Freescale IPO Cuts Default Odds

Offering gives the company $4.4 bln equity cushion

Creditors of Freescale Semiconductor Holdings are growing more confident the target of the largest semiconductor buyout will avoid default after its initial public offering gave bondholders a $4.4 billion equity cushion.

Credit-default swaps on the company, which two months ago priced in a 46 percent chance of default, now imply 35 percent, after the largest supplier of chips to the U.S. automotive industry sold $783 million of equity on May 25, according to data compiled by Bloomberg. Freescale’s most active bonds trade above face value.

Freescale, taken private in 2006 by Blackstone Group LP, TPG Capital, Carlyle Group and Permira Advisers LLP for $17.6 billion, raised 25 percent less in its share offering than the maximum initially sought. Proceeds will be used to help chip away at $7.6 billion of outstanding debt at the Austin, Texas- based company, which now has a market value of $4.4 billion.

“In the IPO, every dollar of that went to the company for debt reduction,” said Phelps Hoyt, the Des Moines, Iowa-based head of high yield research for Principal Global Investors, which manages $235 billion and owns Freescale’s senior secured debt. “That was a dollar-for-dollar increase in the equity cushion, so we view that as favorable.”


Bank Loans
As credit markets eased and investor appetite for high- yield, high-risk securities improved, Freescale has sought to repay bank loans and extend maturities. The company trimmed borrowings by $2.1 billion since 2008 and extended due dates on $5.1 billion of securities to 2016 and later, according to a May 26 regulatory filing.

Freescale’s bonds yield 489 basis points more than Treasuries on average, compared with 491 basis points on May 24, according to Bank of America Merrill Lynch index data. That’s less than the average B rated bond, which pays a 539 basis-point spread.

The semiconductor maker sold 43.5 million shares at $18 each in the IPO, according to a company statement, after lowering the range to $18 to $20 from $22 to $24. It said it planned to raise about $1.15 billion in an IPO on Feb. 11.

The company’s shares rose 4 cents to $18.24 as of 11:26 a.m. in New York Stock Exchange composite trading.

Proceeds will be used with cash to pay back about $888 million of outstanding debt, Freescale said in the May 26 filing. The company will retain about $742 million after fees, and underwriters have a 30-day option to purchase an additional 6.53 million shares, which would raise as much as $112 million, according to the filing.


Credit Swaps
The proceeds will also be used to terminate so-called management agreements with the company’s sponsors and affiliates for $68 million, with $33.6 million going to Blackstone Management Partners V LLC, according to the filing. Those cost about $39 million overall in 2008, 2009 and 2010.

Swaps on the company protecting against a default for five years soared as high as 6,379.8 basis points on March 3, 2009, according to data provider CMA, a unit of CME Group Inc. That implied a 99.6 percent chance of default, based on the expectation investors would recover 40 percent of face value of the bonds if it failed to meet its obligations, CMA data show.

Freescale swaps ended yesterday at 522 basis points before rising to 524.9 basis points as of 11:22 a.m. today, New York- based CMA said.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Robert Hatley, a spokesman for company, declined to comment.


‘Positive Event’
Standard & Poor’s raised Freescale’s credit rating to B from B- on May 31, projecting a decline in the ratio of debt to earnings before interest, taxes, depreciation and amortization to “the low” six times at year-end from 6.8 times in March, according to a note that day.

“I don’t think downsizing from $1 billion to $750 million materially changes the credit profile,” said Steven Ruh, a vice president and analyst in leveraged finance at Neuberger Berman Holdings LLC in Chicago, which oversees more than $12 billion of junk bonds including Freescale debt. “You’re going from decreasing leverage by a full turn to decreasing leverage by three-quarters of a turn, so from a bondholder perspective, this is still a positive event for us.”

Bonds from Freescale tumbled to below 20 cents on the dollar in the two years following the leveraged buyout as the global economy slowed and credit markets froze, causing investors to flee riskier assets.


Bond Prices
“When bonds trade at that level, it’s fair to assume that some participants in the market thought Freescale would, at some point, need to restructure,” Ruh said. “Things began to turn around for Freescale in late 2009, similar to the global economy.”

Freescale’s $764.3 million of 10.125 percent bonds due in December 2016 rose to 107.9 cents on the dollar to yield 4.42 percent yesterday from 107.4 cents on May 24, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The securities traded as low as 13.3 cents in March 2009.

The company’s $254.8 million of 9.125 percent pay-in-kind toggle notes due December 2014 rose to 105 cents on the dollar yesterday from 104.3 cents on May 18, Trace data show. Those tumbled to 6.5 cents in February 2009.

Moody’s Investors Service grades the company B3, one step lower than S&P, and Fitch Ratings assigns Freescale a CCC, Bloomberg data show.


'Out of the Woods’
“The market is trading these things as if they’re already a notch or two from where the agencies have them,” Hoyt said. “A single B rating is in my opinion mostly out of the woods. There’s only a relatively small probability Freescale runs into a problem, but single B credits do have exposure to unforeseen economic events.”

Freescale posted a net loss of $1.05 billion last year, following a gain of $748 million in 2009, Bloomberg data show.

“The company will be very challenged to generate sufficient cash flow to meet upcoming debt maturities over the longer term, and in order for them to do so, they would need to meaningfully outgrow the market and meaningfully improve free cash flow margins,” said Jason Pompeii, a senior director with Fitch in Chicago. “To us, it remains a revenue growth situation.”

The company needs annual sales of about $4 billion to break even, Chief Executive Officer Richard Beyer said in a telephone interview on May 26.


Managing Debt
Even if its revenue falls below the current level of about $4.8 billion, Freescale will still be able to manage debt and invest in its business, he said. Sales last year were $4.46 billion, Bloomberg data show.

Freescale’s bonds were raised to “overweight” from “market weight,” by CreditSights Inc. The New York-based research firm cited improved leverage from the IPO and “continued EBITDA improvements,” in a May 27 note.

“It has been established” that there’s more than $4 billion of equity value underneath the bonds, Neuberger Berman’s Ruh said. “It gives you more confidence in the value of the business as a bondholder.”

 

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