Following its $12 billion acquisition of Freescale Semiconductor, which closed in December, NXP Semiconductors (NASDAQ:NXPI) is reportedly considering selling off a major part of its business. Bloomberg recently reported that NXP is aiming to raise at least $2 billion by selling its "Standard Products" business, a segment that generated 21% of the company's revenue during 2015. While there are pros and cons to such a move, it may be a good time to unload the business.
NXP's two segments
NXP separates its business into two main segments, high performance mixed signal, or HPMS, and standard products. The HPMS segment includes highly differentiated application-specific semiconductor products. Some examples of HPMS products are NFC chips that enable mobile payment solutions and advanced driver assistance systems for automobiles. NXP cites high barriers to entry and lower long-term capital intensity as reasons why the HPMS business is attractive.
The standard products segment consists of standardized discrete semiconductor devices, such as rectifiers and power MOSFETs. The main points of differentiation between NXP and its competitors in this segment are cost, packaging type, miniaturization, and supply chain performance. In other words, scale is the only major competitive advantage.
During 2015, the standard products segment generated $1.23 billion of revenue, down 2.7% year over year. The business is tied to the consumer electronics market, with NXP's products finding their way into PCs, smartphones, and a variety of other devices. The recently announced 9.7-inch iPad Pro from Apple, for example, contains three chips from NXP, including a charging component and a controller.
Reasons for NXP to sell
Because the standard products segment contains largely standardized, catalog products with minimal differences between competitors, it's an inherently less attractive business than HPMS. In 2015, the standard products segment generated a gross margin of just 33.6%, compared to 50.1% for HPMS.
NXP's exposure to the PC and smartphone markets isn't huge. According to the company, PCs accounted for a low-single-digit percentage of revenue prior to the merger with Freescale, while mobile accounted for a high-teens percentage. Still, the continuing decline of the PC market and the slowdown in smartphone sales are certainly having a negative effect on the growth of the Standard Products business. During the first quarter, IDC reported that global PC unit sales slumped 11.5%, and in 2016, global smartphone unit sales are expected to grow in the single digits, down from far more rapid growth in recent years.
Gross margin in the standard products segment has been rising, up from just 24.9% in 2013, but with the company's revenue currently in a funk, margins may fall in 2016. One upside to selling the standard products business is that the influx of cash could be used to pay down the debt. The Freescale merger greatly increased NXP's debt load, which topped $9 billion at the end of 2015, up from about $4 billion one year earlier. NXP expects to pay $95 million in interest during the first quarter, putting annualized interest payments at about $380 million.
Reasons for NXP to not sell
While the standard products segment carries lower gross margins, operating expenses are minimal. Because these products are largely standardized, minimal research and development spending is necessary. During 2015, operating expenses accounted for just 18% of revenue in the standard products segment, compared to 35.5% in the HPMS segment. That puts the operating margins of both segments at roughly the same level, although charges and adjustments related to the Freescale merger knocked down the HPMS segment's profitability.
Beyond being a source of profits, the standard products segment is intertwined with the HPMS segment in a couple of different ways. First, standard products are often used alongside HPMS solutions, allowing NXP to offer complete solutions without needing to turn to third-party suppliers. Second, the company leverages its standard products clients by identifying opportunities to provide higher-margin HPMS solutions.
To sell or not to sell
NXP hopes to receive at least $2 billion for the standard products business, but the ultimate price tag may be higher if a deal goes through. During 2015, the segment generated just shy of $200 million in operating profit, although profitability could decline this year.
There are benefits to having both segments under the same roof, but it may make sense for NXP to sell the business and use the proceeds to reduce its debt. Nearly $400 million per year in interest is significant, and it will eat away at the company's profits going forward.
At this point, NXP has not commented on the report, and any deal may still be weeks or months away. NXP's post-merger strategy of focusing on high-value products seems to point to a high likelihood of a sale taking place, but at the moment, this is all speculation.
Timothy Green has no position in any stocks mentioned. The Motley Fool owns shares of and recommends NXP Semiconductors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.