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Question: Who can destroy $13 billion of industrial value in five years? Answer: A private equity company.
Yesterday’s $4.6 billion valuation of Freescale is in stark contrast to the $17.6 billion valuation put on Freescale when its owners, the private equity company Blackstone, bought it in 2006.
The $4.6 billion valuation comes as Blackstone prices Freescale’s upcoming IPO at $18-20 a share. When Blackstone bought Freescale it paid $36 a share.
Freescale will put 43.5 million shares up for sale representing 17% of the company.
The IPO price has already been reduced from an initial $22-24 price tag which, presumably, has found disfavour among underwriters.
The aim of the IPO is to raise $870 million to pay down some of the original $9.6 billion debt loaded onto Freescale by Blackstone after the takeover. The $9.6 billion of debt has since been reduced to $7.5 billion by buy-backs.
$764 million of the debt matures next year, which is why Freescale needs the money. None of the proceeds of the IPO are due to be invested in Freescale.
The original $9.6 billion debt forced Freescale to find an initial $750 million a year in interest payments.
Freescale has been unprofitable ever since the takeover, and made a $1 billion net loss last year.
Blackstone’s mistaken $17.6 billion valuation of Freescale in 2006 came from its using a metric known as ‘discounted cash flow’ which assumes future revenues at a certain level – a hazardous metric to use in the notoriously volatile semiconductor industry.
Blackstone was also pushed into over-paying because of competing interest from its fellow New York private equity company KKR.
Blackstone is being sued for not revealing, in its own IPO in 2007, the full extent of its exposure to Freescale’s valuation decline.
Rich Beyer, CEO of Freescale since February 2008, has struggled manfully, as you would expect from a former officer in the US Marine Corps, but the level of debt imposed by Blackstone was daunting.
When Beyer took over as CEO of Freescale I told him he was taking on the worst job in the semiconductor industry. And so it has turned out to be.
Understand from my reset revision (been doing and MBA at home while “being a government artist” used to be an engineer)that its the management behaviour is called management utility and well documented in economics.
Don’t think that there is anything “wrong” with DCF as such more likely significant is GIGO. (garbage in….)
Although hope that they were not that stupid just to apply it…to be fair going back 5 years most financial analysis had hockey stick predictions for interest rates, and “the economy will be back to normal by Christmas…..” and what has happened!
Most of the stuff they made me read says that returns on acquisitions range from negative to at best 2% when looking at the finance alone – so no wonder they lost ( your supposed to value the other stuff that comes along for the ride and if i remember rightly you can stuff a load of associated losses under goodwill and something about a tax shield – Is that right Ed)
having now coming to the end of the MBA mill , you have to stop yourself from looking at companies as a kind of Victorian – Edwardian Hugh machine generating money. All steam and cogs “set the balance sheet metrics up right and the thing should just keep churning out the cash regardless of what your doing or if you are doing anything at all” instead of generating, innovation creativity wealth and prosperity for all. Good job that there’s disruptive technologies to kick them up the back side.
For what it is worth, for several years FSL has been able to pay the interest without dipping into about 1B in cash, so the reduced interest and (mis)management fees post-IPO go straight to cash flow, so more debt can be payed off… Would have been happening without IPO had Motorola not tanked and taken a big chunk of FSL down with it. Yes, the PE guys, and stock holders back then and now, are in it for the money.
An excellent point Mike, Blackstone will have another another stain on their name if Southern Cross go bust and a lot of old people are put at risk. The way they ran that business – selling off the freeholds and leasing them back – was almost certain to imperil the business. Now Southern Cross have the cheek to try and cut the rents they pay and, if they don’t, the taxpayer will probably have to pick up the tab for looking after the inmates. Just as a lot of NXP people got EU welfare payments after what KKR did to NXP. And all the while Blackstone and KKR go laughing to the bank with their ‘management’ fees. Mismanagement more like. The EC has to put a stop to these sort of people.
