Analysts Are Optimistic About ON, Concerned About Its Leverage
Fairchild-ON Merger: Do Leverage and Synergies Balance It Out?
Analysts are concerned about ON’s leverage
So far in this series, we’ve seen that ON Semiconductor’s (ON) balance sheet leverage will shoot up after the merger with Fairchild Semiconductor (FCS). ON plans to use the free cash flow generated from the combined company to prepay debt and fund its working capital from the revolving credit facility and cash reserves.
While analysts are optimistic about ON’s organic growth, they’re not happy with this whole leverage arrangement. Zacks Investment Research stated, “We believe the company’s improving end markets, acquisitions, product breadth, diversification across end markets and geographies, and the benefits of restructuring actions are positives. However, the significant debt position and ever-increasing competition remain concerns.”
It’s worth noting that ON had several alternatives to boost growth and achieve all the merger synergies organically.
ON has strong organic foothold
If ON Semiconductor is taken as an individual entity, it has almost 80% exposure in the industrial, automotive, and communications markets. These are the three markets the combined entity is likely to target.
NXP Semiconductors (NXPI) acquired Freescale to expand in the high-growth automotive market. Western Digital (WDC) is merging with SanDisk (SNDK) to tap the SSD (solid state drive) market, which is eating up the HDD (hard disk drive) market. ON isn’t looking to expand in a particular market after the FCS merger.
ON also has the necessary capacity to meet consumer needs and isn’t lagging behind in technology. Taking these factors into consideration, analysts expected ON to outperform its peers in the semiconductor industry.
ON’s ability to generate profits
The key synergy in this merger is cost. But if we look at the organic growth generated from the three high-growth markets, it would have covered the fixed cost of manufacturing operations. An optimum utilization of factory in terms of quantity and right product mix would reduce manufacturing costs and improve profits.
Analysts believe the cost could have been reduced without an expensive acquisition funded through leverage.
In order to tap the niche markets, ON has been making small acquisitions of less than $500 million, including Sanyo Semiconductor, Truesense, and Aptina. This is the first time ON has been involved in an expensive merger to gain market share.
Organic growth prevents debt burden
If ON had continued on a path of organic growth, its free cash flows would have been free without the pressure to repay debt. The company could have spent the cash flow on dividends and share buybacks to keep shareholders happy.
The Semiconductor ETF (SMH) has exposure to 26 semiconductor stocks and 1.1% exposure to ON.
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