May 31, 2017 / 8:22 AM / 8 months ago

Fitch Maintains ASE on Negative Watch; Assigns ST Ratings

(The following statement was released by the rating agency) SINGAPORE/HONG KONG, May 31 (Fitch) Fitch Ratings has maintained the Rating Watch Negative (RWN) on Advanced Semiconductor Engineering, Inc.'s (ASE) 'BBB' Foreign-Currency Issuer Default Rating (IDR) and 'A+(twn)' National Long-Term Rating. Fitch has assigned ASE a Short-Term IDR of 'F3' and a National Short-Term Rating of 'F1(twn)'. ASE and Siliconware Precision Industries Co., Ltd. (SPIL) announced on 18 May 2017 that US anti-trust authorities have approved the plan by ASE and SPIL to establish a holding company to own 100% of the equity interests of both companies. The merger plan received approval from the Taiwan Fair Trade Commission in November 2016. However, it still needs approval from Chinese anti-trust authorities and shareholders. Fitch placed ASE's ratings on RWN on 17 December 2015 following ASE's proposed cash acquisition of SPIL's shares that it did not own. The companies' respective boards of directors approved the merger on 30 June 2016. The merger agreement, unless consummated, will expire by 31 December 2017. KEY RATING DRIVERS Negative Watch Maintained: If the proposed merger proceeds, ASE's ratings are likely to be based on the consolidated credit profile of the holding company, given the two entities will have strong operational and strategic linkages. The RWN reflects Fitch's belief that the holding company's consolidated credit metrics may be meaningfully worse than those of ASE. The RWN will be resolved when the completion of the proposed transaction is certain and the capital structure, financial profile and policies of the combined group are clear. We may affirm the ratings at their current levels or downgrade the ratings, though this is likely to be limited to a single notch. Weaker Leverage: We estimate that, if the merger proceeds and is funded entirely by debt, the holding company's consolidated pro-forma FFO-adjusted leverage could be around 3.0x in 2017, compared to our downgrade rating guideline of 2.0x for ASE on a standalone basis. We expect it will take two to three years for the group to deleverage to below 2.5x, depending on recovery in the global semiconductor industry, achievement of cost and capex synergies and dividend policy. The proposed deal will involve swapping each ASE share for 0.5 shares of the holding company and the holding company paying TWD51 in cash for each SPIL share. The offer for SPIL shares that ASE does not own, including the shares resulting from the likely conversion of SPIL's USD400 million outstanding convertible bonds, would cost TWD130 billion (USD4 billion) in cash, which may be funded by new debt. ASE raised about TWD10 billion in a rights issue during March 2017 to reduce its debt to around TWD98 billion (2016: TWD111 billion). Stronger Market Position: The combined entity will have a stronger business profile with about 29% in the outsourced semiconductor assembly and testing (OSAT) industry, stronger technological capabilities and ability to pool resources to cater for the fast-growing "system-in-package" business. We believe the combined entity will save on overlapping capex and R&D spend. However, these synergies may be offset by some revenue losses as some customers may diversify away from the combined group. On a pro forma basis, we estimate that consolidated group will have about USD7 billion-7.2 billion of lease-adjusted debt and EBITDA of USD2.7 billion-2.8 billion. Solid FCF Generation: We forecast the combined entity to generate at least USD400 million-500 million annually in FCF. The combined entity may invest about USD1 billion in capex and pay around USD400 million-500 million in dividends. The group may spend about USD300 million-400 million in interest and taxes. Low Single-Digit Revenue Growth: We believe ASE's revenue will grow by around 3%-4% in line with the overall growth in the smartphone industry. Smartphones continue to be the single most important driver of assembly and test services from OSAT companies. We expect the combined entity to have operating EBITDAR margin of around 19%-20%, which is similar to ASE's standalone profitability. Profitability could improve in the medium term if ASE manages to continue to improve its profitability in the electronic manufacturing services (EMS) segment. Gross margin in the EMS segment widened to 10% in 1Q17 (1Q16: 8%) due to better prices and cost savings. Negative