The Rise and Fall of Chi Mei Optoelectronics

Key Thoughtz

• The AMLCD business is capital intensive. Variable costs dominate however.
• Operating cash flows depend on material contribution margins, primarily.
• Expanding capacity faster than the ability to sustain or increase contribution margins leads to negative pre-finance cash flow.
• A competitor can collapse in the attempt to win the race if it tries to close the gap too fast.

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Abstract — As we write this, teams of technical and financial specialists are busy planning the integration of Chi Mei Optoelectronics (TSE: 3009), Innolux Display (TSE: 3481) and TPO Displays (TSE: 3195). The rise and fall of Chi Mei Optoelectronics provides an object lesson for all producers striving for dominance in a capital-intensive industry wherein material costs constrain cash flow. The company expanded its capacity faster than it expanded its ability to forward integrate and to create value. In the end, Chi Mei Optoelectronics lost the ability to stand alone, so it merged with a more forward-integrated company.

In this commentary, we examine public disclosures by Chi Mei Optoelectronics (CMO) to shed light on the result of rapid capacity expansion. We find that monies invested in an effort to catch up with industry leaders generate large negative pre-finance cash flows. This finding correlates with earlier studies showing diminishing returns to scale: prices fall as fast or faster than cash costs do. Thus, efforts to catch-up destroy value unless the producer forward integrates sufficiently to capture additional value.

Total Cash Flows, 2002–2009 (billions USD)

Source: BizWitz analysis of CMO disclosures.

The expansion led to large negative pre-finance cash flows. If we total the results from 2002 when the company went public to 2009 when the company prepared for merger, we find that CMO generated only $10.5 billion from operations but put $18.1 billion into the ground, mostly in the form of property, plant and equipment (PP&E). This created a total negative cash flow of $7.6 billion before finance. In essence, CMO put that much money or more on its credit card over eight years. For more insight, download The Rise and Fall of CMO.