The debt exchanges by Freescale and NXP are running into trouble. Freescale has been sued in the New York Supreme Court over its recent buy-out of debt, and NXP's bondholders are pushing for a wider re-structuring of the debt than the one currently underway, involving either a cash injection by owners KKR, or a debt-for-equity swap.
Freescale's buyout of debt knocked $1.5-2bn off its total $10bn debt loaded onto the company by KKR bought Freescale in 2006.
According to Moody's Investors Service, the original $10bn debt is an 'unsustainable debt capital structure". If Freescale failed to reduce it, the interest payable on the debt "may become a source of significant financial stress", said Moody's.
The interest under the original $10bn debt was $700m a year. The interest payable under the new-debt-for-old swap would have been $600m.
The lawsuit against Freescale alleges that the new debt is illegal under the terms of the old debt which said that Freescale could not issue new loans if it suffers a "material adverse effect." The lawsuit says this 'material adverse affect' has happened as shown by its financial performance and falling value.
The Freescale lawsuit alleges that the company's debt buy-out has 'unjustly enriched' the unsecured creditors, because they have exchanged unsecured debt for secured debt.
NXP is in the middle of a move to exchange new secured debt for unsecured debt. So far about ten per cent of the new debt offered has been taken up. The take-up could have been affected by NXP's senior bondholders hiring a New York law firm to challenge the legality of the move.
Senior bondholders in Freescale and NXP are miffed that those creditors who are now unsecured, would become secured creditors under the Freescale and NXP new-debt-for-pd plans.
The issue only becomes important in the event of the bankruptcy of Freescale and NXP, because the status of the debt establishes a pecking order for those with claims on the assets of the bankrupt companies.
Clearly buying semiconductor companies and then imposing massive debts on them is a terrible strategy. "History has shown that the best businesses for LBOs are those with a stable and predictable cash-flow stream," says Nicholas Riccio, managing director for Standard & Poor's Ratings Services.
Semiconductor companies, operating in a notoriously volatile market, rarely have predictable cash-flows. It is surprising Blackstone and KKR didn't know that.
Riccio reckons companies with leverage at 9 or 10 times debt to EBITDA or higher "will have a difficult time surviving in anything but the most positive circumstances." While Freescale's leverage is around 9X EBITDA, NXP's 2008 EBITDA was negative.
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