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STMicroelectronics (NYSE:STM)

Citi Technology Conference

September 04, 2012 01:30 PM ET

Executives

Philippe Lambinet - Chief Corporate Strategy Officer and General Manager

Analysts

Amit Harchandani - Citi

Question-and-Answer Session

Amit Harchandani - Citi

Okay I guess we will get started, first of all thanks to all of you for joining us today. I am Amit Harchandani, I head the European Technology coverage for Citi based out of London and I am also the covering analyst for STM. I am delighted to have STM join us again this year and from STM today we have Philippe Lambinet and Tait Sorensen, Tait is Director of IR and Philippe I guess, those of you who are new to the STM is the firm's Chief Corporate Strategy Officer and the General Manager of the Digital Sector. In fact he is a chip veteran having spent probably 30 years, best part of 30 years of his life looking at chips of all shapes and sizes. So, without further delay I think Philippe said let’s quickly jump into Q&A straight-off so that’s what we are going to do. So, as a start maybe just to get the discussion going Philippe if you could just tell us what are you seeing in the market today. I mean STM is probably the best candidate given your diversified positioning to talk about the broader market trend, how would you characterize current demand versus the first half and is it better, worse, same, is it the same across different product segment?

Philippe Lambinet

When we published our results that the end of July for Q2, we already communicated that the following trend which we saw starting mid-last year an inventory correction and we saw the end of that inventory correction in Q1 this year and the only part of Q2 was actually quite positive. We had a good rebound, April and May bookings were quite good, so we were quite optimistic for the rest of the year. Now when we again when we published our result in July we said let’s not be too bullish, the June bookings and the July bookings have not been very good. The market is softening. What I can say is that softening is continuing. The August bookings have continued to be not very strong. So, it's too early to say whether it will rebound now and in Q4 or whether it's going to be a double dip and it will further weaken. Right now it's flattish so we had taken a flattish booking situation into account in our guidance for Q3 so we have no reason to change our guidance but it's a bit early to say how we will guide for Q4 and of course we will have another month and half before we have to do this but definitely the weakness is there, continues to be there. It's across all applications and it's across all regions, so there isn’t particularly dark spot and there isn’t a particularly bright spot I think all of the market is pretty weak.

The inventory correction is over, I mean the inventory is top inventory in the channel has stopped decreasing. It's at a fairly low level but it's not coming back so people are not bullish enough or confident enough to start restocking. So I think the message is pretty simple we told already the market that June and July were weak. I think we can confirm it's continuing to be flattish and not particularly recovering.

Amit Harchandani - Citi

So you said that it's pretty much the same situation across the different product segments, so no real bright spots per se or would you still say that there are some who are doing slightly better than the others?

Philippe Lambinet

My comment was on the market, not on ST. Of course when it comes ST, ST performance in those markets is different from one unit to the next. We have some units that perform well even that weak market they are growing because they are performing better than the market. I mean we can reiterate what we said in July it's still true. In Q3, we will have the MEMs business grow, we will have MCU business grow, we have IGBT, IGBT modules, Power MOS growing which means gaining market share basically and we have particularly one business that is suffering in Q3 versus Q2 which is the optical sensor, the imaging business which is particularly suffering from two customers who have market share issues in the smartphone segment. So those two customers been weak and our imaging business been very much linked to those two customers. We are suffering in the second half of this year for sure.

After a good 2011 and a decent first half, definitely the second half is not as good. So this was anticipated and already communicated in July and we can’t confirm this right now.

Amit Harchandani - Citi

I think since we are on the topic of near term, I mean a slightly cheeky question if I may. It would be interesting to hear your thoughts on that topic which has dominated headlines recently which is the ongoing litigation between Apple and Samsung. I admit both are your customers and you respect the relationship but in the broader sense particularly when you include the ST-Ericsson perspective, would you say threat for the Android eco-system is an overall negative for your firm?

Philippe Lambinet

Well we don’t like to comment on ongoing litigations and it's difficult to see how this will come out. I think ST has enjoys very good presence in both eco-system and you know ST will benefit from the growth of the overall market. As people know we have MEMs for example in both side in the iOS eco-system and in Android eco-system. We are not particularly anxious on one side or the other no matter how it will go.

So you know let’s see how that, I think the only lesson we get from this is IPs they are important. In ST we sit on a huge portfolio presence and we are very strong and we have our own litigations and we have our own win sometimes also there and I think it's important that we stand very solid and both ST-Ericsson and ST in that regard are companies that can sustain these kind of sites. Now on the customer, we cannot comment.

