* Barring a major change in end markets, risk-reward more balanced
We have been cautious on STMicro based both on valuation but also structural issues faced by the
company (e.g. MEMs competition and the fact that pruning the portfolio is difficult given its employee
base is in high cost areas – 45% in France and Italy). Concerns over cyclicals have seen the stock fall
almost 50% from its 12-month high (22/4/15), shrugging off recent in-line results, further restructuring
and progress with new business lines (FDSOI). We use a scenario analysis and reverse valuation and
conclude: 1) If top line were to deteriorate to the same extent as '08/09 (-21% ex. wireless), the stock
could fall to €2.1/share assuming a valuation of 0.4x EV/Sales, but 2) excluding a major down-turn the
risk-reward is more balanced given the stock is implying 2% revenue growth and 6.3% margins. We
upgrade to Neutral from Sell.
* Fundamental concerns remain
While it has reduced its revenue break-even through a succession of opex reductions, fixed costs remain
relatively high such that we estimate that a 12% reduction in revenue would result in the business
becoming loss-making at the FCF level. It should be noted that we estimate that even allowing for the
full reduction in cost at the business to be pruned (set top boxes/home gateways), STMicro revenue
would have declined 3% y-o-y in 2015. It is also worth noting that "other income" which includes R&D
grants was over 90% of FY15 adjusted EBIT.
* Forecasts lowered
We have lowered our forecasts for '16E/'17E/'18E EPS to reflect a slightly weaker revenue (UBS recently
lowered its US GDP forecasts) and slightly less optimistic timing on the cost take-out in DPG than
previously modelled. It should be noted that at this juncture, and in alignment with UBS economists, we
do not assume that we are headed into another major down-cycle ('09 group revenue fell 21% y-o-y
excluding wireless vs. UBSe -1% for FY16E).
* Valuation: Falls to €4.7/share
Reflecting our lower forecasts, our DCF-based valuation (WACC 9%, g 2%) falls to €4.7/share from
€5.6/share. STMicro trades on 0.7x EV/Sales for a 6% EBIT margin '17E. We upgrade to Neutral on a
more balanced risk-reward.