Fitch Places Renesas on Rating Watch Negative on Proposed Dialog Acquisition

(The following statement was released by the rating agency)Fitch Ratings-Hong Kong/Tokyo-12 February 2021:Fitch Ratings has placed Renesas Electronics Corporation's Long-Term Foreign-and Local-Currency Issuer Default Ratings (IDR) of 'BBB-' on Rating WatchNegative (RWN) following an announcement that it intends to acquire DialogSemiconductor Plc for EUR4.9 billion (JPY616 billion) by end-2021 afterobtaining regulatory and other necessary approvals.The RWN reflects Fitch's expectation that the transaction will heightenleverage. Renesas has secured a bridge loan facility of JPY735 billion as afunding option, and plans to raise new equity of up to JPY270 billion.The RWN will be resolved when the financing strategy is decided and any equityissuance is underwritten and/or when the transaction becomes practicallyunconditional, which may take more than six months. We may downgrade theratings if we believe that total debt with equity credit/EBITDA will be above3.0x for a sustained period following the transaction.Key Rating DriversAcquisition to Delay Deleveraging: We believe Renesas's deleveraging prospectsare likely to be delayed by its proposed Dialog transaction, which is to befunded by a mix of new equity, debt and cash in hand. Renesas's pro-formatotal debt with equity credit/operating EBITDA will rise above 3.0x - thethreshold above which we would consider negative rating action - if it raisesJPY270 billion of new equity for the acquisition and may not decline belowthis level until FY22. We originally expected the company to use its free cashflow (FCF) to reduce leverage to around 2.9x by end-2021, from 3.2x in 2020.Debt-Funded M&A Strategy: We believe Renesas could make anotheracquisition in the medium-term to expand its technology capability and productportfolio. The proposed acquisition of Dialog will be the company's thirdmajor acquisition within a five-year period and reflects its aggressiveM&A strategy. We believe Renesas's net debt/EBITDA is likely to stay aboveits long-term target of 1.0x.Business Profile Improvement: We expect the proposed acquisition to improveRenesas's medium-term capabilities in the internet-of-things (IoT) sector, asDialog has a portfolio of connectivity products that are complementary toRenesas. It will also reduce Renesas's revenue concentration in the automotivesemiconductor segment. Renesas expects to create revenue synergies of USD200million and cost synergies of USD125 million over a three- to five-yearperiod.We believe the improvement in Renesas's business profile will narrow itsbusiness risk difference with NXP Semiconductors N.V. (BBB-/Stable) and thatthis improvement may allow the business to operate at slightly higherfinancial leverage at existing ratings.Competitive Market Position: We expect Renesas's leading market position tosupport its solid operating performance. It is the world's third-largestautomotive semiconductor company and the largest microcontroller supplier,with a 19% market share, according to research firm Gartner. It also hasleading positions in niche product areas, such as memory interface productsand timing products for data centres. The company's positions are supported byits patent-protected low power-consumption process, design technology andproduct customisation offering.Positioned in Strong Growth Markets: Fitch expects Renesas to benefit fromend-markets that have favourable growth prospects, including automotive andindustrial segments, despite an automotive sector slowdown in 2020 due to theCovid-19 pandemic. Semiconductor content in the automotive segment is likelyto rise on greater adoption of electric vehicles and autonomous driving.Renesas also benefits from strong entry barriers given the scale ofincumbents, qualification standards and long-term customer relationships, inaddition to intellectual property on technology.Stable EBITDA Margin: We forecast Renesas's EBITDA margin to remain stable at28%-30% in 2021-2023 as it continues to achieve acquisition cost synergies andimprove its product mix to counter competitive price pressure. The company'sEBITDA margin improved to 30% in 2020 on a greater revenue contribution fromits high-margin industrial, infrastructure and IoT segments. It also madesignificant cost savings of USD62 million in 1H20 after integrating its 2019Integrated Device Technology, Inc. acquisition, including patents, designtools and procurement.Solid FCF Generation: We expect Renesas to continue generating solid FCF, withstrong FCF margins through the cycle, supported by a stable EBITDA margin,manageable capex and conservative dividend policies. We forecast capex/salesof 7%-8% in 2021-2023 (2020 estimate: 5%) as the company reduces investmentsto expand semiconductor fabrication capacity, a key capex driver before 2019.We forecast annual FCF of around JPY160 billion-170 billion in 2021-2023,after taking into account the proposed Dialog acquisition.Industry Cyclicality: Renesas's ratings are affected by its exposure toconsumer-oriented markets, such as the automotive and industrial segments.This is likely to result in above-average cyclicality relative to the broadersemiconductor industry. We estimate unit sales of light vehicles dropped by15%-20% in 2020 due to the pandemic, which led to a substantial decline inrevenue for major automotive semiconductor companies in 1H20.Derivation SummaryWe believe Renesas's business profile will be closer to that of NXP followingthe proposed Dialog acquisition, as both companies' revenue scale and EBITDAmargin will be similar. The Dialog acquisition will improve Renesas's revenuediversification from its product portfolio and end-markets, and strengthen itscapabilities in the power management business line. However, Renesas may havea weaker financial profile given the higher leverage.Renesas has a stronger business profile than Microchip Technology Inc.