It wasn’t just Freescale than were affected by Blackstone’s financial shenagins
http://www.dailymail.co.uk/news/article-1393294/Southern-Cross-Healthcare-destroyed-Stephen-Schwarzmans-private-equity-firm-Blackstone.html
Spot on, yehuda
To my opinion, there were 2 major issues that went wrong with FSL PE purchase (besides the global economy down turn) :
1. After the purchase, asset had to be re-evaluated (to help justify the price paid) and the largest depreciation falls as extra expenses on the businesses.
2. When you have $9B debt, you need close to $800M a year just to pay the interest. This eats your cash-flow and leave very little to normal operation.
I believe FSL businesses suffered from these 2 issues and they played in a competitive arena with 2 hands tied behind their back.
That’s an excellent point, Robert, the value-producing part of Freescale is just producing value elsewhere. Well said.
Well Yes Dave but buying at the top of the market, overpaying by about 3X, then taking out a mortgage which is 2X the value of the asset – represents crass stupidity on a scale which is seen in only one class of person – private equity people.
I guess I am the most naive person here.
To me, there were 3 things which went wrong with this FSL deal. These have nothing to do with the fact of a PE investor being involved, in fact, they are traps for all investments, e.g. buying a house.
1. the price paid (by Blackstone) for the asset was too high. This has been covered in the main story. If you buy a house for too much, through not having done your homework, or believing someone else’s hype, you will quite possibly lose out on your investment when you try to sell it down the road.
2. the financial leverage introduced was not put to good use. PE companies, like home buyers, use debt to enable them to improve the asset. But you have to put this debt to good use if you want to increase the value of your asset. If you buy a house then take a loan to renovate, you’d better renovate it in a way that makes it more attractive to the next buyer. You want to spend x, borrow y, and sell the resulting asset for something more than x+y. If you, instead, put up a baroque facade on your rustic homestead, you might find that other people now value your asset lower rather than higher. So Blackstone obviously did not put all that extra cash they got in via the debt to any good use.
3. the timing was poor. Buying at the top of a bubble is a bad thing (though sometimes hard to see coming). Same with a house – refer to all those people in the US who found their debts unserviceable because the market crashed taking their home valuations down with it.
Pretty standard and simple business thinking, no conspiracy theories necessary. Nonetheless the blame lies with Blackstone on 2 out of 3 of the above.
Cheers
@st0815
I accept that Freescale has been gutted and that this once vibrant corner-stone of the industry is effectively no-more. BUT it is not clear to me that talented engineers necessarily suffer. It would not have been possible for BRCM or QCOM to grow as fast as they did without a source of experienced mixed-signal and comms engineers.
So I’m not sure that society suffers because the productive talents of the engineers are still being leveraged (they’re just working under a different banner)
For one simple reason, yehuda, because the share price may go up. it’s always possible that Freescale will hit on a great market opportunity which will lift the share price. But what is more likely to lift the share price before the next tranche of Freescale shares is IPO’d, is an orchestrated campaign by Freescale’s backers to persuade suckers (banks, pension funds, investment funds etc ) that a higher share price is justified. Only by getting a higher share price on IPO are Freescale’s owners going to avoid making a loss on the $7bn of their own money which they put into buying Freescale. These Wall Street people live by their ability to artificially inflate asset prices. So, although a share price rise is likely to be based on smoke, mirrors and bullshit, it will probably happen nonetheless, and buying now is a way to profit from the rise – if you sell in time.
Since sophisitcated investors are aware of the process you describe, The Baron, then it makes sense to buy now before the Wall Street bullshit machine gets underway to inflate the share price – so long as you get out before reality hits.
History is important in order to learn from mistakes.
Current status (regardless of why it is and who is responsible) is that FSL has more than $7B debt while the IPO value of the company is only less than $5B (according to this excellent paper).
For me it means that whoever invest in it, is purchasing himself a debt paper.
