It turns out that the most semiconductor-savvy guys in the past two years were the managements of Motorola and Philips who negotiated the huge valuations of $17.6 billion and $11.6 billion respectively for Freescale Semiconductor and NXP Semiconductors and sold them to private equity consortiums led by Blackstone and KKR at the top of the semiconductor cycle.
"Freescale was bought at 4 times sales, NXP at 1.6 times sales," Jerome Ramel of Exane BNP Paribas told this week's European Nanoelectronics Forum 2008 in
Ramel explained how the private equity companies came to their disastrous decisions:
"The private equity companies thought there was something wrong about an industry which operated without any debt," said Ramel, "in 2006, what the private equity companies thought about the industry was that it would create large amounts of cash, and should have debt on its balance sheet. But they didn't pay a reasonable price and the market was collapsing."
In coming to their unreasonable valuations, the private equity companies, according to Ramel, valued NXP and Freescale by a measure known as 'discounted cash flow' which assumes future revenues at a certain level.
Anyone who has been in the semiconductor industry for five minutes knows that to assume revenues will stay on a level course is unimaginably stupid. NXP, for instance, is forecasting a 25 per cent drop in revenues for the current quarter. But this piece of private equity arithmetical folly led to the crazy 2006 valuations.
Now Freescale and NXP are in the difficult position of not only having to pay huge debt service payments on the debts which Blackstone and KKR loaded onto Freescale and NXP to defray the inflated costs of their purchase, but Freescale and NXP are obliged, starting in 2011, to start paying back the capital debt.
At the moment, Freescale has to pay $700 million in debt service annually, and NXP pays between $450 million and $500 million every year. NXP, with only $5 billion of revenues spends $1 billion annually on R&D and has operating expenditure, not counting the debt interest payments, of 30 per cent.
NXP is burning cash: it had negative cash flow of $830 million in the first six months of the year. In July, NXP received $1.55 billion for the sale of its wireless interests to ST-NXP and, by late November, NXP borrowed another $400 million.
On top of all these burdens, NXP, like Freescale, will have to start repaying the capital debt in 2011.
According to Ramel: "Even if NXP and Freescale are broken up, there is no way they can repay the debts which they have."
When the debts start to become repayable, NXP and Freescale will have to try and refinance the debt. This will trigger industry consolidation, said Ramel.
"Refinancing will kill some businesses," Ramel told the Paris Forum, "it is clear we're going to see consolidation in the industry."
As the world's political authorities start to re-vamp the financial system they should take some care to stop this kind of thing happening again.
Two of the semiconductor industry's greatest companies look like being destroyed by financiers.
The bonuses attached to the deals which may kill NXP and Freescale will already have been paid to the various financiers involved in doing the deals.
So the financiers get rewarded, while the productive companies they manipulate are pushed to the brink of collapse.
This is capitalism feeding on itself and destroying its own foundations of productive industry for what? Simply to get a bonus for a few people.
So good people in good productive companies may be put out of business by stupid, greedy people looking for a bonus for themselves.
As the financial industry gets reformed by the public authorities, now is the time to put a stop to this nonsense.
You blame the financiers, but don't forget it where all of this money actually went: it went into the pockets of the shareholders of NXP & Freescale.
That $29billion did not vanish: a lot of people (and their pension funds) went "Oh goody - I have made a nice profit on that stock"
I know shareholder votes are pretty flawed, but there was shareholder vote. A democratic decision to take the profit, and it was those shareholders who voted to say "who cares what happens to the company & employees afterwards; I'll take my cash and it is no longer my problem"
One of the things that annoys me about the current crisis is people dodge their responsibility: it is ordinary people who voted to de-mutualise building societies, ordinary people who bought buy-to-let, ordinary people who took big mortgages & credit card bills -- and shareholders who decided to take the profit on selling NXP & Freescale.
You're absolutely right Rupert but I tend to look at it all from a semiconductor industry point of view and see Freescale, the old Motorola Semiconductors which wrote the book on semiconductors, and NXP, the old Philips Semiconduxctors which was a top ten player for over 40 years, being damaged because a flawed financial system, which gives specially lenient tax treatment to private equity companies, allows the PE people to destroy good productive companies for a quick profit.
Remember, the PE guys, after taking over NXP and Freescale, got a lot of their money back immediately by issuing debt in the form of bonds secured on the NXP and Freescale assets.
So all those involved, PE guys, bankers, leading execs etc got nice bonuses, commissions, pay-offs, pay-deals etc and the victims of the saga are the employees of NXP and Freescale who didn't get a chance to vote for or against any of this, and the semiconductor industry which could see two of its great companies destroyed.
Well, I do not really see here where is the difference with the others industries. The system is done this way, if you try to fight it, you will be seen as a communist (and will not be able to fly back to the States ;-) ). "the financial industry gets reformed by the public authorities": they help in the short term, which does not mean a big difference in the long term.
It was a case of jam today, for the shareholders, and I guess for the PE people in some way - although they are less pleased with the deals now. It was just like all the short-sighted carpet bagging of the UK building societies, and symptomatic of the times.
I don't suppose we as employees could have done anything about it at the time, but it was very disappointing to discover how different the way it was sold to us was from the eventual reality. We were told that PE ownership would give us the freedom and access to capital to invest that we didn't have as a public company, when in fact the financiers would probably be demanding faster and higher returns than the market would have done. There was no explanation, as I recall, of the enormous debt that the company itself would assume. Neither am I convinced from what I have seen since the buyout that the KKR or Blackstone or whoever would be ready to take the beneficial long term view that we were assured would be good for R&D.
