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August 6, 2006 6:01 pm

Philips nurses dreams of a future in healthcare

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Philips, the Dutch technology group that cut its exposure to the most volatile of its traditional activities by selling its chip unit for €6.4bn ($8.25bn) in cash this week, is looking at expanding further in the fast-growing healthcare sector with some big acquisitions.

In an interview with the Financial Times, Gerard Kleisterlee, chief executive, said he was “looking at a few bigger things”. Philips has spent $3.5bn in 12 months, mostly in healthcare, but Mr Kleisterlee conceded those had been modest-size deals.

Analysts have suggested that Philips will continue to trail rivals GE, of the US, and Siemens, of Germany, unless it delivers a significant medical equipment deal. Scott Geels, at Sanford Bernstein, said the value of Philips’ stock would only rise with additional earnings improvements or the “wise use of cash on strongly synergistic acquisitions”.

Mr Kleisterlee said the sale on Thursday of 80.1 per cent of the semi-conductor business to a private equity consortium comprising Kohlberg Kravis Roberts, Silver Lake Partners and Alpinvest, did not by itself change the company’s financial flexibility. It could have raised cash for a sizeable deal a year ago, but had not found the right target at the right price, he said.

The value of the chip-unit transaction was more than just financial, he said. It reinforces within Philips a growing sense of assurance that its future lies in the hi-tech healthcare sector, as it leaves behind its manufacturing past.

Mr Kleisterlee said not only had it gained a better understanding of what it wanted to buy, it was now “pretty close” to its optimal structure.

“As we go on we learn more about certain markets and industries that we are interested in, and we have a better idea of the real potential for value creation and synergy from some of the targets that we have in mind,” he said.

What is more, its financing options are increasing. It could take on debt, but equally it has investments worth about €10bn that it can soon cash in.

From January it can sell its 16 per cent stake in TSMC, the Taiwanese semiconductor company, which was worth €5.8bn at the end of the second quarter. It must retain 30 per cent of its 32.9 per cent stake in LG Philips LCD, a joint venture with the Korean electronics group, until July 15 2007. That was worth €3.43bn at the end of June. Philips has other smaller investments worth about €430m.

The decision to return the bulk of chip-unit proceeds to investors through dividends and buy-backs, did not imply a reluctance to make acquisitions, Mr Kleisterlee said. “We are doing this because, tomorrow we do not need a lot of cash for a big acquisition,” he said.

“There are things on the horizon, but on the horizon I can leverage Philips’ balance sheet or dispose of stakes, so we have sufficient financial flexibility to do smaller and larger deals.”

Acquisitions are one part of an expansion strategy. The other aspect is organic growth, he said. Its goals of 5-6 per cent average annual revenue growth and a 7-10 per cent operating margin would not change “substantially” as a result of the chip unit sale.

Mr Kleisterlee did, however, guide towards the bottom of that margin range, saying: “Certainly around
7 per cent is an area that we are comfortable with.”

Philips’ decision to retain a 19.9 per cent minority stake in the chip unit underscored a desire to ensure a “responsible” transition to a new owner, he said.

It did not mean Philips would rush to sell the stake once that process was
complete.

“The equity tied up is minimal and our net explosure is practically zero, while [retaining a stake] still gives us the upside of participating in a successful exit.”

The timing of that exit would depend on “developments in the coming few years” he said.

One option was to “tag along with the exit that, at a certain moment, private equity will also create for itself”.

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