Why anyone would buy such stock?
> Before the PE sale it was an economic asset, creating
> new products, inventing new things. Now it’s crippled
> and barely able to move.
Which is why I wonder why folk buy these husks. Why buy something where it seems likely that KKR/BS etc. will just talk-up the price based on fantasy at best, sell-off their share and then let reality bite?
That, St0815, is an excellent point.
@Robert: society is the loser in these deals. Individual employees may have made a fair bit of money, but the company itself is no longer functional. Before the PE sale it was an economic asset, creating new products, inventing new things. Now it’s crippled and barely able to move.
Each time you do that to a functional company, you are generating an overall economic loss. The cake gets smaller – even though some people get a larger slice.
Well, The Baron, anyone who bought NXP’s shares at the IPO price of $14 in August 2010 would now be doing rather well – the latest share price is $28. I notice NXP is banging the publicity drum and KKR and its pals are no doubt bending investrors’ ears to persuade them that NXP has a booming future on the back of its NFC potential and mixed signal products. And the Wall Street guys know how to inflate an asset price – just look at the crazy values being put on Facebook as Goldman Sachs puffs it up. Of course the higher KKR can puff NXP shares, the better the deal will seem for them when they can finally sell their stake.
My question is who on earth buys the IPO shares? Don’t answer: I know it’s probably one or more of my pension funds… 🙁
All the supposed rocket scientests go into finance and yet they can’t spot a blatant stinker when offered to them. If someone offered you the chance to buy the contents of their cat’s litter tray so their house doesn’t stink of it anymore would you? That seems to my wee brain to be the essence of what the Freescale and planned NXP floats are trying to achieve.
The Baron
Thanks, Robert, that puts a different perspective on it.
Seems like a lot of people are conveniently forgetting that Moto tried, for several years, to sell its semi business to TI. The semi BU valuation was between 0.5 and 1 * Revenue. TI clearly thought it was too excessive and passed on the deal.
Just a couple of years later PE people are offering about 4 * Rev (from memory), so of course everyone took it.
Young Freescale employees got shafted, no doubt about it, but older Moto employees saw all their options vest and also made out like bandits. It was not just Meyer that got a Golden handshake!
Clearly Blackstone limited’s have lots of reasons to complain, the funds that bought these Junk bonds are understandable PO’ed but I’m not sure that anyone else has anything to complain about.
Yes Ian, I have to say I liked Mayer he was open to questions and was straightforward and he worked like a dog. I’ve seen him wretched with tiredness. But the record shows he put the interests of himself and the shareholders first, whereas a great CEO puts the long-term interests of the company first and protects the interests of the employees. By all accounts, Mayer was very instrumental in persuading Blackstone and the other private equity people to buy Freescale. That was a terrific deal for the shareholders and for himself but, as a sophisticated business person, he must have known what private equity ownership would mean for Freescale employees and their families. To sell out those for whom you are responsible in order to enrich yourself is despicable.
I remember Meyer being quite good at the start, but the problem came – entirely understandably – when he had 47 million dollars waved under his nose to sell to Blackstone.
It was the craziness of the PE folks that screwed Freescale, I think, not Meyer.
I do believe you’re right [Anonymous] I found the following two references to a $50 million return:
http://www.businessweek.com/magazine/content/08_15/b4079034490446.htm
&
http://www.efinancialnews.com/story/2008-11-24/freescale-struggles-two-years-after-record-buyout-1
How awful that such a lousy deal should have been so grotesquely rewarded
Nope, check again….Meyer walked away with $50M
Yes brian, and Mayer walked away with $20mill.
That’s the way to do it, Stooriefit. These b.awful businesses like hedge funds and private equity only get off the ground because they find ways to exploit the tax system. So the tax system must be the right instrument to marginalise them.
