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Business Strategy Takes a Major Turn

Expansion through Attack

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Expansion through Attack

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With the rise of hot money and shrewd corporate financing, Taiwan's no-frills growth model has given way to a new expansionary game of acquisition. What capabilities will companies need in order to wage battle in this new environment?

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Expansion through Attack

By Hsiao-Wen Wang, Yi-Shan Chen
From CommonWealth Magazine (vol. 440 )

On November 11 of last year, Taiwan Semiconductor Manufacturing Co. (TSMC) settled a trade secrets theft lawsuit against Semiconductor Manufacturing International Corp. (SMIC). The settlement included the departure of SMIC head Richard Chang, known as the "father of China's chip industry," as well as a cash payout. SMIC also agreed to render eight percent of its total equity to TSMC. With an option to purchase two percent more of the company's stocks at a favorable rate, TSMC became a major stockholder in its erstwhile rival.

"SMIC has been losing money for nine consecutive years, so shareholders on the opposite shore are enthusiastically welcoming TSMC," one senior legal executive opined.

Big Players Making Big Moves

Then on December 9, TSMC, heretofore focused strictly on its core business, made another move, putting up less than 10 percent of its capital outlays last year to acquire 20 percent of leading Taiwanese solar energy company Motech Industrial Inc. The move came as a shock to smaller solar energy companies, as if an aircraft carrier had come to fish amongst the dinghies.

Three days later, Foxconn Technology Group made a move of its own, through its subsidiary Innolux Display Corp., acquiring Chi Mei Optoelectronics for a substantially lower price than that offered by rival bidder AU Optoelectronics. The new Chi Mei Innolux already has in-hand orders for five million flat panel displays from Sony and will fill nearly half of Samsung's LED TV orders. The alliance between Foxconn – which already has a solid distribution network in place in China, the world's single largest television market – and Chi Mei – with its competitive advantage in production capacity – makes for a mutually beneficial strategic marriage.

The year's end was visited with an eye-blurring flurry of activity among the "big fish" of Taiwanese business. What underlying trends ultimately explain this frenzy of activity? The actions of the "big fish" created immediate ripples across the surface of the pond. What will their impact be on the future of Taiwanese business?

No More Slavish Pursuit of Cheap Labor

"Taiwan's business environment is entering a period akin to the Warring States Period; allies one year, rivals the next," says Jack J.T. Huang of the international law firm Jones Day, surveying the landscape.

What he sees is that Taiwanese business has arrived at a critical moment where its growth strategies must take a major turn.

As Huang sees it, during the past 20 years or so, Taiwan has moved from traditional light industries to high technology, relying solely on movement of production offshore for expansion. After two decades of this strategy, however, Taiwanese companies are no longer in ravenous pursuit of cheap labor, moving wherever the pastures are green. With the increasing maturity of Taiwanese enterprises, the deft application of finance, patents and merger/acquisition plays has become the new name of the game, Huang says.

In the wake of the financial crisis, a new wave of merger and acquisition deals is about to sweep across Taiwan's business world. According to statistics from Bloomberg Business News, while M&A fever has cooled around the globe, in Taiwan it continues unabated, despite the financial crisis, with M&A deals last year totaling US$30.6 billion, the second highest ever (Table 1).

M&A Fever Comes Fast and Furious

What sets this wave of M&A deals apart from those of the past is that deals previously tended toward the expansion of production capacity. This time around there are two driving motivations: access to new markets and entry into new industries, observes Hui-Erh Yuan, financial advisory services managing director at PriceWaterhouseCoopers.

For example, in 2009 Uni-President conducted its first cash increase in 42 years, approaching shareholders with hat in hand for the first time in its history. The move was part of the financial restructuring associated with the listing of Uni-President China Holdings on the Hong Kong Stock Exchange three years ago and was intended to raise funds for a major acquisition in the China market.

"Over the past two years China's foodstuffs market has attracted competitors from around the world, and the country has changed from a market led by Taiwanese businesses to a real international battleground," KGI Securities analyst Ni He-hua says. The wave of M&A activity also reflects increasing strategic clarity on the part of Taiwanese businesses, according to Ni.

The reason for Taiwan's relative dearth of past M&A activity is that Taiwanese companies previously preferred to invest in spin-offs, stipulating only that some strategic advantage be gained insofar as ensuring raw materials supplies always be available, says Chiu Yi-chia, associate professor at National Chung Hsing University's Graduate Institute of Business Management.

"Now they seem hellbent on M&A deals, indicating that companies have set new strategic courses," Chiu says. "M&A deals now seek to instill new competency."

One prime example is Foxconn's acquisition of Chi Mei (through its subsidiary Innolux). Having already established its distribution network throughout China's secondary cities, Foxconn then acquired the plant that produces Sony LCD TVs, ensuring branded orders, before setting about looking for additional production capacity. The move demonstrates Foxconn's pugnacious "grab the orders first, build the plant later" character.

With its acquisition of Chi Mei, Innolux now has "new competency" in large flat panel display production and goes from being a "B player" to an "A player," in a brilliant stroke of B-player guerrilla warfare.

