MOODY'S UPGRADES MAXTOR'S CONVERTIBLE SUBORDINATED DEBENTURES TO B3
Moody's Investors Service raised the rating on Maxtor Corporation's $95 million of 5-3/4% convertible subordinated debentures, due 2012, to B3 from Caa3. The convertibles, which are currently subject to redemption at par plus accrued interest, were originally convertible into shares of common stock at $40 per share, on a pre-split basis. However, based on a January, 1996 supplemental indenture adopted at the time of the acquisition of all of the company's then outstanding common stock by Hyundai Electronics America (HEA), the debentures are no longer convertible into Maxtor stock. The debentures may only be converted into a cash payment of $167.50 from HEA, an amount equivalent to the $6.70 per share received from HEA by the former Maxtor common stockholders. Additionally, the convertibles feature a $5 million annual sinking fund which commenced March 1, 1998. The senior implied rating on the company's debt is B1. The rating outlook is stable.
Moody's rating upgrade concludes a review coincident with HEAs acquisition of the company, and takes into account Maxtor's industry leadership over the past thirteen months in time-to-market and time-to-volume production of new per platter capacity points in hard disk drives manufactured for the intensely competitive desktop market. The company's capitalization, while still highly leveraged, has been vastly improved through an initial public offering in July, 1998 which reduced HEAs ownership interest to 46% and enabled the company to repay $200 million of debt. Nevertheless, Maxtor, which has improved its market share to 16% of the desktop segment, continues to be confronted by a myriad of challenges in a capital intensive industry characterized by rapid technological change, rapid rates of product and technology obsolescence, changing customer requirements and rapidly eroding average selling prices. Among those considerations limiting the company's rating are the company's constrained access to capital in the absence of a back-up liquidity facility beyond the existing asset securitization vehicle; the company's significant anticipated capital expenditures to support its timely execution of a business plan predicated on an accelerated production ramp, and diversification into the enterprise drive and the higher end of the sub-$1,000 computer drive markets; uncertainties over the ability of free cash flow to demonstrate coverage of pro forma fixed charges; a moderate debt to cash flow ratio; and the company's reliance on an autonomous array of components manufacturers, whose technology and production volumes must be available on a timely basis for Maxtor to sustain its pace of new platform introductions.
At 2.8 times EBITDA plus annual rental expense (EBITDAR), Maxtor's total debt, including the capitalization of annual rental payments due under the company's operating and equipment leases, appears to be manageable. EBIT plus rentals coverage of pro forma fixed charges, including the $5 million annual sinking fund payment, for the LTM ended September 26, 1998 was a modest 1.7 times. Free cash flow, after deducting pro forma 1999 capital expenditures of $120 million, would not have covered fixed charges, although free cash flow based on annualized FY1998Q3 EBITDA plus rentals does yield a narrow coverage of 1.3 times. The company's September 27, 1998 cash position of $162 million, augmented by IPO proceeds from the $15 million available at the end of FY1998Q2, could be enhanced from greater reliance on the company's $200 million accounts receivable securitization facility, considering the high quality of the company's receivables, as well as prospective cash proceeds realized from the sale of International Manufacturing Services (IMS), for which the company has a 16% ownership interest, to Celestica. Yet, it would be necessary for the company to identify additional funding sources if it is to realize future opportunities among OEMs and channel distributors. Maxtor's ability to raise money in the equities market could be impeded by the overhang of the HEA ownership, as HEA may be compelled to divest additional common equity shares to fulfill its own liquidity needs. Moreover, the negotiation of a bank credit facility could be problematic due to the recent trials endured by the disk drive commercial bank lending community with facilities extended to Western Digital (B2 senior implied), Komag, Read-Rite (B2 senior implied) and StorMedia, the latter having recently filed for protection under Chapter 11 bankruptcy. The company's capitalization is comprised of about $360 million debt (75%), including the $125 million outstanding under theexisting accounts receivable securitization facility and the capitalization of operating leases, and $120 million (25%) equity.
Four elements of Maxtor's turnaround strategy deserve amplification. First, the company elected to focus its limited resources on the industry's predominant 3-1/2 inch form factor and confine its marketing to the desktop segment. Second, the company directed its research and development on a core technology that emphasized magneto-resistive (MR) head technology and controllers based on digital signal processing (DSP) electronic architecture. Third, the product development process was restructured to exploit common design architectures by limiting changes on each new model and deliberately pacing the introduction of major design iterations to yearly intervals. An advanced technology group manages an enabling development phase that anticipates product requirements about 18-24 months ahead of customer introduction, supporting product design teams which adapt the fundamental design concepts to a cost effective process manufacturing strategy. Finally, risks have been mitigated by a management team that has closely coordinated engineering and production ramps with the marketing and sales effort among personal computer manufacturing OEMs.
Maxtor's success is derived from the quality of its product offerings, its ability to sustain its leadership in time-to-market and time-to-volume production, and the tightly managed cost structure that has contributed to its placing among the top two to three drive manufacturers in qualification of its products for major OEM design-ins. Mastering each capacity point transition enables the company to penetrate deeply into OEM purchase programs, affording greater clarity for planning and resource allocation, and protection of gross margins through the minimization of average selling price erosion. Maxtor's high proportion of sales revenues derived from OEMs, having increased to 78% in FY1998Q3, is buttressed by its sales to the retail market, which accounts for another 8% of FY1998Q3 revenues and benefits from higher margins due to the higher drive capacities associated with upgrades. The strong acceptance of its products by OEMs, particularly eight of the top ten personal computer manufacturers including Compaq, IBM and Dell, has enabled Maxtor to keep a tight rein on inventories in the distribution channel, limiting recent activity to three-four weeks supply. TechData was recently added to a select group of channel distributors which also includes Ingram Micro, SED International and Karma.
Maxtor Corporation, a leading manufacturer of hard disk drives for the personal computer market, has its principal executive offices in Milpitas, California.
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