It's no surprise that Motorola (NYSE: MOT ) wants to do an equity carve-out of its chip-making subsidiary, Freescale Semiconductors. With a strong sales rebound in the chip sector, combined with the subsidiary's recent return to profitability, it's a ripe time for Motorola to cut loose Freescale.
But, buyers beware. While the timing's certainly good for Motorola, it's probably not so great for buyers hoping to jump into the initial public offering.
For starters, the outlook for chips remains murky. Sure, with growing demand from computer and other makers of tech gadgets boosting production, the chip industry is red-hot. Industry capacity will remain tight for the next few months. But with oversupply looming in 2005, chip prices are unlikely to return to peaks seen this year. Freescale's value could easily slump as the market reaches the top.
There's also the issue of sustainable profits. If the industry's upswing doesn't last, the chip sales that have returned Freescale to profitability and form the basis for its estimated $2.5 billion valuation may well be a blip.
Besides, Motorola paints an overly rosy picture of its chip division's earnings. In the latest quarterly statement, Motorola announced that Freescale's operating earnings were up to $107 million -- a big turnaround from the $121 million loss a year earlier. Looking closer, Freescale's earnings drop to just $55 million when you ignore a one-time reversal of reserves gain for the chip business that quarter.
Remember, shareholders gain from equity carve-outs, as they do from spinoffs, when the subsidiary gets plenty of autonomy early on. But Fools, take note: After the deal, Motorola will own all of Freescale's Class B common shares, which will wield 92% of the voting power. That means that, until those shares get redistributed, Motorola will exert clout way beyond its financial stake. This begs the question, if Motorola won't let go of the reins, then why bother having Freescale go public?
Think twice before buying into Freescale. It's more than just timing. It's about taking time to carefully examine what Motorola is offloading.
Fool contributor Ben McClure does not own shares of any of the companies mentioned.