates and a 'revolving CEO problem', into two “one-trick-pony’s”, which will become very vulnerable for the risk of falling from grace at their customers. 

However, the investors obviously didn’t share these fears of mine, as the stock rate of Philips skyrocketed after Van Houten made his announcement yesterday.

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