Amit Harchandani - Citi

Moving away from the near term sentiment maybe to the bigger picture, now as we said you are very diversified and if I understand you had a market share of around 5.8% in your addressable, serviceable market if I could call it that. Do you have any sort of medium term goals that you would like to target and say okay fine this is the kind of market share we are looking to get or achieve, I mean internally do you have any such document.

Philippe Lambinet

We don’t have a precise target of course, our aim is to grow faster than the market so our aim is to gain market share and that’s a very important index for us but that’s not the main focus, clearly gaining market share is a priority and we want to gain market share and of course we want to focus the R&D effort and we want to focus where we spend our money, where we can gain share and build a solid position. Clearly, the team is more focused on delivering the mid-term operating margin targets that we have communicated. I think these are more important targets for us and for you than the market share. Of course they are both linked. When we are in a very strong market share position clearly it's easier to protect the margins, it's easier to deliver good operating margins.

But the first thing we look at is the performance in terms of operating margin of each of our businesses rather than the market share.

Amit Harchandani - Citi

But nonetheless I think one of as if clearly your ambition is to grow market share. So, which product families do you think would really be at the forefront of driving these gains, would it be MEMs, would it be something else. So if we just talk about which are the product families which are right up front?

Philippe Lambinet

I already mentioned MEMs, MCU and of course I can add automotive as another business where we want and we will gain share. Clearly, this year is a tough year for imaging so the next two years it will be an important area where we can and we will gain share on image sensors. So the old sense space let’s say MEMs and optical sensors are important areas where we will gain share and then there is the whole story of digital. We are clearly ST-Digital plus ST-Ericsson as a whole has to reinvent itself and restructure itself to be positioned for growth. In some of our businesses in digital we enjoy a very good market share like in set top box, we are above 30% worldwide and with very bright spots also in emerging countries and some high growth geographies so here we have less market share. In some other digital businesses where we don’t have enough market share and here we have to strategically think of where we should stay or not in some of those businesses because in digital the R&D investment is such that if you want to generate profit you have to have a certain scale and therefore you have to have a certain market share. We have seen it in set top box again which is traditionally a good profitable business because we have a high share, there is two people making money in set top boxes and dot com (ph) and all the others who have less than 10% market share they are struggling and they can’t generate profit and digitally pretty much this kind of profile everywhere.

So either we have a pass to get to above 20% market share in the markets we serve or we better do something. So there is a whole strategic review of all the businesses we have in that space, some of them have already been reviewed, addressed restructured and repositioned and imaging is one of those, we changed the business model, working more with foundries, working a lot less OpEx intensive and lot less CapEx intensive than it was in the past. We have positioned it, we are getting new design wins and very diversified market. So that’s positioned for growth and profitability.

Other businesses were in, need to be repositioned as well to guarantee that there will be growth and profitability.

Amit Harchandani - Citi

When you touched upon the digital products segment and obviously it's pretty close to your heart and so you talked about 20% market share sort of a long term part towards that market share. So what gives you that confidence that despite the kind of lack of profitability if I could call it particularly on the DTV site, what’s the path that you see gradually towards the 20% market share, I mean is it your differentiated IP, I know for a fact that on set-top boxes you have your security IP? Are you banking on something similar on the DTV side as well.

Philippe Lambinet

There is two things, first do we have differentiated knowledge or IP or skills, and second is there a way we can spend less R&D. I think in the case of DTV we do have differentiated IP. In 2008 we acquired Genesis which had the (inaudible) video scaling IP which is becoming more and more relevant and more and more important HD came and now 4K, 2K is coming, the ability to upscale video with very high quality is a key differentiating IP. So yes, we do have IP. Now, do we have a way to be in that market without spending so much money? We've announced at the end of April while ST-Ericsson was publishing its new strategy, we've announced that we would consolidate inside ST all application processor development to serve all the markets that need an application processor and those markets are today, smartphone, tablets, set top box, TV, car entertainment and so on. So there is multiple markets that because basically 50 billion devices will be connected to internet by 2020. Those 50 billion devices are potential market, at least a part of that several billion devices are potentially using application processors in the future. It’s a market that will boom in the next five years and we've announced that we will unify the processor roadmap into one unit.

So we'll stick in the skills from ST-Ericsson from our set top box unit, from our CD unit from our car entertainment unit from our gateway ASIC unit and we put that in to one theme. So of course this has several interests.

