Freescale Limps Out of the Gate

May 25, 2011

Frequent readers will recall that I have developed an appetite for cold IPOs this year, most notably Neophotonics and Sequans thus far in 2011, though this will not extend to the grotesque orgy of poor decision making and self dealing that is the IPO of Freescale Semiconductor.  In sum, I view it as another good reason to be short UBS, another good reason to be long MSPD, another good reason to wonder why private equity firms are public and another good reason why the sell side is truly dead and research ideas seem so plentiful these days.  These conclusions will be elaborated upon in detail below, and note that none of this bitterness has anything whatsoever to do with my being short when the folks at Blackstone, TPG and Carlyle decided that $18B was a bargain price for Freescale in 2006. 

 

Freescale priced its shares at $18 after the close today (that’s an enterprise value of $10B, down by nearly half over 5 years), at the low end of an $18-20 range that was reduced last week from an initial $22-24.  Based on our quick analysis of the company, $18 is no bargain either.  Even after using most of the estimated $730M in proceeds to pay down debt (minus the $70M paid back to the PE guys for their “management fees”) the company remains massively levered with $6.5B in gross and $5.75B in net debt on EBITDA of about $1.2B plus a 200M share overhang.   

The really fun thing is that Citi is the lead manager of the deal and also is the bank that will receive the highest amount of proceeds ($50M) in terms of the repayment of the revolving credit line.   So the IPO investor is enabling Citi and Blackstone to get paid, in exchange for the opportunity to own a low margin semiconductor warhorse at over 2x revenue and around 40x run rate earnings (after a massive amount of interest expense) of about $0.40. Even if one assumes that they are able to get close to $1.00, $18 seems aggressive especially given the likelihood that if anything goes seriously wrong in terms of macro demand and company execution, FSL is a zero shot.  The senior secured high yield debt, with coupons in double digits in some cases, seems like a much more interesting play especially now with $5B of apparently sanguine public market cap in front of it.  An equity price under $15 makes more sense to me.

 And LinkedIn tells us the range reduction is not related to “market conditions” but more to the fact that the “financial sponsors” of  the world have made sure that no one except GS and MS knows how to manage an IPO process anymore.  THIS DEAL HAS THIRTEEN BANKS ON THE COVER, with the Citi lead again likely relative to their lead role in the revolver (calling the Hon Messrs Glass and Steagall) and UBS fresh off the mangling of the SQNS IPO is positioned last among the eight “bulge bracket” names on the cover.  That’s right before the five boutiques, which is largely reflective of UBS’ competitive position and, along with providing a Euro hedge for ALU and a macro hedge for Europe in general, another great reason to be short UBS .  Though it is a pretty big deal, it’s clear that (1) no one is going to make any money on any of these IPOs and (2) this obviates any meaningful investment in quality research, or any commitment to doing it for 1% economics.   Given my current focus this should make me happy, as given the current structure of the sell side inefficiencies are absolutely everywhere, though it is somewhat sad to see what’s become of the business.

 The company is growing in the mid to high teens driven by wireless infrastructure exposure and strength on the industrial/automotive side, and the company also has cellular device exposure and as the former Motorola semiconductor unit still counted the pre split MOT as a ten percent customer in 2009.   However, as a PE owned entity one could question the level of investment in research and marketing, with opex to revenue at FSL in the 28% range compared to peers such as Broadcom, Qualcomm and ST Micro in the 35% plus range and gross margins in the 40s substantially below peer levels.  This innovation concern is exacerbated by our recent datapoint suggesting that competitor Mindspeed is over a year ahead of Freescale in developing baseband infrastructure chip solutions for LTE networks.