SMEs Drive for Top Tier

Using M&A deals as a path from the second tier to the top tier is not just for huge conglomerates. Founded 32 years ago and now with 52 subsidiaries under its umbrella, Fair Friend Enterprises Group last year leapt into the wreckage of the U.S. and European economies to snap up 10 companies making automotive electronics, aerospace goods, LCD displays, digital cameras and circuit boards. Fair Friend chairman Jimmy Chu now finds himself referred to as the "Terry Gou of machine tools."

"I found that M&A can be used to get a handle on new opportunities and new trends and not just for expanding existing production capacities," Chu says.

TSMC's wrangling with Foxconn for a stake in Motech Industrial Inc. was also an effort to acquire "new competency."

On the evening of last December 9, just hours after the 4 p.m. announcement of TSMC's acquisition of a stake in Motech, Y. Simon Tsuo, Motech's CEO, was on a plane to the U.S. to finalize the details of a long-negotiated acquisition of solar cell maker GE Solar from General Electric, a move enormously beneficial to TSMC's intention to enter the "branded" power generation market.

"TSMC wants to build solar power plants in the U.S. and Europe, and with the GE branded solar cells, it'll be easier to land projects," Tsuo explains. And TSMC has two directors on the Motech board to maintain a better handle on costs and raw materials prices.

These M&A activities point to a greater maturity in strategic management and greater dexterity in financial operations among Taiwanese companies. Meanwhile, patent battles – a skillful endeavor more akin to Odysseus blinding the Cyclops Polyphemus with a burning stake – have become a new strategic tool for Taiwanese companies.

Previously, Taiwanese companies engaging in intellectual property rights (IPR) battles sought nothing more than cash damages, market share or to eliminate the competition. Most dexterous in this regard has been the internal legal team at Foxconn. Legend has it that one defendant company chairman appeared before Foxconn chairman Terry Gou, financial report in hand, pleading for mercy: "Chairman Gou, I'll sell you my company, okay?" Foxconn has acquired more than 10 companies through IPR litigation.

IPR Battles: Striking the Lethal Blow

In the past two months, however, both the TSMC settlement with SMIC and an agreement that Taiwanese chip maker MediaTek made with U.S.-based Qualcomm have shown the strategic stakes can be even higher in Taiwan's IPR battles.

For example, the agreement between MediaTek and Qualcomm, hammered out late last year, allows MediaTek to sell handset chips for Wideband Code Division Multiple Access (W-CDMA) networks, a mainstream third generation technology, using Qualcomm's patents without having to pay Qualcomm any licensing fees. This means huge savings for MediaTek. In return, Qualcomm has received access to MediaTek's client lists and monthly order data. Because all of MediaTek's customers must sign separate licensing agreements for the use of Qualcomm's patents, the access Qualcomm has gained to MediaTek's downstream network greatly outweighs its losses from a single licensing deal with MediaTek.

The good news for MediaTek is, in acquiring the rights, it dodges a global battle on two fronts, the China market and the U.S.

For Taiwanese companies, the overriding lesson of TSMC's acquisition of a 10-percent stake in SMIC seems to be that by manipulating the IPR battle, they can seize the Achilles' heel of a nation's industrial development, and thus control it.

"Where's the pride in taking down SMIC?" one lawyer asks privately. "It's like the Shaolin Temple kicking down some tiny temple down the mountain."

Having exhibited magnanimity in not pursuing their rival to the point of destruction, TSMC's true victory will lie in making good use of its wise action, exchanging it for a piece of China's semiconductor market, forecast to grow 15 percent this year.

As Chiu sees it, TSMC can put its admission ticket on the SMIC board to good use, engaging United Microelectronics Corp. (UMC) in price wars through SMIC "commando proxies" and maintaining a balance of terror. That leaves the massive force of TSMC "regulars" to steadily make inroads into high-end process capacity, retaining a high profit margin of 50 percent. In Taiwan, TSMC can on the one hand play the role of a Prince Charming that "can do no wrong," while on the other hand it can raise the standard of China's IC design industry.

The seven-year IPR legal battle between TSMC and SMIC was in all a brilliant display of Taiwan's overall IPR power.

Attack-style Expansion: SMEs Beware

When attack-style expansion becomes a standard in business, it's time for Taiwan's one million-plus small- and medium-sized enterprises to rethink their approach and strategy in doing business with major corporations.

Roscher Lin, chairman of the National Association of Small and Medium Enterprises, has seen more than a few assiduously built small- and medium-sized enterprises get gobbled up after their owners succumbed to the temptation of big orders. For their own protection, Lin recommends that SME owners band together to expand their bargaining power in price negotiations and, faced with the temptation of big orders, to carefully consider things and not blindly expand production capacity and fall into the trap of the constant pursuit of expanding operating revenue.

"Details such as compensation or legal liability in the event of an order cancellation need to be clearly spelled out," Lin says. "If they don't reach a good agreement, SMEs may have to experience the pain of canceling orders. Every plant expansion is fraught with risk, and your clients may have ulterior motives," Lin reminds SME owners.

The big corporations are on an all-out offensive in this New Warring States Period of business competition, and the SMEs now have to readjust to new dance partners. From the CEO at the top to the assembly line worker at the bottom and all the lawyers and accountants in between, they're all continuing to search for their new roles in this epic struggle, hammering out a new script of business competition and cooperation.

(Additional interviews by Hsiang-Yi Chang. Research by Shiau-Jing Ding)

Translated from the Chinese by Brian Kennedy

Keywords:

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