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Rating Action:

Moody's affirms SUSE's B3 CFR following Rancher acquisition, outlook stable

16 Sep 2020

Frankfurt am Main, September 16, 2020 -- Moody's Investors Service, ("Moody's") has today affirmed the corporate family rating (CFR) of Marcel Lux IV S.a.r.l. (SUSE) at B3 and affirmed the probability of default rating (PDR) at B3-PD. Moody's has also affirmed the instrument ratings of the senior secured bank credit facilities at B2 of Marcel Bidco GmbH and Marcel BidCo LLC and assigned a B2 instrument rating to the new $300 million equivalent term loan, issued by Marcel Lux Debtco S.a.r.l. The outlook on all ratings is stable.

The proceeds of the new facility combined with cash on hand and equity of $197 million will be used to finance the acquisition of the open-source Kubernetes container management platform Rancher which has been announced in July 2020.

RATINGS RATIONALE

The rating action primarily reflects the high leverage of close to 8x following the acquisition of Rancher as well as the diluted margin profile of the combined entity, as the acquired business is in a phase of rapid growth and is expected to contribute to the group's EBITDA from 2022. In particular, the stable outlook reflects the expectation to reduce leverage back to levels for the B3 rating category in the next 12-18 months and the continued ability to generate positive free cash flows going forward. Driven by the high leverage and the strong growth necessary to achieve the deleveraging the rating is weakly positioned.

The B3 CFR additionally reflects (i) the company's position as distant number two player in a niche market and the resulting limited scale measured by revenue; (ii) the predominantly indirect nature of customer relationships due to the increasing reliance on indirect sales channels (e.g. cloud service providers, OEMs, hardware vendors) with some concentration in these intermediaries; and (iii) the effects of customer transitions to the cloud, such as shortening average contract duration and resulting less favourable cash flow dynamics, as well as potentially increasingly indirect relationships with end customers.

However, the B3 rating also reflects SUSE's track record of sustained good growth over the last years as part of Micro Focus and on a stand-alone basis since 2018 as well as the cash generative nature of the business supported by strong EBITDA margins and limited overall investment needs, despite sizable one-off cash costs related to the carve-out over 2019-20. In addition, it reflects (i) the company's position as one of two main paid Linux enterprise operating system (OS) providers with solid positions in certain customer segments (i.e. its SAP, IBM, HPE relationships), (ii) the strong growth dynamics in the core server OS market fueled by the increasing use of Linux as the preferred cloud server OS and the strong demand for Rancher Kubernetes solutions although the track record is so far limited, (iii) good revenue visibility resulting from a subscription-based, upfront-cash business model and high stickiness of the product and (iv) the company's geographically diversified revenue base with multiple distribution channels.

OUTLOOK

The stable outlook reflects our expectation that the leverage will not exceed 8x (Moody's adjusted) in the next 12-18 months, a level that is commensurate with a B3 rating. Additionally, it reflects the expected realization of synergies and sustainable cost reductions to cope with the initial margin deterioration and risks around the expected strong growth of the acquired business in a swiftly developing market environment with related substitution risk.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Positive pressure on the rating could result from SUSE's continued strong performance in its core market and return to visible reported EBITDA growth following the dilution from the Rancher acquisition such that Moody's adjusted debt/EBITDA declines sustainably below 6.5x while the free cash flow generation is maintained at or above 5% free cash flow/debt (Moody's adjusted).

Conversely, negative pressure on the rating could arise from free cash flow (after interest) turning negative or lack of EBITDA growth. Leverage increasing above 8x could in any case strain the rating as would a significant weakening of the company's liquidity profile. Any shareholder distributions as well as debt-funded acquisition will create negative pressure on the rating as well.

LIQUIDITY

We view SUSE's liquidity profile as adequate. Following the acquisition of Rancher we expect around $25 million of cash on balance sheet, which is complemented by the fully undrawn $81 million revolving credit facility (RCF) due 2025. We also expect the company to continue to generate free cash flow. The RCF is subject to a springing total net leverage covenant tested when the facility is drawn for more than 40%. The covenant is set at 8.09x (calculated as per the definition in the Syndicated Facility Agreement), and we expect the company to retain sufficient capacity.

STRUCTURAL CONSIDERATIONS

The rated first-lien debt, comprising the $360 million, €300 million equivalent senior secured term loan B, both due 2026, the new $300 million term loan B due in 2027, as well as the $81 million senior secured RCF due 2025, benefits from first-ranking security interests in shares, bank accounts and intercompany receivables, and a guarantor coverage of at least 80% of the company's consolidated EBITDA, tested annually. The debt ranks ahead of the unrated second-lien $270 million debt and is consequently rated B2, one notch above the company's B3 corporate family rating.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS

Moody's takes into account the impact of environmental, social and governance (ESG) factors when assessing companies' credit quality. SUSE's ratings factor in its private equity ownership and an aggressive financial policy, illustrated by its very high financial leverage with an additional meaningful debt quantum to finance the significant purchase price for Rancher.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Software Industry published in August 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1130740. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Dirk Goedde
Asst Vice President - Analyst
Corporate Finance Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Christian Hendker, CFA
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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