When a Buyout Goes Bad

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Freescale, Mayer said, was also on the verge of landing new mobile-phone customers, which would lessen its dependence on Motorola. Not that there were any worries there: Motorola's flip-top Razr phone was a monster hit, with some 30 million sold in 2005. Mayer assured the prospective buyers that Freescale would keep chugging along in the face of a slowdown in semiconductors because it was far more diversified than its peers, which include wireless chip players Skyworks Solutions (SWKS) and RFMD (RFMD). Mayer then met with representatives of each of the private equity firms to answer more questions. One attendee was so impressed that he trumpeted Freescale's "world-class CEO" when pitching the deal to his superiors.

The buyout firms thought they were getting a bargain. By their estimates, Freescale's stock, then trading at around 27, was undervalued relative to its peers, which were tethered tightly to the unpredictable chip-industry business cycle. Freescale didn't seem likely to suffer the same earnings swings, the prospective buyers thought, and should fetch more.

Just as the private equity firms were putting the finishing touches on a $37-a-share offer, another group—KKR, Bain Capital, Apax Partners Worldwide, and Silver Lake Partners—swooped in with a proposal to pay between $40 and $42. KKR had just bought Royal Philips Electronics' (PHG) semiconductor business, later renamed NXP. By merging Freescale with NXP, KKR figured, it could wring out more than enough cost savings to justify the higher price.

TAILSPIN TIME

With the new offer on the table, Mayer headed to Dallas for a three-day marathon of presentations to the new bidders and their investment bankers, lawyers, and accountants. At a kickoff dinner, Mayer curtly told the 30 or so guests that Philips had been trying to offload NXP for a while, and that he had passed on it. "I thought it was funny," says someone who attended the dinner.

The rival bid forced the Blackstone-led group to up its price to $40 a share, some 33% above Freescale's market price. Blackstone's team also promised to finance only about 60% of the purchase with debt, less than other buyouts at the time. And the firms arranged a $750 million line of credit as a safety precaution in case the semiconductor business slumped. "We didn't take as much money as the banks were offering," says Carlyle Managing Director Daniel F. Akerson. Freescale's board was sold. The deal closed on Dec. 1, 2006.

Within weeks, however, Freescale's condition began to worsen. Motorola, which accounted for a quarter of Freescale's revenues, went into a tailspin: Sales of its Razr phone had plummeted and its new phone, the Krzr, wasn't generating much buzz. In the first quarter of 2007 Motorola's market share dropped to 18% from 22% a year earlier. Soon after, giant cell-phone maker Nokia (NOK), which Freescale had been counting on as a new customer, decided not to use the company's chips in a new phone model. "People said, Whoa, the roller coaster just turned the other way,'" says an executive at one of the private equity firms that owns Freescale.

It didn't help that another recent change in accounting rules required Freescale to reflect on its books the difference between the value of the company's physical assets and the buyout firms' purchase price. That took a big bite out of profits: In April, 2007, it posted a $539 million first-quarter loss, after booking a $212 million gain a year earlier. In town hall meetings with employees and conference calls with investors, Mayer explained away the paper losses, assuring everyone that operating earnings were in the black and cash was plentiful enough to cover Freescale's interest payments.

The private equity firms seemed mystified, however. They weren't naive enough to think Freescale would never hit a rough patch, but they figured that if cell-phone chip sales slipped, other divisions would make up the difference.