STATS ChipPAC:Much awaited reorg but 1Q16earnings surprises to downside;Maintain Hold

　　STATS ChipPAC (STATS) recently announced FY15 and 1Q16 results alongwith its parent company JCET. Apart from earnings, JCET also announcedmuch awaited corporate reorganization. In this report we present our thoughtson recent developments as well as our updated bond views.

　　Much awaited reorganization announcement

　　JCET announced that it has entered into agreement with SMIC and IC Fund toswap their stake in STATS with stake in JCET. Additionally, SMIC announcedto subscribe to further stake in JCET with total proceed of RMB2.7 billion(~USD400 million). In terms of next steps, two key approvals are required 1)from the board and shareholders of JCET and 2) from CSRC. Post thetransaction completion, SMIC will effectively become the single largestshareholder of JCET with 14.26% stake. IC Fund will hold 9.5% stake in JCET.Xinchao Group’s stake in JCET will reduced to 14% (from 18.4%) withremaining being public holding.

　　Share swap reorganization is not totally surprising as STATS has indicated thisin the past and we had highlighted the same in our initiation note in Nov, 2015.However, additional equity stake leading to money injection in JCET iscertainly positive from 1) emphasizing SMIC & IC Fund commitment to theGroup and 2) improving liquidity for the consolidated group. New equityinjection largely takes away concern around potential refinancing risk, in ourview. Thus, despite SMIC and IC Fund’s ownership in STATS changing fromdirect to indirect we view this development as slightly positive overall. It is alsoworth highlighting that SMIC & the IC Fund’s total combined investment in thegroup now stands at ~USD800 million (including new equity subscription).

　　Earnings announcement - 1Q16 is weaker than expected

　　Looking at standalone STATS numbers, 4Q15 results were largely stable but1Q16 is quite weak primarily driven by larger than expected decline in revenue.1Q16 revenue of USD244 million is 20% lower QoQ and 34% lower YoY. Thisled to company reporting gross loss of USD5 million for 1Q16. 1Q is seasonallylow but large part of revenue decline was on account of dismal semiconductordemand particularly for smart phones as well as inventory correction by somecustomers. EBITDA dropped to USD35 million (USD 63 million in 4Q15) as aresult of lower revenue.

　　OCF (pre interest expense) dropped to USD20 million (compared to USD47million in 4Q15). Capex was relatively subdued at USD35 million (compared toUSD54 million in 4Q15) though still large enough for negative FCF. Total debtstands at USD1.1 billion and company has subsequently completedrefinancing of bridge loan through take out facility (USD315 million facilitycomprising of USD268 million TL and USD47 million of RCF ) in Apr, 2016.Cash balance declined to USD97 million at the end of 1Q16 compared toUSD118 million at the end of 2015 end.

　　What to expect for rest of 2016

　　Looking ahead, company has indicated that business has picked up slightly in2Q16 and early indication from customers seems to suggest potential furtherdemand/revenue pickup in 2H16. It continues to remain optimistic on potentialorder from new Chinese customers post the acquisition by JCET. As regards capex, it expects to incur USD260 million with substantial portion to be usedfor expansion of its eWLB capacity in Singapore.

　　We remain cautious on industry demand and do believe that any new orderfrom Chinese customers would likely be only towards the end of 2016. In sucha scenario, capex program does look aggressive on a standalone basis. Thatsaid, we understand that capex program is contingent on support by JCET(estimated USD200 million from the new equity subscription by SMIC).

　　Credit ratings

　　Moodys downgraded STATS rating by one notch to B2 post 1Q16 results.More importantly it has maintained outlook as negative. Key downgradetriggers include 1) debt/EBITDA above 5.5x, 2) cash balance falling belowUSD75 million and 3) doesn’t receive USD200 million capital injection forcapex. Looking at 1Q16 numbers, downgrade triggers could be breached evenif there is slight pick-up in EBITDA in subsequent quarters. That said, our basecase is capital injection by JCET and pick up in revenue and profitabilityleading to outlook returning stable.

　　S&P on the other hand currently has rating at BB- with stable outlook.

　　Downgrade triggers include 1) debt/EBITDA of more than 4x, 2) YoY decline inrevenue and EBITDA, 3) loss of any major customer and 4) aggressive capexspending. Based on 1Q16 numbers and 2016 capex guidance, three out of fourtriggers will likely be breached. However, S&P is relatively more sanguine onparental support, in our view, and would likely consider the new equityinjection in JCET more positively. Overall, we will not be surprised to seeoutlook changed to negative though S&P may wait to see recovery insubsequent quarters before downgrading the rating.

　　Bonds view

　　STATS 2020 ($99.75/100.5; ask ytm of 8.4%) has done well post the lows inFeb this year. Bonds remained fairly stable post earnings and reorganizationannouncement but have come off by ~1.5 points since Moodys downgradeyesterday. We had turned neutral last week as it looked relatively faircompared to global peer. We continue to be cautious on capex intensivecyclical industry though industry risk is somewhat offset by potential policyand parental support in STATS’ case.

　　As regards regional comparables, there seems to be some upside compared toother SOE linked HY names such as Zoomlion 22 (ask price of 84.5; ask ytm of9.3%), West China 19C17 (ask price of 105.5; ask ytw of 4.6%). But suchnames have better China onshore investor support which is still not very strongfor STATS in our view. Even STATS’ structure is inferior though it benefits frombeing a secured bond. Thus we maintain Hold.

　　Key upside risks include better than expected pick-up in demand and potentialsynergies & new customer contracts in China. Key downside risks includefurther decline in revenue and EBITDA, loss of any contract/customer andfurther rating downgrade.