Stodgy Philips Gets Lean and Mean

02/13/2008 12:00 am EST

Focus:

John Christy

Founding Editor, Forbes International Investment Report

John Christy, editor of Forbes International Investment Report, says the giant Dutch electronics manufacturer has become a vigorous competitor-and its stock is cheap.

It wasn't long ago that Philips Electronics (NYSE: PHG) was a case study in many of the things that were wrong with Europe Inc. The 117-year-old Dutch company was a lumbering conglomerate that made everything from semiconductors to light bulbs, without clear leadership in anything. The Philips brand had become tired, and hungrier Japanese and Korean competitors turned out better products. Its anemic returns on capital lagged that of American competitors such as General Electric.

Today Philips is on its way to becoming a case study in European restructuring. While still a conglomerate, it has streamlined its business and revitalized its brand under the leadership of chief executive Gerard Kleisterlee. Its financial performance has also improved.

In 2006, Philips unloaded 80% of its volatile semiconductor business for 6.4 billion euros ($9.6 billion). It has also been steadily selling off its holdings in Taiwan Semiconductor (NYSE: TSM), which it hopes to unwind by 2010. Philips also plans to sell most of its nearly 20% stake in its South Korean venture, LG Philips LCD, by next year.

Meanwhile, Philips has been busy putting all of this cash to work. In December, it announced a whale of a share buyback, worth 5 billion euros ($7.2 billion). It has also been on a shopping spree, buying a handful of companies that will bolster its growth prospects. These include Respironics (in home health care), Visicu (in health care information technology), and Genlyte (in lighting fixtures). These deals should put Philips in a position to deliver more stable growth and better profitability in the future.

Selling light bulbs, for example, used to be a fairly dull business. That has changed thanks to greater demand for environmentally friendly products. Philips is a leading maker of light-emitting diodes (LEDs), such as those used to light the ball in Times Square on New Year's Eve. LEDs are brighter, cooler, and more-energy efficient than regular bulbs, and Philips is building a dominant position in this market.

Philips [also] is capitalizing on another important trend-the growth of home care and patient monitoring. Another growth opportunity: emerging markets. About a third of Philips' revenue comes from emerging markets, including Asia, Latin America, and Russia.

In September, Philips boosted its target for EBITDA (earnings before interest, taxes, depreciation, and amortization) margins to 10% by 2010, versus 7.5% today. Factor in the effect of future share buybacks and projected annual sales growth of 6%, and Philips expects to double its operating income per share by 2010.

At a recent $38, Philips is selling at less than 12x 2009 estimated earnings and 1.3x book value. If Philips hits its restructuring targets-and assuming that its valuation multiples remain roughly similar over time, then it's not impossible to envision the stock doubling in the next three years-a 25% annualized gain.

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