Barbarians at Kirkop Gate

 17^th November 2006
The Malta Independent - Friday Wisdom

Kirkop’s relevance here is that it hosts Malta’s primary manufacturing industry, ST Microelectronics, by far our largest exporter and certainly one of our major success stories in manufacturing, wherein a small industry that started here in the early 1980s grew and developed itself at the cutting edge

of the semiconductor technology.

We owe much for this to Sicilian born Pasquale Pistorio, a former Motorola executive, who managed to turn the French and Italian chronically loss-making semiconductor companies into a profitable Franco-Italian combination. Even better, it has grown to become the world’s fourth largest supplier of microchips after Intel who command 15 per cent of the world market, Samsung with seven per cent, Texas Instruments with five per cent. It holds the fourth ranking jointly with Toshiba at four per cent each.

Pistorio was the person responsible for locating the plant in Malta in 1980, no doubt motivated by the possibility of quality production at a low cost. Since then the plant found many other reasons beyond the cost factor to flourish at Kirkop. It is with good reason that Malta recently bestowed upon Pistorio a state decoration. We owe him much more.

Pistorio is now retired but his privately expressed views are still sought within the industry. Recently during a conference in Paris he reiterated his long held view that the semiconductor market will ultimately be concentrated around a handful of giants with a myriad of smaller niche satellite players alongside.

This basically means that the market is ripe for a period of consolidation through mergers and acquisitions to combine operating units, thus streamlining production and saving on exorbitant research costs.

The process has already started. Recently Philips, the Dutch conglomerate, sold its microchip production divisions to Kohlberg Kravis Roberts (KKR), a giant in the world of private equity investments.

KKR are the original barbarians. In financial terminology barbarians is a term used to define hedge funds and private equity funds who are attracting huge billions of dollars from private investors giving them unimaginable financial strength in order to make friendly acquisitions. In some cases they use these funds to position themselves, even in a hostile manner, commanding significant stakes in large companies where they perceive the management is not doing a good enough job and that value can be extracted by using shareholders’ rights to push for changes that management, in their opinion, is not strong enough to execute on its own.

A typical example this week is Deutsche Telekom (DT). Their CEO was forced to resign during the fourth year of his five-year contract. US private equity giant Blackstone through their five per cent equity stake in DT, thought he was not delivering shareholder value. Blackstone were termed locusts by the former SPD government who had resisted such approach but the Merkel government saw the validity of the argument and through its sizeable shareholding blessed the change at the helm of DT, which is still a German flag carrier on the international scene.

The term “Barbarians at the Gate” knows its origin to a book (and subsequently a film) dealing with the leveraged acquisition in 1988 of RJR Nabisco, the American food giant, for a record of USD 31.4 billion, most of which was financed by debt. It remained the largest acquisition till 2006 when we are starting to see bigger figures in acquisitions due to the plentiful supply of private equity liquidity.

Barbarians refer to the heartless way in which such private equity investors move once they acquire control of a company in order to cut down its costs and recover their leveraged investments as quickly as possible.

On the assumption that once KKR made a sizeable investment in acquiring Philips microchips division they will be on the lookout to acquire similar sizeable outfits which could be merged for extraction of better value added, and considering that once this process starts four per cent market share companies will either have to downsize to satellite status or grow into a mega force through mergers and acquisitions, it is highly likely that the barbarians are already at the gate of companies like ST Microelectronics.

The French and Italian government through their shareholding are likely to resist the barbarians at the gate for some time, certainly until the French presidential elections are out of the way. But once the elections are over, it will become hard to resist the logic of consolidation for survival and thus to keep the barbarians outside the gate.

Whether this will be good or bad for the Kirkop outfit depends on the level of competitiveness and innovation housed within the plant. If, as I have the impression, the Kirkop outfit is one of the most successful and avant-garde plants of ST with considerable cost advantages, the Barbarians’ arrival at ST’s gate could well prove to be a blessing for Malta.