Number one, it saves tons of money. When you stop doing five times the same thing, and you do it only one time, you save a lot of R&D cost. You reduce your exposure to any given market. So if you have a multi-market processor, it's actually more balanced on various segments and not all segments go well at the same time. And number three, is you combine the best of all world. So people keep telling me you have a unified processor roadmap, fine, great. So you can save R&D cost. But the needs of the different markets are different. Smartphones need low power consumption. Car entertainment, automotive needs very high reliability, set top box needs security, TV needs fantastic video quality. Those are different requirements for different markets, but nobody said low power consumption is bad for TV. Nobody said security is bad for tablets. So they are all very good features to have for all these markets in the future. And very clearly security will become a huge asset on any connected device. I mean piracy, terrorism; overall internet security is becoming a huge issue worldwide. So the assets of ST in terms of security are extremely good at this no matter what markets you're talking about. Hollywood's been very strong at protecting the HD content in set top boxes because they don't want that content to be copied. Well, definitely they will be also forcing some security technologies in to the tablet, smartphones and TV markets because content has to be protected.

So there is a lot of these features, whether you're talking video quality, power consumption, security and reliability, none of those features are bad. They are all good in all the segments and ST is the only company that has all these skills because traditionally for the last 25 years, because that's our anniversary this year, so for the last 25 years, we've been addressing consumer, we've been addressing automotive, we've been addressing network devices, we've been addressing all these markets. So we know those markets, we know the requirements and we can combine them into one. So there is efforts going on now to restructure our digital business. And here I include ST-Ericsson. And so our overall digital efforts, there is a lot of effort being applied to restructure it and lower the cost and there is a lot of effort being applied to produce a single roadmap which will be compelling for our customers.

Since we've announced this, which put that in practice, the team it exists now, it’s a single team. We can have products next year from that team. And the customers are delighted. They are delighted because single software ecosystem, a single architecture is good for them as well. They don't have to port things from one to the other and typically customers now tend to want to address set top box space, TV space, car entertainment space for example, any connected device space. So they want to be able to also play in multiple markets without having to redevelop software. So this approach we think is a winning approach and it saves money. It lowers the R&D investment and it definitely allows us to impact more market.

Amit Harchandani - Citi

So would you say that, we should expect a sharp pickup in the digital margins anytime soon?

Philippe Lambinet

There is two reasons for that. Number one, there is the strategy, but any strategy in the real sense of the word takes several years, particularly with the long designing cycles we have in certain of those markets, some of those markets. So clearly this is a several year effort. In the short-term, definitely the restructuring phase quickly to improve the margins and also the announced change of strategy of (inaudible) and will definitely help the overall consolidated results.

Amit Harchandani - Citi

I think you had talked about ST-Ericsson and I think I'll just ask the question, that probably many want me to ask, how much longer is STM willing to wait for ST-Ericsson to turn around and become profitable? Is there a realistic timeline? I mean you have been very patient but is that patience running thin now?

Philippe Lambinet

I will reuse things that have been said already by either Carlo Bozotti, our CEO or Didier Lamouche, CEO of ST-Ericsson. When Didier announced his new strategic plan at the end of April, he announced a restructuring plan, so 1,700 people to be tucked. And which would result in lowering the breakeven down to 600 million a quarter, so $2.4 billion sales on a year timeframe. And his roadmap to reach 2.4 billion or 600 million a quarter run rate was getting to that point somewhere in 2014. So that's what Didier said. Now in subsequent presentations and his phone calls and speeches, Carlo said that we think 2014 is a bit too far away which is an indication that our patience tends not to go that far and I think this has been confirmed. So we think 2014 is a bit too far away and also 2.4 billion is not such an easy target if you ask me, starting from 1.5 billion last year moving up to 2.4 billion is not an easy target in a market which is a tough market. Which tends to be also more and more vertical with captive, the two big guys having some part of their business captive. So it’s a tough target and 2014 is a bit too long. So the two shareholders have asked the management of ST-Ericsson to look at alternatives and Didier in April said, look I had in ST-Ericsson the apps processor, the modem, the ModAp which is a combination in one chip of those two; application processor and modem, the connectivity, power management and a few other things like IR and so on. So these are the businesses I have. I've already outsources now the apps processor because it's going to come from ST. So ST-Ericsson is licensee of the same unified processor that ST is now developing. So it's already sold that apps processor thing and reduce its R&D spending.

