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Freescale IPO Downgrade: Internet Bubble Doesn't Float All Boats

Last week, the LinkedIn (LNKD) IPO seemed to inflate a tech bubble. And yet, last night, one-time Motorola chip division Freescale (FSL) reduced its IPO price from $20 to $18.

So, is there a bubble or isn't there? The answer is a most definite yes, with a caveat. Bubbles come through the irrational exuberance of investors who give their hearts to the latest fad that they think will turn into a financial killing. However, not all technology lies in the promised land of social networking and games. Freescale's history, recent financial performance, and massive debt from a 2006 leveraged buy-out are enough to make investors question whether they're about to step into instant success or a big pile of dog doo.

Investors were hot for LinkedIn because the stock was scarce, demand seemed high, and, most importantly, revenue and earnings kept improving. However, that's not the picture you get from Freescale's numbers from its latest S-1 filing with the SEC (click to enlarge):

Sales went down from 2008 to 2009 and then back up again in 2010. The company wants to write that off to the global recession. But there are more problems than just revenue. Gross margin in 2008 was 39.6 percent. In 2009, margin dropped to 26.9 percent. Last year, it was back to 37.9 percent. Compare that to Intel's (INTC) FY2010 gross margin of 65 percent or the 53.6 percent of Texas Instruments (TXN). In its latest quarter, margins rose to 40.5 percent -- a good deal better than the 36.2 percent of the same period in 2010, but still far away from what many other semiconductor companies do.

The semiconductor business is a cash-hungry monster because of the cost of building new plants or upgrading equipment to take advantage of critical new technologies. Factory utilization is key, because the more chips a company manufactures, the less the fixed costs are per chip, which increases margin. And utilization was up to 74 percent last quarter, versus 66 percent the year before. However, sales will have to jump substantially for utilization to buoy margins to the levels that competitors enjoy. That puts Freescale at a big disadvantage, as other semiconductor companies have more money to spend on improving technology.

Then there's the history of the company. After Motorola spun off the division, it went public and then some private equity investors including Blackstone Group took it private in 2006 for $36 a share. Although they're keeping their stakes, the company is selling new shares at a hefty discount to help pay down some of the $7.5 billion in debt from the previous leveraged buy-out. No one wants to see that amount of debt on the books when the industry is cash intensive. Pay off debt and you have less for necessary capital improvements. Invest in the improvements, and the debt weighs on you.

Even though Freescale chips are used in some popular devices like the Amazon (AMZN) Kindle, it still costs the company too much to make the chips it sells. And that's enough to weigh down anyone's boat.


Image: Freescale
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