News & Analysis

Freescale ‘toggles’ to PIK option

In a worrying sign for a major LBO deal, the semiconductor company, bought out by a constortium of private equity investors for $17.6bn two years ago, has chosen to service a portion of its debt through in-kind securities in order to preserve cash.

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Freescale Semiconductor, taken private by The Blackstone Group, The Carlyle Group, Permira Funds and TPG for $17.6 billion in 2006, has elected its option to pay-in-kind on its interest payment due 15 June 2009 in order to preserve liquidity.

As part of the buyout transaction, Freescale was issued $1.5 billion in “PIK-toggle” notes, giving the company the right to pay its debt with more debt, as opposed to cash.

In a recent regulatory filing, Freescale called the decision to exercise its PIK option a “prudent method to enhance liquidity in light of the dislocation in the current financial markets and the uncertainty as to when reasonable conditions will return”.

The firm on 23 October drew down $460 million of its $750 million revolving credit facility in an additional move to improve its liquidity position.

“There is no way [Freescale] can repay the debt”, according to Jerome Ramel, a semiconductor analyst with Exane BNP Paribas, quoted earlier this month at the European Nanoelectronics Forum 2008 in Paris.

The switch to in-kind payments by PIK toggle borrowers may simply be putting off default and hurting debt-holders in the process, according to a June 2008 study by US ratings agency Standard & Poor’s.

“For firms with poor financial prospects, the issuance of PIK-toggle notes might only be delaying the inevitable and could likely deteriorate the recovery prospects for non-PIK debt holders,” said the report. “Default risk is high and recovery prospects are low among our sample of PIK issuers.”

The study examined a sample of 41 PIK-toggle notes, including those of Freescale, totalling $22.9 billion in debt.

Freescale is not alone in its use of PIK. As of 21 October, Moody’s Corporate Finance had identified 11 private equity-backed companies that had either exercised, or announced their intention to exercise, their PIK option this year. S&P identified only five in June.

Apollo Global Management backs six of the companies identified by Moody’s: Berry Plastics Group, Harrah’s Operating Company, Metals USA, Momentive Performance Materials, Realogy and Claire’s Stores.

Other companies include: Laureate Education, which is backed by a consortium including Kohlberg Kravis Roberts and Citi Private Equity, Crestview Partners-backed Symbion, Avista Capital Partners’ WideOpenWest Finance, Welsh Carson Anderson & Stowe's US Oncology Holdings and TH Lee-backed Simmons Holdco.