Philips Cashes In Its Chips

It appears that the notion of soup-to-nuts "vertical integration" took another step back into history last week. European electronics and health-care company Philips Electronics (NYSE: PHG) announced the sale of 80% of its semiconductor unit, leaving it more focused on businesses such as consumer electronics and health care.

Philips, which apparently plans to drop the "Electronics" from its name, sold the chip unit to a group of private equity investors consisting of KKR, Silver Lake, and AlpInvest for more than $4 billion in cash and the assumption of another $5 billion in debt. Based on the price of the 80% stake, Philips' remaining interest would be worth in excess of $1 billion.

As the purchase price might suggest, this wasn't some also-ran division of little consequence. This unit is among the 10 largest chip makers in the world and third in Europe behind Infineon (NYSE: IFX) and STMicroelectronics (NYSE: STM); it also boasts high-profile clients such as Dell (Nasdaq: DELL) and Nokia (NYSE: NOK). Given the purchase price and relative valuations, Philips got a rather good deal here -- almost certainly a better deal than it would have garnered through an IPO.

This move will likely be an important step in reducing the overall sensitivity of the company to the notoriously volatile chip sector. And while some may think Philips is sacrificing the advantages of having its own in-house chip capabilities to serve its consumer-electronics units, I don't think it's a major issue. More than 90% of the chip unit's sales were to external customers, and while guaranteed internal supply has its advantages, so does the freedom to shop around the world for the best possible deals and technologies for a given application.

Philips will also probably look to sell large portions of its equity stakes in Taiwan Semiconductor (NYSE: TSM) and LG.Philips (NYSE: LPL). I hope, though, that management opts to be patient. In the case of Taiwan Semiconductor in particular, selling now would strike me as selling below fair value.

Philips' stock has done pretty well over the past year, but it could still be undervalued. Not only can the company benefit from focusing more resources on higher-return projects in the consumer and medical businesses, but valuation should also be aided by increased investor comfort with the overall makeup of the business. If the higher return/lower volatility story plays out, patient shareholders should continue to like what they see.

For more Foolish thoughts on consumer electronics:

• What's the Story, Dell?
• Philips Demands More Patience
• World Cup Headbutts LG.Philips

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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).