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Rating Action:

MOODY'S RATES UGS CORP'S SUB NOTES B3, SEC BANK DEBT B1

05 May 2004
MOODY'S RATES UGS CORP'S SUB NOTES B3, SEC BANK DEBT B1

Approx. $1 Billion in Debt Rated - First Time Rating for Issuer

New York, May 05, 2004 -- Moody's Investors Service rated the debt of UGS Corp., a subsidiary of EDS Corp. which is being purchased by a consortium of buyers in a highly leveraged transaction. The new owners of this well-established software and services company will be affiliates of Bain Capital, Silver Lake Partners, and Warburg Pincus. The following ratings have been assigned:

Senior implied rating of B1;

$125 million secured revolving credit facility maturing 2010 rated B1;

$500 million secured term loan maturing 2011 rated B1;

$550 million global senior subordinated note issue due 2012 rated B3 (these notes will be issued in dollars and euros);

Speculative Grade Liquidity Rating of SGL-3;

Senior unsecured issuer rating of B2.

The rating outlook is stable.

The ratings reflect UGS' very high leverage measures, despite a cash equity contribution representing half the purchase price of the company, as a result of the high price relative to historical earnings and asset values. The ratings consider UGS' modest cash interest coverage when earnings are adjusted for capitalized R&D; Moody's expectation that cash flow available for debt repayment will be very modest in the near term; provisions in the debt agreements that allow for near term increases in debt levels and leverage measures; and UGS' short history as a combined entity, all under EDS' ownership. UGS has experienced quarterly and cyclical volatility in revenues and margins since its combination, a period that coincided with an economic downturn and its merger integration. The ratings also recognize UGS' status as a newly-independent company which is still developing stand-alone systems and processes. A concentration in customers and product offerings is offset in the near term by the "mission critical" nature of UGS' products to its larger customers.

The ratings are supported by the significant cash investment of $1 billion in common and preferred equity by the sponsor group; an established history of recurring revenues from license renewals and service and maintenance income; very good prospects for recurring revenue as a result of the company's long history of providing major customers with enterprise-critical software and services, and a large number of installed seats; UGS' meaningful market position in its product segments and across geographic markets; and diversification of customer industry segments.

The rating outlook is stable, although the ratings are somewhat weak in their category. The rating of the subordinated notes could be more sensitive to weakening credit metrics or operating performance, given its subordinate position in the corporate structure and the amount of legally and structurally senior obligations ahead of the notes. The ratings contemplate that debt repayment will be slow in the early years of the transaction, given Moody's expectation that annual net cash flow available to repay debt could initially be less than 5% of the outstanding debt. Ratings could rise if UGS is able to repay debt more rapidly while maintaining or improving operating measures. Ratings could fall if UGS increases leverage, utilizes its revolving credit facility to finance operations, or suffers operating setbacks.

UGS top line and operating margins were volatile during the 2001 -- 2002 period, when the company was created from two separate acquisitions by EDS. Trends have improved over recent quarters, although it is still too soon to determine whether renewal of maintenance contracts will return to historical levels. UGS had been a solid cash flow producer, although its cash generation will be diminished as a result of the estimated $75 million in annual interest payments following the transaction. Modest interest coverage could be reduced further if interest rates rise. Moody's estimates that EBIT to interest, after adjusting for capitalized R&D, is likely to be below 1.5 times as a result of higher depreciation due to purchase accounting adjustments. Moody's expects adjusted EBITDA to interest is likely to be about 2.0 times. Initial debt to forecast EBITDA, adjusted for capitalized R&D, will be high at about 6 times.

UGS has a complex corporate structure which limits the organization's support of the rated debt. UGS generates the majority of its operating income overseas, but incurs the majority of shared expenses, including R&D and interest expense, in the U.S. The rated debt is guaranteed only by the U.S. entities. The company uses licensing agreements as a mechanism to transfer substantial benefit from non-U.S. sales of licenses to the U.S. debt issuer. Nonetheless, the debt holders may not have the benefit of the full enterprise in a distressed scenario.

The rating of the subordinated notes is particularly sensitive to changes in credit and operating metrics as a result of the corporate structure, weak covenant protections, and the large amount of secured debt. Financial covenants for the notes which restrict payments, affiliate transactions, and incremental debt are calculated on a group of subsidiaries which is larger than the group of guarantors. The indenture offers limited protection against transactions with non-guarantor affiliates, the ability to make restricted payments or pay dividends, and to make loans or other payments to direct or indirect parents of Restricted Subsidiaries (including non-guarantor entities), affiliates, consultants, or employees. Moody's believes that bondholders could experience material loss of principal in a distressed scenario.

The bank debt is well-secured by the value of tangible and intangible property, including patents and other intellectual property. Moody's believes the banks benefit from the majority of the enterprise value of the company, as the value of assets is concentrated in the guarantor group. The subordinated notes are legally subordinated to the large amount of secured debt and are structurally subordinated to liabilities of non-guarantors. Secured debt can increase by $100 million in the near term, with the approval of the banks.

The speculative grade liquidity rating of SGL-3 indicates adequate liquidity. UGS will have no cash on its balance sheet and could use some borrowings under its revolver for transaction expenses at closing. Including letter of credit outstandings, Moody's expects that availability under the $125 million revolver will be $80 to $85 million at closing. The SGL-3 rating reflects Moody's expectation that UGS will generate sufficient cash flow to finance its operating needs internally, but has modest access to backup sources of liquidity.

UGS is the holding company for the operating companies. It is two levels below the ultimate parent company at which the equity investments have been made. The bulk of equity, $830 million, was contributed in the form of common equity, with about $220 million contributed in the form of perpetual PIK preferred. In case of an IPO, the issuer can upstream dividends and other payments to the parent company.

UGS Corp., currently known as UGS-PLM Solutions, is headquartered in Plano, Texas. The company is one of the leading providers of product lifecycle management software. Revenues were $897 million for the year ended December 2003.

New York
Andris G. Kalnins
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Marie Menendez
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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