Looking back of course it now seems obvious that people like Mayer, who made something like $47 million on the deal, would sell it to us as a great opportunity. I had a lot of time for him given what he had done for Freescale until then, but there I feel he let us all down badly (to put it mildly). I think that the PE buyouts of NXP and Freescale had a huge influence on the unravelling of the Crolles Alliance. It was such a pity to see all that come to nothing.
I too am saddened that a company where I spent 15 years and which I also once considered to be a semiconductor great has come to this.
If you think what the European Semiconductor Industry was like when Pistorio, Schumacher and McGregor ran, respecitively, ST, Infineon and NXP, it makes you want to weep.
Well Yes Bob you're right that's how the financial system did work, but I can't beleive the public authorities are going to allow the financial people to make such a mess again )(or not for a few years anyway).
The authorities are bound to put in reforms and controls. Clearly the PE industry was taxed too leniently and, with the low prevailing interest rates, was encouraged by the financial conditons to buy up companies.
Normally European takeovers are subject to regulatory approval. This doesn't seem to have happened with NXP but, in future, the authorities have to change the rules to allow scrutiny of PE takeovers.
Working for a privately owned, VC backed company I can say that not all Private Equity companies (read 'people') are bad - or that all PE deals will lead to the companies in question being driven into the ground; be it debt burden, asset stripping, further poor M&A, whatever...
...however, the deals in question always did look like certain individuals going for a quick buck and to hang with the eventual outcome!
I know the Freescale deal better than the NXP deal (having had many good friends at the former) however both 'smelled bad' from the outset.
The de-regulation of the financial industry seen throughout the past 10 years has always been fraught with danger i.e. greed, power corrupts and we all know that the money men influence so much in every company / industry, giving them more scope (less scrutiny) meant treading a thin line. That suited the politicians then, how does the backlash suit them now? Hopefully they (and we, the voters) will have learned from this. In the meantime I doubt our industry (and many of those similarly inflicated at this awful time) will ever recover. Let's hope at least when we get out the other side we will be leaner, fitter and wiser!
Thanks Gary, I remember at Electronica 2006 I talked to loads of industry people about the NXP and Freescale deals, which had just been done, and every one of them thought just as you do that they 'smelled bad' - over-valued, poor timing, and with Freescale having already been through a couple of re-orgs - one to prepare for spinning out of Motorola, and one for its IPO.
In retrospect I think the deals were done because the PE companies were desperate for deals - any deals - because they would all get commissions and bonuses etc and they were probably sensing that the PE buy-out party would soon be over.
NXP and Freescale, as recently spun-off divisions of big companies, were easy targets. Their owners were happy to sell. The NXP and Freescale managements were easily persuaded to go for it. After all Michel Mayer is said to have picked up over $40m from the deal. Both NXP and Freescale's management at the time seemed pretty naive about PE's record - like all of Wall St the PE people want steadily increasing revenues and profits and the semi industry just doesn't deliver that consistently. Never has. Probably never will.
Meanwhile the Motorola and Philips managements skinned the PE people alive on price. So it was a horrible mixture of ignorance, stupidity and greed which has led to the present mess. Don't forget it was these deals which lead to the collapse of Crolles and so much of Europe's independence in microelectronics technology.
One, somewhat ironic, side-effect of the crunch is that as interest rates come down those who borrowed (borrowed to excess) benefit - largely at the expense of the prudent few who saved...
That said, it seems that even the well-run, prudent companies are going to have a hideously hard time getting any debt financing next year:
http://www.bbc.co.uk/blogs/thereporters/robertpeston/2008/12/2009_is_pay_back_year.html
If that happens then the leverage of NXP & Freescale will affect far more companies than just those two.
What seems hideous to me is that those banks which helped Blackstone and KKR pile all this debt on Freescale and NXP are being bailed out by the state. It's as if the taxpayers have paid to have these companies hobbled and their employees sacked.
I realize it is “poor form” to celebrate anyone's imminent demise, however, I can't help but view this as an unbelievable opportunity!
The underlying problem is more wide spread than just Private Equity destroying FSL and NXP, look no further than ST or IFX or TI or CNXT to see similar cracks opening in the veneer of these once great companies. Combined these companies control close too $50B pa revenue. Imagine, for one minute, that even half this revenue gets reallocated in the next 2 to 3 years. This will represent the largest shift in revenue the semiconductor sector has ever experienced. The real value will be identifying how this redistribution takes place, and which companies will emerge victorious from this firestorm. The “pricing power” the winners will have, combined with their unbelievable growth, will guarantee that we see a return to “price to sales” ratios of 7 or maybe even 10.
Ultimately, I would respectively suggest, that engineers benefit from these insane fluctuations. Imagine BRCM in 3 years time has $10B pa revenue and makes 30% net profit, every VC and VC wannabe in the world, will have their check books wide open, and be funding anything that looks like a sane semiconductor start-up business plan. And so the game continues…….
That's extremely interesting. There are some examples of what you forecast e.g Icera attracts more and more VC funding to get the markets of FSL, TI IFX and ST while these big companies look to consolidation as the answer.
I think you've put your finger on it. The dinosaurs are fading away. The new semiconductor industry could be very exciting.