July 8 (The following statement was released by the rating agency)
Fitch Ratings has downgraded STMicroelectronics NV's (ST) Long-term Issuer Default
Rating (IDR) and senior unsecured rating to 'BBB-' from 'BBB'. The Outlook is Negative.
The downgrade and Negative Outlook are driven by persistently weak operating
performance, portfolio and cost restructuring that is rarely interrupted and the
lasting effects of the revenue concentration to Nokia Corporation
(BB-/Negative), formerly its largest customer. A sound balance sheet - strong
cash balances, low debt maturities and solid liquidity - and an improving
operating environment provide some balance. Exit from the ST-Ericsson (STE)
wireless JV - to be completed by Q313 - will bring to a close an extremely
challenging period and offers the potential for far stronger margin performance
KEY RATING DRIVERS
ST has invariably failed to deliver margin ambitions. It has also had a
persistent history of portfolio restructuring, cost cutting and business
impairments, the latter most recently related to STE. The inevitability of a
constantly changing reporting structure, and inconsistency in the way revenues
and earnings are reported, leads to a lack of visibility and obliqueness in
predicting future performance.
While the dissolution of STE is a welcome acknowledgment of the failure of a
capital intensive and unsustainably loss making part of the group, management
continue to face challenges across some parts of the product portfolio.
Cost Cuts Achievable, Revenue Challenge
ST is targeting a medium term operating margin of 10% or more and guided
verbally that annual sales of USD9.0bn to USD9.2bn (USD2.25bn - USD2.3bn per
quarter) will be necessary to achieve this target. Fitch estimates ST will need
to produce a gross margin of between 36.5% and 37% if this target is to be met;
a level that low capacity utilisation has failed to deliver for the past seven
A quarterly opex target of USD600m to USD650m by Q114 does seem achievable,
particularly given the roadmap outlined for dissolving STE. Meeting USD9.0bn or
more of sales from a 2012 base of USD7.1bn (excluding wireless) is far less
STE Exit Credit Positive
USD3.1bn of operating losses over 2009-2012 and a consistent failure to improve
the top-line at STE makes the decision to exit the wireless JV and a clear
roadmap to exit by Q313, welcome and a strong credit positive. While the JV's
problems have their roots in the accelerated decline of Nokia Corporation, a
promising industrial idea, proved quickly the difficulty of turning design wins
with multiple tier one handset vendors into any kind of tangible revenue
momentum. In an industry where product life cycles are measured in matters of
months, management appeared consistently unable to deliver on time.
The Good Disguised
Losses within wireless and weakness in other parts of the portfolio have tended
to hide the fact that parts of ST's product portfolio are market leading, have
acceptable margins and offer some growth potential. ST is the market leader in
micro-electro-mechanical systems (MEMs) motion sensors for consumer electronics
and mobile handsets accelerometers and gyroscopes and has a strong supplier
position with Apple in each. MEMs revenue has grown 20 fold in the past five
years - estimated at close to USD800m in 2012.
Management has set a medium term operating margin target of 10%. Historic
experience has however been that targets are rarely met with any kind of
consistency. Fitch therefore takes a cautious view of this ambition and we are
not currently assuming this target is achieved over our three year rating case.
Positive: Future developments that could lead to positive rating actions
Consolidated operating margins trending consistently in the mid-single digit
range (once the effects of the STE dissolution have worked through). Clean
operating results to be judged from Q114.
Neutral to low-single digit free cash flow margin (post dividend cash flow to
sales). Fitch's rating case currently assumes very modest negative free cash
flow in 2014 and 2015 - a metric that underscores the Negative Outlook.
Negative: Future developments that could lead to negative rating action include:
A failure to generate anything more than zero to low-single digit operating
margins on a consolidated basis post 2013.
Free Cash Flow - a failure to generate positive free cash flow on a sustainable
basis will be cause for concern and would likely lead to a downgrade in the
absence of management action (ie. capex and or dividend cuts).