Fitch Places Freescale's 'B ' IDR on Rating Watch Positive on Planned Merger with NXP
Freescale entered into a definitive agreement to merge with NXP in a transaction valuing Freescale's equity at \$11.8 billion. The combination creates a leading high performance mixed signal semiconductor supplier with number one market share in automotive semiconductors and general purpose microcontrollers, positioning the company for growth in automotive markets and secure connectivity.
The Rating Watch Positive reflects the combined company's strengthened operating and free cash flow (FCF) profile, as well as credit protection measures. Upon completion of the merger, Fitch anticipates upgrading the ratings to the mid- to high-'BB' category.
Fitch expects nearly \$10.5 billion of combined revenues in 2015, versus \$4.9 billion for standalone Freescale. Limited overlap in core markets provides cross selling opportunities within robustly growing automotive, secured connectivity and internet of things markets.
Pro forma for the merger, Fitch expects strengthened operating EBIT through the cycle from NXP's higher profit margins and \$200 million of merger-related cost synergies by the end of year one. Fitch anticipates mid-cycle operating EBIT margin in the low- to mid-20%, versus the high teens for Freescale on a standalone basis. Higher profitability should drive \$1 billion to \$1.5 billion of annual FCF, versus \$250 million to \$500 million for standalone Freescale.
Fitch expects Freescale's total leverage (total debt to operating EBITDA) at or under 5 times (x) exiting 2015, driven by profitability growth and debt reduction. Pro forma for the merger, Fitch estimates total leverage in the 3.25x to 3.75x range.
NXP will fund the transaction with a combination \$1 billion of available cash, \$1 billion of new debt and stock that will give Freescale shareholders just below 32% ownership of the combined company. The deal is expected to close in the second half of 2015 and has been approved by the boards of both companies. The deal is subject to both Freescale and NXP shareholder approvals, as well as regulatory approvals in various jurisdictions.
In reviewing the proposed transaction, Fitch will focus on the strategic and operational benefits of the merger as well as the level of anticipated operational and legal integration resulting from it. Fitch will assess the achievability and reasonableness of potential cost and revenue synergies. Fitch will review the pro forma capital structure to determine the proportion of secured debt within the capital structure, recovery prospects of the various debt instruments within the capital structure, and the extent of any legal ties or guarantees afforded to the legacy Freescale indebtedness.
KEY RATINGS DRIVERS
The ratings continue to reflect Freescale's:
--Leading share positions for embedded processors in markets characterized by longer product life cycles, including automotive microcontrollers (MCU), from which Freescale generates 25% of total revenues, and radio frequency (RF) power devices for mobile wireless infrastructure;
--Secular growth in key end markets, including unit growth and increased content in automotive, proliferation of mobile devices and demand for bandwidth in networking, and increased connectivity for industrial, translating into low- to mid-single digit longer-term revenue growth;
--Strengthened FCF profile, driven by more stable revenues and lower interest expense from ongoing debt reduction.
Ratings concerns center on Freescale's:
--Significant exposure to automotive (approximately 40% of revenues) and wireless infrastructure end markets (more than 30% of revenues), including the more project oriented China LTE infrastructure roll-out. Both end markets are experiencing solid growth that Fitch anticipates will moderate in 2015;
--Long-term structural challenges growing market share due to incumbent supplier advantages associated with ongoing design collaboration, which at the same time fortify Freescale's customer relationships and leading market positions;
--Significant and increasing fixed investments in research and development (R&D) and, to a lesser extent, capital spending to maintain competitive technology roadmap.
Fitch's key assumptions within the rating case for the issuer include:
- Mid-single-digit revenue growth through the intermediate term.
- EBITDA margins approach 23% through the intermediate term.
- Capital expenditures are assumed to be elevated, but remain in the mid-single digits as a percent of revenue to support growth initiatives.
- Annual FCF averages near \$300 million, primarily driven by interest expense reduction from debt refinancing and mandatory prepayment of Senior secured facilities.
Positive rating actions will result from the completion of the merger, as Fitch does not expect significant reduction in total leverage prior to the anticipated merger close.
Negative rating actions, including the stabilization of the ratings at 'B+', could occur if the proposed merger falls through, given that Fitch does not anticipate significant increase in total leverage prior to the proposed merger's close.
If the merger falls through, Fitch would maintain Freescale's prior rating sensitivities.
Fitch expects to resolve the Rating Watch Positive on the release of further details regarding the finalized capital structure.
Fitch believes Freescale's liquidity was sufficient as of Dec. 31, 2014 and consisted of:
--\$696 million of cash and short-term investments, of which \$298 million is located inside the U.S.;
--An undrawn \$400 million senior secured RCF due February 2019.
Fitch's expectation for \$250 million to \$500 million of annual FCF also supports liquidity.
Total debt was approximately \$5.6 billion as of Dec. 31, 2014 and consisted of:
--\$2.7 billion senior secured term loan due March 2020:
--\$783 million senior secured term loan due January 2021;
--\$500 million of 5% senior secured notes due 2021;
--\$960 million of 6% senior secured notes due 2022;
--\$473 million of 10.75% senior unsecured notes due 2020;
--\$180 million of 8.05% senior unsecured notes due 2020.
The Recovery Ratings (RR) reflect Freescale's current capital structure and Fitch's belief that Freescale's enterprise value, and hence recovery rates for its creditors, will be maximized as a going concern rather than liquidation scenario. In estimating a distressed enterprise value, Fitch assumes post-reorganization operating EBITDA of \$750 million. Fitch applies a 5x distressed EBITDA multiple to reach a reorganization enterprise value of approximately \$3.75 billion.
As is standard with Fitch's recovery analysis, the revolver is assumed to be fully drawn and cash balances fully depleted to reflect a stress event. After reducing the amount available in reorganization for administrative claims by 10%, Fitch estimates the senior secured debt would recover 51% - 70%, equating to 'RR3' Recovery Ratings. The senior unsecured and senior subordinated debt tranches would recover 0% - 10%, equating to 'RR6' Recovery Ratings and reflect Fitch's belief that minimal if any value would be available for unsecured note holders.
Fitch places the following ratings for Freescale on Rating Watch Positive:
--Long-term IDR 'B+';
--Senior secured bank revolving credit facility (RCF) 'BB-/RR3';
--Senior secured term loans 'BB-/RR3';
--Senior secured notes 'BB-/RR3';
--Senior unsecured notes 'B-/RR6'.