Now on any of the other blocks it was clearly said in April, ST-Ericsson is looking for ways to accelerate to go back to breakeven and is looking for partnerships or any other form of deals with potential partners on any of those blocks. I don't think we can be more open than this. I think it sets the stage and in fact, I think many actors in the markets understood very well the message and I think we started to talk to a lot of people. The timing for this to happen is not entirely under our control because the partners has to potential partners has to also agree on the timing. And the exact content of the deal of course cannot be disclosed because there is many scenarios on the table. Nothing is taboo. The only thing the shareholders want is not even to go back to breakeven. The things the shareholders want is to find a way not to have to spend cash anymore as soon as possible and 2014 is a bit too far away. So that's all I can say. That's what I have been saying in the one-on-ones today, on three-on-ones or whatever, that's what we keep saying. The patience doesn’t go as far as 2014. Carlo even used those words and I think that was in July when we announced the Q2 results. He said we are dealing with this problem with a sense of urgency. So we understand it's urgent for you and it's urgent for us.

Amit Harchandani - Citi

I think that seems to resonate well because clearly given that you are such a diversified manufacturer, surely for you there must be other superior probably revenue and strategic options where you can invest your cash instead of putting it in ST-Ericsson.

Philippe Lambinet

It's clear; many people are asking us, okay, fine. I mean we get a lot of questions on how we use that cash for dividend and whatever. Today, I didn’t get any question on you plan to use your cash on M&A. clearly; we first need to fix the ST-Ericsson cash consumption issue before we can even talk about M&A and so on. But on the "analogue" power side of the company, there is a lot of M&A things we could do and we're not doing them at the moment because the utmost priority of course is to stop the cash drain on that side of the company. So it's clear that we first address this and plenty of options open to us.

Amit Harchandani - Citi

And you talked about analogues and you clearly for a company such as yours, the backbone if I could call it of your growth will obviously be your slightly differentiated manufacturing model, you're still manufacturing your own chips. How do you see your manufacturing evolving over the medium term? Clearly you’ve done a bit of outsourcing on the advanced nodes but particularly on the analogue side, move to 300 millimeter and do you see an immediate need to do that. If we just talk about manufacturing and how do you see that evolving?

Philippe Lambinet

Okay, I think we in the past years, we took care of the most important issues. We closed a few fabs as you know. We're now down to a size that we think we can live with in the mid-term. We don't think we're going to close any other fab. So we're pretty happy with what we have. We don't think we're going to need a major investments any new fab and we don't think we're going to have to close any old fabs for quite a while. So let`s say in the next three years. So we're quite comfortable with our model which is that we can over a cycle, we can invest less than 10% of our revenue in CapEx and maintain the competitiveness of our manufacturing machine with less than 10% CapEx to sales ratio. So that model which has been announced a long time ago still stands and we still feel comfortable, we can live with that.

We have created a network of partnerships I was already mentioning on imaging that we now have a partnership with a foundry which will as the business grows; we will be able to grow that business without consuming CapEx. We have similar deals on other differentiated technologies like FD-SOI. During the summer we've announced the deal with GLOBALFOUNDRIES. So when we grow that digital business we will be able to do it without investing in fab capacity and we are discussing similar foundry deals allowing us to grow without investing too much. So that's a policy in the company now, that 10% is the maximum over a cycle that we want to invest in CapEx. We have this policy that today because of the market down turn; we have a pretty low outsourcing percentage below 10%. We want to grow that percentage to 20% in the next years. So definitely there is a fab like approach to the problem, and partnerships are being signed with foundries to allow us to grow without investing too much. So that's been our model for a while. Now from time to time there is an exceptional, last year was exceptional. We were above 10% because we had to double our men capacity and we had to follow the very big growth we had also in automotive. So for certain specialty devices and furthermore customers it's very important that we use our own fab and it’s a competitive advantage being an integrated manufacturer in the automotive space and for us it was very important to grow our men capacity to follow the very, very high growth we have. But for the rest, we don't need and this year, as you’ve seen we've announced CapEx numbers that are much less than half of last year's CapEx for sales that are not half, that's similar to the sales of last year, slightly up. So clearly we can investment much less. This year, we don't need to invest in capacity. The growth is not there and the fabs are not fully utilized even. So it’s a good prudent approach and good cash management. So over cycle we can generate cash. We can improve on that financial position. Despite the ST-Ericsson cash trends. So we fix the ST-Ericsson trend, the cash will be in extremely good shape.

Amit Harchandani - Citi

Anything else that you want to add on analogue in 300?

