By Tova Cohen and Steven Scheer
MIGDAL HA'EMEK, Israel (Reuters) - Executives at Panasonic were surprised when Russell Ellwanger, CEO of Israeli chipmaker TowerJazz <TSEM.TA>, asked to partner in three of their factories without putting any cash on the table.
"They had said that to do the deal it would be between a $300 million (226.12 million pounds) and $400 million cost for us," he told Reuters in an interview. "I said, 'No, we want to do this deal ... but we will pay nothing'."
Instead Ellwanger sealed the joint venture with what he characterized as a win-win deal: his company filled the unused capacity at the Japanese plants and struck a five-year deal to supply chips to Panasonic <6752.T> from the joint venture. It also agreed to hand over $7.5 million in TowerJazz stock, plus about half of what it earned from selling chips made at the factories to other customers.
The latter presents Panasonic with $100 million a year.
Ellwanger has managed to strike agreements - like the 2014 Panasonic one - to expand the company's manufacturing operations with minimal investment. He is counting on this strategy to drive further growth - but it has its limits and risks.
Rather than building or buying a factory at huge cost, TowerJazz looks for plants owned by bigger fish with idle capacity that is hitting their profitability. It takes up that capacity while striking supply deals and offering other incentives such as a cut of profits and technical know-how.
Ellwanger used similar tactics to acquire a factory in Texas from Maxim Integrated Products <MXIM.O> that wasn't producing at full capacity and thus costly to run. Rather than paying in cash, it struck a 15-year supply deal with the U.S. multinational and handed over $40 million in stock.
In the latest deal, TowerJazz said in August it was linking up with Tacoma Semiconductor Technology to establish a plant in China. It will not invest any money but will provide technological and operational expertise in exchange for half the annual capacity of 240,000 chips.
The ability to identify such opportunities has been Ellwanger's signature since 2005, when he left California to take on the task of running TowerJazz, which had $100 million in annual revenue and was saddled with $530 million of net debt.
The company, which specializes in the kind of analog chips used in cars, medical sensors and power management, is now debt-free, profitable and with annual revenue approaching $1.5 billion. Its shares are up 64 percent in 2017 versus a roughly 30 percent gain in the Philadelphia chip companies index <.SOX>, and have doubled over the past 12 months.
LIMITS TO GROWTH
The strategy of filling the unused capacity of the likes of Panasonic and Maxim is partly born of necessity. Building or buying a factory can costs hundreds of millions of dollars, a big undertaking for a company with net cash of $143 million at the end of June.
However such opportunities do not come around very often, limiting the company's growth. And with chipmaking heavily dependent on volume, TowerJazz faces a challenge in increasing production capacity fast enough to remain competitive in the market for specialty analog chips.
At present the company only has enough capacity to increase annual revenue to $1.62 billion by the end of 2019, according to Credit Suisse semiconductor sector analyst Quang Tung Le, who last month started coverage of Tower.
Craig-Hallum analyst Richard Shannon said the company would hit the limits of their capacity by the end of 2018, precluding further growth. "The timeframe to get capacity online (in China) will not be early enough," he added.
The analog chips produced by TowerJazz regulate functions such as temperature, speed, sound and electrical current as opposed to digital chips that process binary information. Manufacturers of analog, and mixed-signal, devices tend to have more varied markets than digital.
In the analog/mixed-signal foundry sector TowerJazz has a 30 percent market share followed by Vanguard <5347.TWO>, Hua Hong Semiconductor <1347.HK>, Dongbu Hi Tek <000990.KS> and X-FAB <XFAB.PA>.
"Since Russell took over he has performed a heroic turnaround of a company that was on its deathbed," said Robert Katz, managing director of New York-based Senvest Management, TowerJazz's second-largest investor with a 5.2 percent stake.
Ellwanger says TowerJazz had enough capacity without China to get through 2018, but he's actively pursuing more deals like the one with Panasonic to fill the impending gap.
"There are technologies we are looking at buying," the CEO said in the interview at his offices in the northern city of Migdal Ha'emek, near TowerJazz's two Israeli plants, built before he joined the company.
He added that TowerJazz wanted to "get strongly into sensors".
Drexel Hamilton analyst Cody Acree said South Korea's Dongbu could be a target as it would be immediately accretive to TowerJazz's earnings. German-based X-FAB and Taiwan's Vanguard also make sense as targets, he said, but trade at higher valuations.
Ellwanger declined to comment on such speculation, though he said: "I would have nothing against having a facility in Korea."
(Editing by Pravin Char)