NXP Semiconductor NV; Market Cap (as of 06/03/15): $22.7bn
Freescale Semiconductor Ltd; Market Cap (as of 06/03/15): $12.3bn
On March 2, NXP Semi announced it will acquire Freescale Semi in a $11.8bn transaction. Amalgamating the Eindhoven-based chip manufacturer with its American rival will create the leader in both Auto and MCU (Multi-Chip Unit) semiconductors, with combined revenues of more than $11bn and an enterprise value of $40bn.
Founded in 1953 as a division of Phillips, NXP (NXPI) specializes in technology for cars, cyber security and the Internet of Things – an ultra-connected world of technology devices. Phillips then sold 80.1% of NXP to a private equity consortium (KKR, Bain, Silver Lake, Apax and AlpInvest Partners) in 2006 for $9.4bn. However, following cumulative losses of $5bn, NXP was re-listed on the NASDAQ in 2010. With revenues of $5.6bn in 2014 (+17.3% yoy), NXP is a top-twenty global seller of chips. NXP’s recent strategy has been to position itself in the mobile payment sector by providing Apple’s IPhone 6 with secured communication chips to complete transaction through Apple Pay.
Freescale was founded in 1948 as a division of Motorola with a portfolio of applications similar to NXP (i.e. MCU’s and automotive & communications chips), but is also specializes in radio frequency devices. Similar to NXP, Freescale was taken private by a consortium led by Blackstone for $17.6bn in 2006 and floated in 2011. Freescale generated $4.6bn of revenues in 2014 (+10.7% yoy).
The semiconductor sector is currently undergoing concentration. Three acquisitions have already been announced this year: Avago Technologies acquisition of Emulex for $600m, Maxlinearpurchase $287m of Communication Inc, and Lattice Semiconductors $600m acquisition of Silicon Image. In 2014, Qualcom took over CSR for £1.56bn and Infineon Technologies acquired International rectifier for roughly $3bn.
Price competition, coupled with increasing R&D costs, has deteriorated the industry’s return on capital. To face this challenge, the only solution semiconductor companies have is to cut their operating expenses, which would only be effectively attainable through economies of scale. Additionally, the Internet of Things, which connects cars, houses, and other devices, has increased the demand for chips, especially in the mobile sector. However, chip manufacturers are facing a loss of bargaining power against Apple, Samsung and Nokia and the pressure to restructure before mobile payments become overwhelmingly attractive is rising.
Furthermore, as the companies in this sector are highly cyclical, they constantly face the risk of an economic downturn. This is the main reason private equity companies, which invested in NPX and Freescale in 2006, faced losses. They were not able to predict that their investment was made at the peak of the economic cycle. Back in 2006, the net debt/EBITDA ratios of NPX and Freescale were 5 and 6 respectively; this was a bet that the economic cycle was not going to turn. Downturns like that do not happen often and are difficult to predict. That is why the risk inherent in cyclical companies does not disappear and companies prefer to operate at lower debt ratios.
Following the acquisition, NXP will occupy a leading position in the fragmented markets for both auto and broad-based MCU semiconductors with 13% and 14% market share respectively. As customers seek supply chain consolidation, requesting different semiconductor parts come together rather than individually, a dominant market share in both of these areas will strategically position NXP to maximize potential revenue synergies. As a result, NXP’s management has estimated that the combined entity will grow more than 1.5x faster than the market.
Additionally, the acquisition develops a broader and more diversified customer base for NXP. By cross-selling solutions, NXP can improve its presence in the USA, China and the EU while capturing emerging growth in the Smarter World – an idea encompassing the key ‘megatrends’ in Energy Efficiency, Connected Devices, Security and Health.
The deal structure
The deal values Freescale’s equity at $11.8bn, implying an enterprise value of $16.7bn when $4.9bn of net debt is taken into account. As a result, the P/E (TTM) stands at 47.0x. When compared with a sector average of 19.7x, according to Thomson Reuters, the deal appears relatively expensive for NXP. However, the implied P/E is only marginally higher than the trading multiple before the announcement of the transaction, which was approximately 44.0x, implying a very narrow premium (ca. 5%) as markets already valued Freescale richly. Moreover, the estimated 2015 P/E stands at 18.7x, in line with the sector. When analyzing EV/EBITDA ratios, the deal implies a multiple of 15.3x. Although slightly higher than average multiples of precedent transactions in the sector, the significant expected cost synergies should reduce realized ratio of the acquisition in the future.
According to the agreement, the deal will be settled through a combination of cash and shares. For each Freescale share, shareholders will receive 0.3521 of an NXP ordinary share and $6.25 in cash, implying an 83% shares and 17% cash deal structure. Hence, the total consideration will entail 115m NXP ordinary shares, $1bn of new debt and $1bn of cash from NXP’s cash-in-hand balance. As a result of the merger, NXP will have to face a high net debt burden since its net debt/EBITDA ratio, currently at ca. 1.5x, will increase to almost 3.0x. Therefore, the firm has committed to a disciplined FCF management in order to decrease the ratio to ca. 2.0x by Q3-2016. Moreover, notwithstanding the expected accretion effect on both EPS and FCF from year 1, mainly due to $200m in cost savings in the first full year after closing and $500m of annual cost synergies thereafter, the repayment of debt may negatively influence pay-out ratios in the future until 2016/2017.
Market Reaction & Closing
The market reacted positively to the announcement, showing genuine interest from investors in the deal. NXP share price jumped 17.3% to $99.56 from $84.895, while Freescale’s share price rallied 11.8% from $36.11 to $40.36 on the day of the announcement. Since Freescale shareholders benefit from interesting upside potential due to their 32% stake in the combined entity, with price movements set above the value implied by NXP’s offer.
The deal is expected to close in the second half of 2015, subject to regulatory approvals, customary conditions and approval from both companies’ shareholders.
Credit Suisse, which will provide financing for the deal, has been appointed as the exclusive financial advisor to NXP. Morgan Stanley acted as the exclusive financial advisor to Freescale.
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