(BB+/Stable) because of its leadership in the microcontroller segment andstronger competitive position in auto semiconductors. However, Renesas'sfinancial profile may be similar to that of Microchip following its proposedacquisition, with similar leverage ratios, depending on its acquisitionfunding plan.Key AssumptionsFitch's Key Assumptions Within Our Rating Case for the Issuer:- Organic revenue to increase by 3%-4% in 2021-2023;- EBITDA margin to remain at 28%-30%;- Effective tax rate to be around 16%;- Capex/sales to be 7%-8%;- No dividend payment or share buyback.RATING SENSITIVITIESThe RWN would be resolved on completion of all the conditions precedent to thedeal and visibility of the final funding mix for the transaction.Factors that could, individually or collectively, lead to positive ratingaction/upgrade:- The ratings would be removed from RWN and a Stable Outlook could be assignedif we expect Renesas's total debt with equity credit/operating EBITDA to falland be sustained below 3.0x within 18 months of the transaction closing.Factors that could, individually or collectively, lead to negative ratingaction/downgrade:- We may downgrade the ratings if we expect total debt with equitycredit/operating EBITDA to be above 3.0x for a sustained period following thecompletion of the transaction.Best/Worst Case Rating ScenarioInternational scale credit ratings of Non-Financial Corporate issuers have abest-case rating upgrade scenario (defined as the 99th percentile of ratingtransitions, measured in a positive direction) of three notches over athree-year rating horizon; and a worst-case rating downgrade scenario (definedas the 99th percentile of rating transitions, measured in a negativedirection) of four notches over three years. The complete span of best- andworst-case scenario credit ratings for all rating categories ranges from 'AAA'to 'D'. Best- and worst-case scenario credit ratings are based on historicalperformance. For more information about the methodology used to determinesector-specific best- and worst-case scenario credit ratings, visithttps://www.fitchratings.com/site/re/10111579.Liquidity and Debt StructureAdequate Liquidity: Renesas's liquidity was adequate at end-2020, with a cashbalance of JPY220 billion sufficient to cover short-term debt of JPY93billion. The company also has solid access to local banks, with a committedunused revolving credit line of JPY125 billion. It also secured a JPY735billion bridge loan facility in February 2021 as a possible funding option forits proposed acquisition. However, the company plans to raise long-termfunding for its proposed transaction and keep the JPY735 billion bridge loanas the backup.REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING Theprincipal sources of information used in the analysis are described in theApplicable Criteria.Renesas Electronics Corporation; Long Term Issuer Default Rating; Rating WatchOn; BBB-; Rating Watch Negative; Local Currency Long Term Issuer Default Rating; Rating Watch On; BBB-;Rating Watch NegativeContacts:Primary Rating AnalystKeith Poon, CFAAssociate Director+852 2263 9996Fitch (Hong Kong) Limited19/F Man Yee Building 60-68 Des Voeux Road CentralHong KongSecondary Rating AnalystRoman Schorr,Director+81 3 3288 2673Committee ChairpersonSteve Durose,Managing Director+61 2 8256 0307Media Relations: Alanis Ko, Hong Kong, Tel: +852 2263 9953, Email:alanis.ko@thefitchgroup.comWai Lun Wan, Hong Kong, Tel: +852 2263 9935, Email:wailun.wan@thefitchgroup.comAdditional information is available on www.fitchratings.comApplicable ModelNumbers in parentheses accompanying applicable model(s) contain hyperlinks tocriteria providing description of model(s).Corporate Monitoring & Forecasting Model (COMFORT Model), v7.9.0 (1(https://www.fitchratings.com/site/re/986772))Additional DisclosuresSolicitation Status(https://www.fitchratings.com/site/pr/10152253#solicitation-status)Additional Disclosures For Unsolicited Credit Ratings(https://www.fitchratings.com/site/pr/10152253#unsolicited-credit-ratings-disclosures)Endorsement Status(https://www.fitchratings.com/site/pr/10152253#endorsement-status)Endorsement Policy(https://www.fitchratings.com/site/pr/10152253#endorsement-policy)ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS.PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK:HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS(HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS). 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