CHICAGO - (Business Wire) Fitch Ratings has lowered the following ratings on Freescale Semiconductor Inc. (Freescale):
-- Issuer Default Rating (IDR) to 'B' from 'B+';
-- Senior secured bank revolving credit facility (RCF) to 'BB/RR1' from 'BB+/RR1';
-- Senior secured term loan to 'BB/RR1' from 'BB+/RR1';
-- Senior unsecured notes to 'CCC+/RR6' from 'B/RR5';
-- Senior subordinated notes to 'CCC/RR6' from 'CCC+/RR6'.
The Rating Outlook remains Negative. Fitch's actions affect approximately $10.1 billion of total debt including the assumption of a fully drawn RCF.
The ratings and Outlook reflect Fitch's expectation that Freescale's free cash flow will be negative for the fourth quarter of 2008 and all of 2009, excluding a number of non-recurring cash items, due to:
-- Significantly weakened consumer spending prospects over at least the near term, which Fitch believes will be exacerbated by tight credit markets and drive a sharper than previously contemplated contraction within the global semiconductor market. This should negatively impact Freescale across all business segments, including its historically more stable Microcontrollers and radio frequency (RF), analog, and sensors segments;
-- Sharper-than-anticipated production cuts for all of Freescale's automotive customers, particularly the big three U.S. automakers, which face ongoing market share erosion and to which Freescale has significant exposure;
-- A precipitous decline in quarterly cellular segment sales to below $100 million beginning in the current quarter, the fourth fiscal quarter of 2008, from more than $350 million in the year ago fourth quarter, as a result of Motorola's (historically 90% of Cellular segment sales) cancellation of its remaining contractual purchase obligations with Freescale. Nonetheless, Fitch believes Freescale's planned partial or full divestiture of or exit from the unprofitable Cellular unit within the coming months will enable the company to re-focus the significant capital previously invested in the cellular-related research and development (R&D) into markets offering higher profitability and more meaningful revenue growth opportunities.
The ratings also reflect Fitch's expectations that Freescale's credit protection measures will weaken over the near term, driven by a combination of lower profitability anticipated for 2009 and the company's recent draw down on its RCF. As a result, Fitch estimates interest coverage (operating EBITDA-to-gross interest expense) could fall to nearly 1.0 times (x) and leverage (total debt-to-operating EBITDA) could approach 10x. As a follow up on to its 2008 restructuring activities, Freescale recently announced additional restructuring plans for 2009, which are expected to reduce fixed costs by up to $400 million (on an annual run rate basis) by the end of next year. Nonetheless, the ratings and Outlook incorporate Fitch's expectations that cost reductions will not offset significant revenue declines in 2009, which Fitch believes will exceed 10% (excluding the Cellular segment).
Despite these challenges, Fitch recognizes that Freescale has sufficient liquidity to absorb even greater than anticipated cash usage over the next two years. As of the quarter ended Sept. 30, 2008, Freescale's liquidity was supported by approximately $1.8 billion of cash and cash equivalents and approximately $230 million of availability remaining under the company's $690 million senior secured revolving credit facility due 2012, pro forma for the $460 million draw under this facility subsequent to the most recently ended quarter. Freescale drew against its RCF to bolster its liquidity in the face of meaningful uncertainty through 2009, particularly regarding the extent of sales declines, as well as the timing of cash restructuring charges and the receipt of cash payments from Motorola associated with its cancelled purchase agreement.
Further negative rating actions could occur if:
-- Freescale's free cash flow burn is greater than expected, which likely would be profitability driven and suggest the company's financial flexibility could be meaningfully reduced within the next 18 months;
-- The company delays the sale of or exit from its cellular business or fails to replace these lost revenues over the intermediate term.
Conversely, Fitch may stabilize the ratings if Freescale:
-- Meaningfully reduces debt with cash proceeds from the sale of the cellular business; or
-- Experiences greater than anticipated operating margin expansion or revenue growth, neither of which Fitch believes is likely through 2009 and possibly the first half of 2010;
Fitch expects Freescale's free cash flow for 2008 will be more than $400 million, although this amount includes one-time payments in the first quarter of 2008 from equipment sales and Motorola to reduce purchase commitments. Nonetheless, Fitch believes Freescale will be challenged to be free cash flow neutral in the fourth quarter of 2008 and currently believes the company's use of free cash flow for 2009 will exceed $250 million unless the company is able to stem meaningful gross margin erosion and achieve its cost reduction targets, assuming working capital efficiency ratios remains at near current levels. Additionally, Freescale's only debt amortization until 2013 is 1% per annum under the term loan facility, or approximately $35 million per year, and the company has no financial covenants.
At Sept. 30, 2007, total debt was approximately $10.0 billion and consisted primarily of:
(i) $460 million outstanding under the company's $690 million revolving credit facility due December 2012;
(ii) Approximately $3.4 billion of senior secured term loan expiring Dec. 1, 2013;
(iii) $500 million of floating rate senior notes due 2014;
(iv) $1.5 billion of 9.125% PIK-election senior notes due 2014;
(v) Approximately $2.34 billion of 8.875% senior notes due 2014; and
(vi) Approximately $1.5 billion of 10.125% senior subordinated notes due 2016.
The Recovery Ratings (RR) for Freescale reflect Fitch's recovery expectations under a distressed scenario, as well as Fitch's expectation that the enterprise value of Freescale, and hence recovery rates for its creditors, will be maximized in a restructuring scenario (as a going concern) rather than a liquidation scenario. In deriving a distressed enterprise value, Fitch applies a 35% discount to Fitch's estimate of Freescale's operating EBITDA for the latest 12 months (LTM) ended Sept. 30, 2008 of approximately $1.4 billion. The discount is equivalent to Fitch's estimate of maintenance capital spending and total interest expense for Freescale, assuming the company exercises its option to pay in kind (PIK) interest expense on the above referenced $1.5 billion PIK-election senior notes. Fitch then applies a 5x distressed EBITDA multiple, which considers that a stress event would likely result in a contraction to Freescale's current multiple. 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. The 'RR1' for Freescale's secured bank facility and term loan reflects Fitch's belief that 91%-100% recovery is likely. The 'RR6' for Freescale's senior and senior subordinated notes reflects Fitch's belief that 0%-10% recovery is realistic. However, Fitch believes that, for the senior subordinated notes, expanding the notching down by one is appropriate due to the structurally superior position of the senior unsecured note holders.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
Fitch Ratings
Jason Pompeii, +1-312-368-3210 (Chicago)
Nick P. Nilarp, CFA, +1-212-908-0649 (New York)
Cindy Stoller, +1-212-908-0526
(Media Relations, New York)
cindy.stoller@fitchratings.com
