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Can the tech make its Philips acquisition pay?

by Russ Mould

It’s been four months coming, but Pace Micro Technology’s acquisition of Philips Electronics’ rival set-top box operation has finally closed, marking the latest step in the firm’s recovery since Neil Gaydon took over as chief executive in April 2006.

The purchase will create the world’s fourth largest set-top box maker, with unit shipments forecast to exceed 11 million this year. This trails France’s Thomson and American giants Motorola and Cisco, but increased share was not the prime driver for the deal according to chief financial officer Stuart Hall. ‘The objective is not to be the number-one set-top box maker in the world. We are concentrating on the quality end of the pay-TV market,’ he says. ‘It is the increased [operational] leverage that is significant’.

Buyer beware

One concern, however, is Philips’ record as a canny seller of assets over the past decade, established firstly under chief financial officer Jan Hommen and continued by his successor Pierre-Jean Sivignon. The Dutch giant’s 2006 spin-off of its semiconductor unit, NXP, was well-timed and management has proved consistently shrewd when disposing of equity holdings such as LG.Philips.LCD. It should also be noted Philips’ CEO Gerard Kleisterlee has targeted an EBITA margin of 10%-11% and a return on invested capital of 12%-13% by 2010.

Return to profit

Even after heavy restructuring, the Dutch firm’s set-top box operation lost money for the second year in a row in 2007 and Kleisterlee clearly had doubts whether it would have been capable of such returns as part of Philips. But Hall is quick to point out the considerable synergies his firm should be able to extract from the acquired operation. Pace’s strong market positions in the UK, Europe, Australia and the US cable television market will be complemented technologically and geographically by the Philips business.

‘Pace has been restructured with new customer accounts teams and new products. Our gross margin has been increased from 15.3% to 20% and we will apply this model to the Philips business,’ he says. ‘Philips has a gross margin of 14% and we can move that to our level with increased scale and better balance.’

The deal, which was classified as a reverse takeover, saw Pace pay 64.5 million shares upfront, with a deferred consideration worth a maximum of €5 million (£3.9 million) in cash over the next three years, depending upon the acquisition’s performance.

Philips will therefore have a 21.6% stake in the enlarged firm, and is obliged to retain at least a 17% holding for the next 12 months.