Freescale Semiconductor (FSL)

[SeriousMoney]

Freescale Gets in Fighting Form, Helped by Former Parent Motorola
BARONS ONLINE, By MARK VEVERKA, MONDAY, OCTOBER 31, 2005

FREESCALE SEMICONDUCTOR WAS SPUN OFF from Motorola more than a year ago, but the Austin, Texas, chip maker still counts the former mothership as a big customer and has clearly been sharing in its recent successes.

Freescale (ticker: FSL) hit a 52-week high of 25.99 on July 28 before fears about a foundering auto industry began to spook investors. About one-third of the company's revenues come from silicon it supplies to Detroit, Tokyo and Munich. But even at about 23 on Friday, Freescale's shares are still up about 45% from a year ago.

"We entered the market quite undervalued, and I think that the market has given us credit for beating earnings estimates since going public," Freescale Chief Executive Michel Mayer told Barron's in a recent interview.

The nation's third-largest chip maker, behind Intel (INTC) and Texas Instruments (TXN), didn't miss a beat when it reported earnings a couple of weeks ago. Driven by intense cost-cutting and major organizational restructuring, profits nearly tripled for the third quarter to $164 million, or 38 cents a share.

Sales rose only about 1.4%, to $1.45 billion, reflecting the lackluster demand for automotive and networking-gear chips. Revenues from chips for handsets, however, rose 8.5%, reflecting brisk sales of Motorola's latest models, including the ultra-thin RAZR phone.

As is often the case with huge units within major conglomerates, the former Motorola (MOT) chip unit needed some serious belt-tightening, says Mayer, a French national and former IBM executive.

"One of the things I inherited was sub-par financial performance, [so] we've had to undergo significant manufacturing restructuring," Mayer says.

One of his primary goals has been to fatten gross margins to north of 45%, which is close to being accomplished. Third-quarter margins clocked in at 43%, which explains how Freescale managed to nearly triple profits despite relatively flat sales. "We have been very clear with Wall Street that at this part of our life, margin expansion is very important," Mayer says.

Of course, cost-cutting and manufacturing efficiency can only take you so far. And fond as Mayer is of Free-scale's former parent, he is anxious to grow the company's wireless business beyond Motorola. He also plans to expand business in automotive, especially in Japan, where Freescale has about 1,000 employees on the ground. Plus, Mayer hopes to make more inroads into consumer electronics and entertainment, which has been a key area of concentration for its competitor up the Interstate in Dallas: Texas Instruments.

The weakness in automotive and networking gear has driven Freescale shares down about 11% from their July high. But that isn't dampening UBS semiconductor analyst Tom Thornhill's enthusiasm for the shares. The analyst upgraded Freescale last week to Buy with a target of 28, calling the dip an opportunity.

Thornhill contends that the company will make up for softness in its transportation and networking businesses, which together account for more than 70% of revenues, with yet more margin expansion and higher mobile-wireless sales. He figures that Freescale is trading for 18 times calendar 2006 earnings (adjusted for options) of $1.23 cents a share, which is slightly lower than Texas Instruments' multiple of 19.

Of course, betting on Motorola having a strong holiday season with its latest phones isn't a slam dunk, but it isn't a long shot either.

Open-Source Protection

If the likes of Lloyd's of London can insure University of Southern California quarterback Matt Leinart from career-ending injury, it can certainly figure a way to protect corporations from liability related to running open-source software on their networks. That, at least, is the thinking of Matthew Hogg, an executive with Kiln of London, a Lloyd's underwriter.

Hogg and Daniel Egger, chief executive of Open Source Risk Management, a New York consulting firm, have teamed to launch a completely new insurance policy that covers risks associated with users of Linux and other open-source software.

"It puts open source on a level playing field with other types of software," Egger said in an interview. "We hope this product becomes a standard part of risk management."

Called "Open Source Compliance Insurance," the policies are expected to be written initially for about $5 million to $10 million. And while many corporate lawyers may not understand what it is, or why they might need it, they will soon. Most major companies use open-source software somewhere in their enterprises. It is basically free, and it is shared. It is a major threat to the proprietary and expensive closed-software products sold by Microsoft.

At some point in the enterprise, a company's proprietary software code meets the open-source code, which is where the potential risk lies. Companies are discovering that some code they would rather not share with the public is considered by non-profit governing bodies as "open." If deemed so, these companies stand to lose monetary value associated with the code.

When Cisco Systems bought consumer wireless-router company Linksys, it found out after the fact that Linksys unwittingly used open code it thought was proprietary. Cisco paid a premium for some of Linksys' code, but had to share the code eventually with the public and eat the premium it paid in the acquisition cost.

The first policies will be written for "early adopters" of this innovative policy. Says Hogg: "Big companies have been asking for this kind of coverage." All that remains is whether they will buy it.

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