NXP and Freescale Can’t Repay Debts, says BNP Paribas
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 Paris, “the valuations were too high.”
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.