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Analysis: Should NXP file for bankruptcy?

Posted: 06 Mar 2009 ?? ?Print Version ?Bookmark and Share

Keywords:NXP option? Chapter 11 bankruptcy? market downturn?

NXP B.V.'s management should begin to consider filing for Chapter 11 bankruptcy reorganization in order to improve its chances for surviving and emerging stronger from a rapidly deteriorating semiconductor market. Such a move would lessen the huge debt burden loaded on the chipmaker by former parents Philips Electronics and its private equity partners.

To be sure, a bankruptcy filing wouldn't be welcomed by Philips or the Kohlberg Kravis & Roberts-led (KKR) group of equity investors that took the company private in a leveraged buyout deal in 2006. But recent events point to more difficulties ahead for NXP unless it is able to shed more than $6 billion in debts and the huge interest expense it must pay annually to service those notes.

The company's latest offer to swap portions of its existing debts for new secured notes represent only a Band-Aid that will only provide temporary relief, not the total cure NXP urgently requires. The bond exchange represents only about 25 percent of NXP's outstanding debt, Standard & Poor's analyst Patrice Cochelin said in a report, leaving the company with almost $5 billion in long-term debt.

The huge debt, combined with falling sales as demand for chips weakens and negative cash flow from operations, could doom NXP. Fourth quarter 2008 sales, for example, tumbled 39 percent, to $1 billion from $1.7 billion in the comparable 2007 quarter, driving its gross profit margin down to 18 percent from 38 percent. The net loss for the quarter was $645 million versus net income of $69 million in Q4 07.

Furthermore, NXP is looking at a hefty double-digit sales decline for the current quarter. Company executives admitted that "visibility of sales for the full year ahead is even more limited," adding that revenue in Q1 could drop by as much as 40 percent from the December quarter.

"Our ability to give guidance on our expected first quarter revenues is limited, due to the unusual conditions prevailing in the semiconductor industry," the company said in a filing with the U.S. Securities & Exchange Commission. "However, our current expectation is that our 2009 revenues will be lower than our 2008 revenues, and the size of this decline could be significant. A decline, combined with the large cash cost of our redesign program, our interest expense and our capital expenditures would lead to reduced liquidity at the end of 2009."

Ratings agency Standard & Poor's (S&P) cut its corporate rating March 4 for NXP to "CC" from "CCC," and put the company on a "credit watch with negative implications" following the company's offer to exchange portions of its unsecured debts for new secured euro- and dollar-denominated notes.

The exchange offer was meant to help NXP reduce interest expense payments at a time of reduced cash flow from operations tied to the downturn in the global economy and sliding demand for semiconductor products.

While the move should help take some pressure off the Dutch company, it is unlikely to pull it out of its current financial doldrums, S&P's analysts noted, pointing out that even a successful completion of the bond-exchange program would still leave NXP with high debts and interest expense obligations.

Combined with the ongoing market downturn and other strategic operational moves being taken by the company to lower costs, this could result in high cash utilization in 2009, further jeopardizing NXP's ability to pull quickly out of the financial mess that followed its spin off from Philips.

"We continue to believe NXP may consume significant cash in 2009 because of our anticipation of continued decline in the global semiconductor market, the company's restructuring plans, and its still-high interest burden," S&P's Cochelin said.

Better option?
Why would bankruptcy filing be a viable option for NXP Semiconductor?

First, the company is running huge negative cash flow, and the situation is likely to continue through at least 2009 with the possibility of losses extending through 2010 if the semiconductor market fails to rebound strongly soon.

S&P, for instance, estimates NXP had "negative free operating cash flow of $1 billion in 2008," representing $622 million in negative cash used for operating activities and "gross tangible and intangible capital expenditures of $415 million."

If NXP's cash flow tanked in 2008 when the market turned severely negative by the fourth quarter, then the situation could be even worse in 2009 as sales plunge and cash generation shrivels as credit markets tighten for most manufacturers.

Already, NXP has tapped a hefty chunk of its line of credit and might not be able to get new financing in the near term. The reason is its weakened market position along with concerns the company might not be able to meet financial obligations.

NXP closed its latest quarter with about $1.8 billion in cash, including money drawn from its credit facility. It appears to have enough money to fund operations and interest expense payments through the end of 2009. However, while NXP's management point to the company's improved liquidity position at the end of 2008, they often fail to highlight the fact that a major portion of its cash and marketable security comes from the sale of its wireless IC business to STMicroelectronics, which paid a total of $1.64 billion for the division.

Additionally, NXP drew about $600 million from its 500 million euro line of credit, leaving it a negligible amount for future withdrawals.

What could dissuade NXP from picking the bankruptcy option? Possibly the fear that the private equity companies that currently control 80 percent of NXP along with ex-parent Philips could end up losing most if not all of their stake in the company.

KKR appears to be resigned to the reality the NXP leveraged buyout was a blunder. KKR has written off about 80 percent of the value in its investment in the IC vendor, a move necessitated by the sharp decline in the company's market value.

While NXP's shareholders may be hesitant to push the company into bankruptcy, it remains a better strategy for the company, its customers, employees and the entire semiconductor industry.

NXP remains a major player in several markets. With proper restructuring, the elimination of a substantial portion of its interest expense and lower manufacturing costs, the company could still emerge as a strong competitor in the semiconductor industry.

- Bolaji Ojo
EE Times

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