Description

Price: $24.70+-

Shares outstanding: 238m

Equity Value: ~$5.9bb

Enterprise Value: ~$10.1bb

Shares short (source: Bloomberg): 1.5mm, up 380k

2010 EBITDA: ~$1b

2011 Estimated EBITDA: ~ 1.4b

2012 Estimated EBITDA: ~$1.5b

Estimated 2012 Free Cash Flow: ~$850mm

Trade:

Long NXPI or pair it versus short SMH or semiconductor basket; participate in potential imminent secondary offering

Situation Overview:

NXPI is a "highly" levered semiconductor company trading at a substantial discount to the broader semi universe ahead of various catalysts. Since re-emerging after a difficult August 2010 IPO, NXPI is now moving from a value investor story to a growth investor story. After completing various operational improvements and improving the capital structure, the company is now paying down debt at a rapid pace, and should generate ~$3 per share in free cash flow. In addition, growth opportunities in Near Field Communications, a fast emerging mobile payment technology being adopted by Google's Android, should allow NXPI to re-rate from trading at ~7x Forward FCF to closer to an industry multiple on any metric of profitability.

Most Recent Entry Catalyst: Registration of 25mm share secondary offering by original LBO and Strategic  investors (KKR, Phillips, Bain, Apax, Silver Lake, Alpinvest); "sell" mention on Cramer ahead of Sound Solutions divestiture

Exit Catalyst: Rapid deleveraging; valuation re-rating to closer to broader semiconductor peers; growth opportunities such as NFC technology; further debt restructuring (this is largely done); share repurchases; LBO investor exit (or perhaps they cancel the secondary with recent stock weakness); closing of Sound Solutions & NuTune divestments

Catalyst #1: Secondary overhang removal (launch or cancel given recent weakness);

Catalyst #2: Sound Solutions & Nutune divestments.  Sound Solutions, being sold to Dover, is expected to close in the next 3-4 weeks and will generate$855m in proceeds (8.9x PF EBITDA to Dover).  Deal is accretive to earnings post debt pay-down (0.7x deleveraging) and is a major catalyst in the company's balance sheet transformation. The divestiture resides within Standard Products (lower GM) and on a proforma basis NXP business mix transitions to ~ 75% HPMS/25% Standard (vs. ~67%/33% currently). Additionally, the transaction removes a slower growth division within NXP (estimated 2% organic) while retaining the HPMS sales contribution into Sound Solutions on an exclusive basis.

Catalyst 3: NFC technology revenue opportunity:  Near Field Communication (NFC) is a standards-based, short-range wireless connectivity technology that enables simple and safe two-way interactions between electronic devices. NFC technology allows consumers to perform contactless transactions, access digital content and connect devices with the simplicity of a single touch.

• NFC-enabled smart phones allow point-of-sale payments with a wave of the phone
• Gartner forecasts NFC transaction volume growth of 100% CAGR through 2014, with e-payments penetrated at 30% of total transaction volume by 2014. Barclays sees total industry TAM at $1bn by 2015 (40% CAGR).
• According to Barclays, NFC could generate an incremental $200mm-$400mm of revenue in the next 3-4 years from NFC
• Additional handset partnership announcements, ISIS qualification/certification

Catalysts not included in analysis: gross margin improvement as has been highlighted by various analysts (Morgan Stanley says 380bp improvement is possible, Barclay's at 600bps by 2012, GS at 400-600 bps)

Absolute Valuation / Downside Protection:

Assuming the current entry multiple of 7.4x forward EBITDA and exiting at 7.5x in 3 years using the current capital structure of ~3.1x net debt (i.e. no additional leverage) the IRR is low 20% using modest top line growth. Re-leveraging by 0.5x turns would increase the IRR by 500bps.

Relative Valuation / Downside Protection:

• Trading at 2.25x EV/Sales vs. 3.0-3.5x for peers
• Trading at 10.5x 2011 P/E vs. 14x for peers
• Trading at 8.3x 2012 P/E vs. 11-14x for peers
• Trading at ~ 14% forward FCF yield vs. 5-9% for peers

Summary:

NXPI is an attractive cyclical business with strong end-market exposure, trading at a discount to semiconductor peers (15-40% discount on P/E). We think the stock is worth $31-$40 (25-60% upside off a +/-$24.70 price).

Catalyst