Philippe Lambinet

No, we do produce some analogue. We have only one internal fab in 300 millimeter and we do produce already mix signal devices. So analogue devices in (inaudible) there. So that's already ongoing. We probably see a need at some point for our obesity roadmaps to also be able to assess some 300 millimeter capacity. That's not an emergency but that's probably something we will have to look at within the five year horizon and there are ways to do that without spending too much money. We think also we have a fantastic tour with Singapore. Singapore is easily upgradeable to 200 millimeter because the fab is capable so we just have to upgrade some equipments. So mega fab, because Singapore is a mega fab. A mega fab in 200 millimeter in Singapore, we believe can be competitive with medium sized fabs in US, 300 millimeters. So we think have a tool to face the coming competition in 300 millimeters, because we already have 300 millimeter capacity and we have extremely competitive 200 millimeter capacity in Singapore. So we don't feel at a disadvantage.

Amit Harchandani - Citi

We've talked about offline and clearly and there is one interesting dynamic that I think a couple of investors mentioned to me. They said, you look at STM, it generates roughly 9.5 billion of revenue and it's got like these 50,000 employees and I look at probably TI, it generates much more revenue with lesser number of employees. So is this a European effect or is there something else to it?

Philippe Lambinet

Actually most of our employees are in Asia, not in Europe. There is very big employment in our back-ends. So we have six front ends, five in Europe, and one in Asia and Singapore and we have six backends. Out of those, we have two in China, one in Malaysia, and one in Philippines, and this is where the big headcount is and this is where of course TI is more in outsourcing than we are and so we're comparing apple and oranges, basically when we do this kind of calculation and if you look at how heavy somebody is in backend. Backend is area where cheap labor is very important, but also numerous labor. So we have a lot of people in those four Asian plants. But they don't cost more. And in fact, when we compare the cost we get internally and in those plants, compared to the costs we would get outsourcing, it’s a no-brainer. It saves a lot of money to ST. Makes ST more competitive. It's not a burden, because it's easy to scale up or to scale down, that workforce. So it's very flexible workforce and in the good days, we hire a lot in the bad days, we let go a lot. And we work like that, just like sub-contractors do. So we're not any different. So we're not any different. The only difference is, we internalize that margin instead of giving it to sub-contractors. So we're perfectly happy with that part of the business model.

Amit Harchandani - Citi

So we can expect you to very well remain in the backend business but potentially there might be some scope for the (inaudible), right, I mean particularly products which are not high volume?

Philippe Lambinet

Absolutely and we do use sub-contracts a lot. We also co-develop technologies. I mean some years ago we announced a technology alliance and an R&D alliance with (inaudible) for example. We've also had some joint R&D development with ASC. So we do have joint R&D with several package manufacturers knowing that again, we're quite happy with those backends we have in Asia. We don't plan to grow them too much. They are a good size, they are good critical mass. If we need outsourcing, we use outsourcing, we're very happy with that as well and we don't plan to open a new plant. So if there is growth, of course we're going to load our factories first but then we have outside the sources that are from day one compatible because we've done this joint R&D work. So we can very easily transfer our products outside if needed.

Amit Harchandani - Citi

And I guess another one that I had which I should have probably asked earlier but when we talked about cash, you did mention that obviously cash burn from ST-Ericsson so on and so forth, but still at the end of the day with the last two years, you have paid a very good dividend yield, arguably one of the best within the tech sector were not the reason, so I think some investors particularly like the stock because they have such a high dividend yield. Having said that, your financial position obviously over the last two years has come down because of the cash burn at ST-Ericsson. So how confident are you that your dividend would still sort of remain intact, given that you still have such concerns to address.

Philippe Lambinet

Roughly speaking our net financial position remains flat. If you look at the attributable to ST, of course the ST-Ericsson you cannot count that ST is paying 100% of ST-Ericsson cash needs. Ericsson is contributing 50%. So if you take only that 50% ST has contributed to and you look at our net financial position, it's been flattish let`s say in the past few years and despite the cash consumption of ST-Ericsson, despite the fact that we take dividends, despite the fact we invested a lot last year and despite the fact we even bought back some debt. So despite that, we had a net financial position above $1 billion, we're in the 1.2 range right now, positive. And also I want to remind you that in the past we had some times negative net financial position and we paid dividend anyhow. So the management of the company of course doesn’t decide the dividends and this is up to the shareholders to decide. So we will see what they decide and we will see. But if we need to pay dividend, we can, that's just the message.

The other thing is, yes, you're right, our yields are very high. There is two ways you can reduce the yields. You can reduce the dividend or you can increase the stock price. We like the second way much better.

Amit Harchandani - Citi

Well I think on that note probably, we'll conclude this session.

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