S&P Cuts Long-Term Ratings on MagnaChip (MX) to 'B+'; Management, Governance Deemed 'Weak'

Standard & Poor's Ratings Services said it has lowered its long-term corporate credit and debt ratings on Korea-based analog and mixed-signal semiconductor manufacturer MagnaChip Semiconductor Corp. (NYSE: MX) (MagnaChip) to 'B+' from 'BB-'. The outlook on the long-term corporate credit rating is negative.

"The downgrade reflects our assessment of the company's management and governance as weak as a result of growing uncertainties over the timing and scope of the restatement and filing of its financial statements," said Hong Kong-based credit analyst JunHong Park. "The rating action also reflects a likelihood that the negative effect on the company's business and financial conditions will be larger than we had previously expected."

On Aug. 12, 2014, the company announced an expansion of the scope of an internal review and revealed that it included errors and adjustments related to revenue recognition, cost of goods sold, inventory and reserves, and related business practices, for both distributor and nondistributor customers. Also, the company indicated that some of the adjustments could have a material impact on certain intervals in the restatement periods.

We believe the expanded scope of the company's internal review and the continued delay in financial reporting show substantial weakness in its internal controls, financial reporting, and transparency. Reflecting this, we have revised our assessment of MagnaChip's management and governance to "weak" from "fair."

We have also made a somewhat negative revision to our base-case scenario to reflect the potential for the restatements to have a higher impact than we expected. Still, we see uncertainties in the potential for the restatement to lead to a substantial deviation in our base-case assumptions about revenue and profitability-related ratios for the company. However, in our base case, we do not expect the restatements to substantially alter the company's cash flows apart from extra interest payments to holders of US$225 million in its bonds as a result of a covenant breach.

Our base case continues to anticipate that the restatement event will have a limited negative effect on the company's liquidity, given that it had cash and equivalents of about $150 million as of the end of 2013 and no scheduled debt repayments in 2014. Nonetheless, while a low likelihood, bondholders could choose to accelerate bond repayments under the bond indenture if the company fails to deliver its financial statements by Feb. 13, 2015.

We continue to assess the company's business risk profile as "weak," reflecting volatility in the semiconductor industry, potential variability in the company's operating performance, and its relatively small scale. We view MagnaChip's financial risk profile as "significant," reflecting the company's moderate debt and potential variability in measures of its financial condition. In our base-case scenario, we anticipate that MagnaChip will be able to maintain a ratio of debt to EBITDA of about 2.5x-3.0x.

The negative outlook reflects increasing uncertainties about the timing and scope of the company's financial restatements and the impact on its business and financial conditions.

We may lower the ratings if we see an increasing likelihood of an acceleration in bond repayments, such as if the company does not complete its financial reporting and restatements by late November of 2014. We could also lower the ratings if the restatement has a significantly negative financial impact on the company or if its profitability and cash flows decline substantially due to a weakening competitive position. A ratio of debt to EBITDA exceeding 3.0x could indicate such a deterioration.

We may revise the outlook to stable if the restatement does not materially change the company's profitability and measures of its cash flow, leading us to believe the company could maintain a level of profitability comparable with the average for its industry and debt to EBITDA below 3.0x on a sustainable basis.

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