Freescale’s mega-LBO does not compute

February 25, 2011

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Robert Cyran

The mega-buyout of Freescale Semiconductor just does not compute. The chipmaker started quaking under its hulking debt almost immediately after a private equity foursome bought it in 2006 for $17.6 billion. A restructuring and a rebound in sales have helped turn things around. But even if Freescale fetches the same valuation multiple in its planned initial public offering as rival NXP Semiconductors, Blackstone, Carlyle, Permira and TPG would see more than half their initial investment burned out.

It never made much sense to leverage a chip company to the hilt. The booms and busts of the semiconductor cycle make sales and profits highly cyclical. To wit: Freescale has just endured three consecutive years of operating losses. And the high pace of innovation means companies can’t afford to skimp on R&D and capital expenditures during a downturn.

If Blackstone and friends mistimed their buy, they at least picked a good time to sell. The Philadelphia Semiconductor Index is up more than 30 percent over the past 12 months as demand has picked up. Using $1.2 billion of estimated IPO proceeds to pay down debt also will help keep a good thing going. The face value of the company’s debt already has been trimmed by $2.1 billion since 2008. Less leverage could help Freescale refinance at lower rates and extend maturities.

Selling stock has at least one other important benefit for the current owners. It sets them up to divest if the chip sector boom should get white hot.

It’ll be a painful step, though. NXP, another pre-crisis chipmaker mega-LBO, went public last August. It has a similar profile to Freescale and an enterprise value of a little over eight times last year’s EBITDA. Put Freescale on the same multiple, and it would be worth about $9.4 billion.

Adjust for the $1 billion of cash on Freescale’s books and its $7.6 billion of debt, and it leaves, on paper, around $2.8 billion of equity for the company’s backers. That’s less than half the estimated cash they put in at the time of the buyout. Private equity investors won’t need the latest microprocessor to work out the deal just hasn’t added up.

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