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Commentary: Who's to blame for NX'Ps fate?

Posted: 17 Sep 2008 ?? ?Print Version ?Bookmark and Share

Keywords:NXP financial results? wireless market? IC industry?

NXP Semiconductor didn't need enemies, competitors or bad financial advisersnot with parents like the ones it had at its birth in late 2006.

One parent, Royal Philips Electronics N.V., wanted to get out fast from the capital-intensive semiconductor market. The second parent, a group of investors led by Kohlberg Kravis Roberts & Co. (KKR), saw huge dollar signs in a sector it barely understood.

The combination has been a fiasco for NXP, the IC company that emerged when Philips sold 80 percent of its semiconductor business to the investors, keeping 20 percent for what the management assumed would be a huge future payout from an initial public offering.

The circumstances surrounding NXP's birth and Philips' decision to sell a major chunk of the company to investors rather than spin out the entire business to shareholders incapacitated the company and made it extremely difficult for the company to compete against rivals with better cash liquidity and even lower debt leverage.

To finance the purchase, the KKR group borrowed heavily and tacked on the loans on to NXP's balance sheet, leaving the company with a huge debt burden when the transaction closed. NXP's long-term debt was as high as $6.7 billion at the end of the second quarter, according to Standard & Poor's, which calculates the company is spending approximately $485 million annually servicing the debt.

Additionally, the company's high operating costs have hurt margins and squeezed cash flow even as inventories increased, resulting in a net loss of $330 million in the June quarter compared with a net loss of $359 million in the year-ago quarter.

To shore up its weak cash position, NXP during the quarter borrowed $450 million from its revolving credit line to boost quarter-ending cash balance to $660 million from $519 million at the end of the preceding quarter.

With $6 billion in annual sales and a leading position in several major IC markets, including consumer electronics, automotive, identification and multimarket applications, NXP should have emerged as a leading force in the high-tech sector.

That's not the case.

On Sept. 12, company announced the latest reorganization program in its two-year history as it struggles with losses, negative cash flow, mounting manufacturing and R&D costs, a weakening U.S. dollar and pressures from problems in the global economy.

This set of problems would have been extremely difficult for any company, but at NXP the situation is compounded by the $6.7 billion debt millstone conveniently hung on its neck by parents Philips and the KKR-led investors.

Temporary solution
Cost-cutting will help relieve the financial pressures facing the company but what ails the IC vendor won't be cured by job cuts or another round of operational restructuring.

Don't be fooled, either, by the numbers tossed out by NXP's management. The $550 million in annual savings the company expects from the latest action sounds substantial, but will the goal be achieved in the midst of growing global economic problems, a fluctuating U.S. dollar and a comprehensive reorganization program that is likely to sap employee morale and detract management from its core goals?

While NXP management tried to portray the reorganization as the panacea for the company's problems, analysts contend it will at least initially add to NXP's woes. In fact, the multifaceted restructuring plan, which will affect the manufacturing and R&D operations, further complicates management's task of restoring the company to profitability and will erode its cash position significantly in the first year, according to industry analyst Patrice Cochelin, based in Standard & Poor's Paris office.

"NXP's liquidity position, which already was affected by first-half 2008 cash operating losses, has tightened further as a result of the restructuring announcement," Cochelin said in a report.

Although the company faces numerous problems, the major constraint on NXP's management continues to be its cash-flow situation. Operating costs remain dangerously high despite efforts by the company to reduce expenses. Meanwhile, its R&D budget exceeds the industry average by several percentage points.

In Q2, for instance, NXP's R&D expense totaled $345 million, representing 23 percent of sales, compared with 20 percent for fellow European semiconductor vendor STMicroelectronics N.V., and 16 percent for market leader Intel Corp. during the same three-month period.

As a percentage of sales, NXP's general and administrative expenses are also significantly higher than those of ST and Intel. In Q2, NXP reported SG&A expenses of $327 million, or 22 percent of the quarterly sales. Meanwhile, Intel and ST had SG&A expenses respectively of 15 percent and 11 percent.

NXP should have started out with a lower debt burden, but now that the company is stuck with billions in long-term financial obligations and a huge annual payment in service fees, management needs to concentrate on paying down the obligations.

In order to do this, NXP may have to sell off some additional business units, an option the management has apparently considered based on recent developments.

Hope in wireless unit sale
Months earlier it looked like NXP was about to put some of the financial pressures behind it when it agreed to the sale of its wireless IC unit to ST. The approximately $1.6 billion it expected from the transaction was to be used to pay down debts and strengthen the company's deteriorating cash position. With cash flow from operations turning negative, the company desperately needed the additional cash injection.

Management also was looking to shore up the company's shaky finances with additional payments from ST, which had exercised its option to purchase NXP's remaining 20 percent stake in ST-NXP Wireless. That money should still come in handy and should help offset the $800 million estimated cash payout NXP expects to disburse as a result of the planned reorganization, said Cochelin.

"In the very near term, [NXP's] liquidity is supported by the $1.55 billion of gross proceeds from the disposal of its wireless chip business," Cochelin added. "We expect liquidity to be further supported by the sale of NXP's remaining 20 percent stake in the wireless joint venture."

This slightly positive development did not prevent the lowering of NXP's long-term corporate credit rating, however. S&P also put the company on its negative credit watch citing its $6.7 billion long-term debt and the "very weak profits and cash flow generation."

NXP hopes to address the cash flow and profitability problems with this admittedly comprehensive reorganization plan. The company wants to lower payroll by 4,500, sell or shutter several manufacturing facilities and reduce R&D expenses to about 16 to 17 percent of annual sales.

By closing or selling manufacturing plants, NXP expects to reduce operating costs by $300 million and lower R&D costs $250 million for a combined annual cost reduction of $550 million.

This may not suffice, however. To erase the memory of circumstances surrounding its birth, NXP eventually may be forced to sell business units and concentrate on a few operational divisions. Failing this, it can always opt for a merger with ST or Infineon, taking a cue from the financial market where ailing companies are agreeing to be bought by stronger rivals.

- Bolaji Ojo
EE Times

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