You’re right, Mike, NXP and Freescale were never worth the values paid for them but, equally, they were never able to bear the level of debt imposed on them. On a happy note I seem to remember that in Freescale’s case, Blackstone and its private equity collaborators actually put up $7 billion out of the $17.6 billion purchase price out of their own pockets. So at least they’re getting royally punished for their stupidity.
It wasn’t intended to be a sensational title, brian, it’s just that, even after the IPO money has been spent to reduce debt, Freescale will still have $6.7bn of debt round its neck which it just can’t shake off by trading its way out. Blackstone have done a terrible thing to the company.
Kudos for David’s intentional sledgehammer of a title. FSL’s downfall was due to Motorola’s cellular business taking a dive instead of being the hockey stick of growth. Michel Meyer was responsible for this mess too. Let’s not forget him.
So how about tax on the profits of share trading being divided by the length of time the shares are held measured in years?
Tax for long term investors (pension funds) virtually nil, tax for short term investors (hedge funds and traders) astronomical. A win-win.
We can play tunes with tax on dividends to make sure greedy owners don’t milk the divi at the expense of investment in nice things like R&D & capital investment.
@Dr bob
For bonus points
Who was the PE company that took On-semi private? and for what price was it purchased from Moto?
extra bonus points if anyone can remember the incredible rate of return these PE guys achieved for their LBO’s in the 1990’s
Freescale (and NXP) were never actually worth the values paid for them and so there wasn’t “destruction of industrial value” on that level, the real loss being to the funds that invested in the PE companies to make these silly bids. Of course there has been industrial damage to the companies since as attempts were made to extract some value from them but not on the level quoted.
A few years ago, even before the crash, the German government did look at a system of ‘holding’ shares after their sale so that the couldn’t be quickly resold, and also making sure that money actually did change hands before the transaction was complete. Their central bank would be able to control that time electronically so as to smooth out market fluctuations. Unfortunately their banks argued successfully that this would put them at a competitive disadvantage and got it stopped rather than what was really needed was the same system to be rolled out worldwide.
You’re right, of course, Torben, what these people do is investment masturbation – unproductive and non-creative. You can’t stop people doing it but you could tax the gains on short-term holdings at a higher rate than the tax on long-term holdings.
The meek shall inherit the earth, Dr Bob?
Ah! Freescale, the former micro arm of Motorola. The other former semi arm (discretes) being On Semi who are now entering the micro arena.
There must be a moral there somewhere.
A lot of the financial problems we have today would be eliminated if a global law was introduced which forbade trading of shares at any other price than the initial emission price. This would mean that the only return of investment on shares would be dividends, where the current case seems to be that most money is earned by ultra fast trading, where shares are sold maybe seconds after they are bought. Obviosly, this is a zero-sum game (unless shares overall gain value, which tends to lead to bursting bubbles) and no real value is produced by these activities.
If dividends was all that was interesting, share holders would be a lot more concerned with the health of companies they owned. Of course, there would still be majority holders that would “milk” the company by making the company pay too high dividends, but at least the other problems would be eliminated.
But I can’t really see this happening, as that would put a lot of speculants out of work, and these have sufficient lobbying power to protect their jobs.
I think the accountants have seven different metrics, Craig, but sensible people use common sense. Freescale IPO’d in the summer of 2004 at $13 a share. When Blackstone started sniffing the share price shot up and when KKR also started sniffing the price soared. But the market had spoken – $13 a share. And, of course, a sensible person would look at the price paid for NXP a few months before Blackstone bought Freescale – $10bn. And NXP was a similar-sized, similarly profitable company to Freescale. And Blackstone paid $17.6bn for it – representing $36 a share. So the metric should have been common sense – everyone in the industry knew that $17.6bn was crazy – but not everyone on Wall Street.
“…a metric known as ‘discounted cash flow’ which assumes future revenues at a certain level – a hazardous metric to use in the notoriously volatile semiconductor industry…”
David, do you have a view on what sort of metrics Blackstone should have used?