OREANDA-NEWS. Fitch Ratings has affirmed Dutch technology group ASML Holding N.V.'s (ASML) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+' following the company's announcement to acquire Hermes Microvision Inc. (HMI). The Outlook is Stable.

ASML announced that it intends to acquire Taiwan-based HMI for TWD100bn (EUR2.75bn). HMI is a leading supplier of pattern verification systems used in the manufacture of semiconductor devices. ASML plans to finance the acquisition with EUR1.5bn of new debt, EUR500m of new equity and the remaining EUR750m from existing cash reserves. The envisaged financing structure will more than double the company's gross debt to EUR2.6bn. The transaction, which is subject to regulatory approval, is expected to close in 4Q16.

The increase in debt comes after a period of gradual and sustained improvement in ASML's operating risk profile and is within the limits of ASML's 'BBB+' rating. ASML's adherence to maintaining the company's existing liquidity buffer, Fitch's expectations of strong free cash flow (FCF) generation over the next two to three years (assuming no significant macro-economic downturns) and a low dividend pay-out ratio enable ASML to retain financial flexibility. However, the step change in the company's gross debt and net cash position has led us to update our rating sensitivities to reflect the potential for a net leverage position and highlight the importance of strong liquidity in the run-up to the refinancing of any significant debt.

KEY RATING DRIVERS
Strong Acquisition Rationale
The acquisition of HMI reflects the need in the industry to move from point-based solutions to more integrated solutions in the manufacturing process of semiconductors to improve process control and yields. The approach will become an increasingly important driver to reducing incremental costs as ever smaller, energy-efficient and more powerful microchips require finer resolution while involving greater complexity and intensity in manufacturing. ASML has already made significant investments in EUV technology that will enable the development of next generation micro-chips for which improved control and yields will be key to the technology's value proposition. HMI's e-beam metrology control loops work for both EUV and immersion patterning.

HMI is a leading manufacturer of high-resolution, pattern verification systems for defect detection. These systems are an essential and an increasingly important step in the manufacturing of high-end semiconductors. By acquiring HMI's capability, ASML is seeking to improve the metrology of its own EUV and immersion systems, accelerate HMI's product development and expand the product portfolio into new segments. To this extent, ASML's acquisition of HMI strengthens the company's operating profile and market position.

Commensurate Increase in Debt
Fitch views ASML's use of its balance sheet to strengthen its operating profile as credit- supportive compared with other options such as increased share buybacks. We also believe the increase in gross debt, while reducing the company's headroom within its 'BBB+' rating, is being undertaken at an appropriate time in the evolution of the business and in a manner which preserves cash reserves for liquidity.

ASML has maintained gross debt around EUR1.1bn for the past five years and is now increasing this to EUR2.6bn as a result of the acquisition. The increase in debt, in our opinion, occurs after a period of gradual and sustainable improvement in the company's operating risk profile. The improved operating profile reflects the fruition of EUV technology following years of investment in R&D, a about 90% market share of high-end lithography machines, which drives the bulk of ASML's and the sector's lithography equipment sales by value, increased collaboration with key customers such as Intel, TSMC and Samsung, and industry consolidation which is likely to lead to greater stability in overall industry capacity planning.

Maintaining a Conservative Financial Policy
At end-2015 ASML had a strong net cash position, with EUR3.4bn of cash and EUR1.1bn of debt. We expect ASML to maintain a cash liquidity buffer of between EUR2bn and EUR2.5bn. However, a combination of payments for HMI, potential increases in working capital, growth in dividends, the company's EUR1.5bn share buyback programme for 2016 and 2017 and a policy of returning excess cash above its liquidity buffer to shareholders, is likely to see ASML's funds from operations (FFO) adjusted net leverage at between zero and 0.6x over the next two-to-three years.

Change in Rating Sensitivities
The strength of ASML's operating profile enables the company to support a net debt position. However, a prolonged cyclical downturn in the run-up to the refinancing of a significant proportion of the company's debt increases the importance of strong liquidity. These factors have led us to update our rating sensitivities to include a measure for leverage and a tightened definition of liquidity. These are detailed below.

Market Position and Business Model
ASML's ratings are supported by a strong market position and technological leadership in the supply of lithography systems. This is reflected in a revenue market share of around 80%. The company sustains its position through R&D and working closely with its key customers on product evolution, roadmap and delivery. ASML manages its cyclical and technological exposure by maintaining a scalable business model and by maintaining sufficient resources to continue R&D through periods of economic downturns.

Product and Customer Concentration
ASML's focus on one cyclically exposed, technology-driven product segment, with high R&D costs, supplied to few large semiconductor manufacturers raises the company's operating risk and is a constraint on the ratings. This is partially offset by the company's revenue mix, improving stability from end-customer consolidation and customer shareholdings.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer are detailed below.
- Revenue growth of 3% in 2016, driven by 10% growth in field option and services.
- Stable R&D expenditure at EUR1.1bn in 2016.
- EBITDA margin of 26% in 2016, growing to 28% by 2019.
- Stable capital expenditure of 6% of sales per year.
- Cash dividend increase of 10% in 2016, in addition to ASML's 50% increase in 2015.
- Share buybacks of EUR550m in 2016 and EUR950m in 2017.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Positive rating action is unlikely in the near term. The unique nature of ASML's business, including the cyclicality in its customers' end- markets, technology migrations that drive the need for high R&D investment and the company's limited diversification, are a constraint on the ratings

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Operating margins materially below 10%-15% in downturns and below 25%-30% at the peak of upcycles. Fitch, however, recognises that operating losses may be incurred during extreme cyclical contractions.
- Liquidity (defined as gross cash plus undrawn, committed RCF facilities beyond three years less any debt maturities occurring within three years) consistently below EUR1.5bn. The company's public commitment is to a strong cash balance.
- Major loss of market share. Revenue market share is currently estimated at around 75%-80% (up from 65% in 2009). A decline to 55%, albeit still strong, would signal a rapid shift in market position and one that would probably reflect a sustained negative trend.
- Mid-cycle FFO adjusted gross leverage remaining above 2.0x (equivalent to 1.0x FFO adjusted net leverage) on a sustained basis.