Industry Outlook: The OSAT industry is likely to face soft market fundamentals, high competition, debt-funded consolidation, and large investment requirements. Competition is likely to remain intense because capacity utilisation could fall below 2016 levels as the industry's third-largest company, Jiangsu Changjiang Electronics Technology Limited (JCET), aggressively adds capacity and may gradually narrow the technology gap with Taiwanese peers. Average selling prices (ASPs) may decline by 3%-5% annually. Industry revenue may increase by only 3%-4%, driven by smartphone demand growth in China and India. Most analysts forecast global smartphone demand to rise by only a low-single-digit percentage in 2017 and for the PC and tablet market to continue to decline. The on-going consolidation in the OSAT industry will only partly address the fragmentation of the market and price erosion. The benefit of consolidation may be realised only in the medium term in the form of higher capacity utilisation, better bargaining power and stable ASPs. Short-Term Ratings: The short-term ratings assigned are based on the short-term/long-term rating relationships outlined in Fitch's Criteria for Rating Non-Financial Corporates. The short-term ratings are not on RWN as we believe that any downgrade of the long-term ratings will be limited to a single notch; it would take a two-notch downgrade of the long-term ratings to lead to downgrades in the short-term ratings. DERIVATION SUMMARY ASE's 'BBB' ratings reflect its leading market position in the OSAT industry, technological capabilities and established relationship with its customers. ASE's 2017 FFO-adjusted leverage of 2.3x is better than OSAT peers, including Amkor's 2.5x and JCET group's 4.0x-4.3x. ASE's FCF generation is also much higher than peers' given its larger CFO relative to annual capex, which is due to its stable capacity utilisation. We believe that ASE's market position, advanced technological and packaging capability and diversity of revenue will help in withstanding intense competition in the industry. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Successful completion of the establishment and listing of the holding company in 2017 in line with the terms of the joint statement announced by both ASE and SPIL on 30 June 2016. - Revenue to grow by 3%-4% in line with the industry. - Stable EBITDA margin. - Progressive achievement in capex and R&D synergies over the medium term. - ASE to pay about TWD130 billion to acquire the rest (67%) of the stake in SPIL. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action Positive rating action is currently not envisaged. If the merger does not proceed, Fitch would likely remove ASE's ratings from RWN and affirm its ratings. Developments That May, Individually or Collectively, Lead to Negative Rating Action Fitch plans to resolve the RWN once completion of the merger is practically certain and there is clarity on the merged entity's future capital structure and financial policies, which may take place six months after the merger's completion. The ratings will depend on pro-forma leverage on completion and on the visibility and credibility of a sustainable deleveraging path using post-dividend free cash flow and potential new equity proceeds. We may affirm the ratings at their current level with Stable Outlook, if, following discussions with the company, we determine that lower business risk offsets the higher financial risk associated with weaker credit metrics. LIQUIDITY Adequate Liquidity: At end-March 2017, ASE's had unrestricted cash of TWD38 billion and available undrawn committed facilities of TWD5 billion, which were sufficient to pay for the short-term debt of TWD35 billion. ASE has committed syndicated bank facilities available to fund the cash of TWD130 billion needed to acquire the remaining 67% stake in SPIL. FULL LIST OF RATING ACTIONS Advanced Semiconductor Engineering, Inc. - Long-Term Foreign Currency IDR of 'BBB' maintained on Rating Watch Negative - National Long-Term Rating of 'A+(twn)' maintained on Rating Watch Negative - Foreign-currency senior unsecured rating of 'BBB' maintained on Rating Watch Negative - Short-Term IDR assigned at 'F3' - National Short-Term Rating assigned at 'F1(twn)' Anstock II Limited - Rating on USD300m 2.125% senior unsecured guaranteed notes due 2017 of 'BBB'; maintained on Rating Watch Negative The notes are unconditionally and irrevocably guaranteed by ASE. 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