Assigns B2 ratings to senior secured first lien bank facilities
London, 01 June 2017 -- Moody's Investors Service has assigned a B2 corporate family rating (CFR)
and a B2-PD probability of default rating (PDR) to WP/AV CH Holdings
II B.V. (Avaloq), the top entity in Avaloq's
restricted group. The action follows the launch of the syndication
of CHF 410 million equivalent senior secured first lien facilities which
will be used to (1) fund the acquisition of a significant minority stake
in Avaloq by Warburg Pincus for a consideration of approximately CHF 306
million, (2) refinance Avaloq's CHF 175 million existing senior
bank debt (unrated) and, (3) provide cash on balance sheet at closing
and pay for transaction fees and expenses.
Today's new rating assignment balances the following factors:
-- Leading position in Swiss private banking niche,
with generally positive industry fundamentals
-- Large recurring revenues
-- Degree of business concentration
-- Known contract attrition and lack of volume in transaction
processing segment
-- Risk of rising leverage
-- Good free cash flow generation and liquidity
Concurrently, Moody's has assigned B2 ratings to the proposed new
CHF 350 million equivalent senior secured first lien term loan B due 2024
and pari passu ranking CHF 60 million equivalent revolving credit facility
(RCF) due 2023, which shall be borrowed by WP/AV CH Holdings III
B.V.. The outlook on all ratings is stable.
RATINGS RATIONALE
Avaloq's B2 CFR reflects its leading position in Swiss private banking
software and processing services, which is supported by positive
industry fundamentals. However, Avaloq's rating is
constrained by its geographic concentration in Switzerland, as well
as some lack of product and customer diversification. In spite
of a large recurring revenue base, some of the group's contracts
have been terminated and Avaloq will thus face revenue attrition in the
next two years following acquisition activity amongst customers and will
have to compensate for lost revenues and profits whilst ramping up the
profit contribution of its processing activities outside Switzerland.
As a result, Moody's adjusted debt/EBITDA is unlikely to decrease
from its opening level of 4.3x (5.4x before the capitalisation
of software development costs) in the next two years but Moody's
expects that the group will be free cash flow generative and will maintain
a good liquidity profile.
"Until 2019, Avaloq will have to replace lost revenues and
EBITDA arising from known contract attrition, which will limit its
ability to grow earnings from the CHF 82 million reported in 2016 and
will not result in any deleveraging from the opening level, in the
absence of any mandatory debt amortization" says Frederic Duranson,
a Moody's Analyst and lead analyst for Avaloq. "However,
we expect that the ramp up of its international processing activities
will help lift Avaloq's EBITDA and the group will maintain a good
cash flow generation and liquidity profile" Mr Duranson adds.
Avaloq's credit profile benefits from the leading position that
management claims in the Swiss private banking software and services industry,
ahead of finnova (unrated) and larger peers such as Temenos (unrated)
and SunGuard (part of Fidelity National Information Services, Inc.,
Baa3 stable). Furthermore, the group stands to benefit from
the positive fundamentals underpinning the banking software market,
which all support increased levels of outsourcing to third party vendors,
including (i) the regulatory burden (ii) "digitalization"
and (iii) cost efficiency requirements.
However, Avaloq's credit profile is held back by its relatively
low business diversification. The group generates approximately
75% of its revenues from Switzerland and more than 85% from
Europe. Avaloq also has a degree of customer concentration.
It serves over 150 entities but only 62 financial institutions and its
top 10 customers represented just under half of revenue in 2016 but this
number is 43% if adjusted for the very large customers which will
stop contributing to revenue in the next 24 months. Moody's
does not expect that customer concentration will decrease in the next
two years. Avaloq also exhibits a degree of product concentration
given its current focus on private banking solutions. Moody's
acknowledges that the product suite in this area is comprehensive and
exportable internationally and is complemented by processing capabilities,
however the group's penetration in retail banking remains limited.
As is typical of software vendors, Avaloq has a large recurring
revenue base (approximately 67% of the total), made up of
the recurring maintenance fees it earns on its software products as part
of its multi-year or perpetual contracts as well as the recurring
fees generated by multi-year transaction processing agreements.
Transaction processing fees are nevertheless exposed to downside risk
in case the volume of processed transactions reduces. Moody's
does not see any structural trend towards lower volumes in Avaloq's
markets. However, there remains potential for revenue volatility
given the customer concentration and the fact that licence and consulting/implementation
revenues can be lumpy as they largely depend upon the addition of new
customers or modules.
Avaloq has materially grown its revenue and EBITDA in the last five years,
mostly thanks to new customer acquisitions. Software and transaction
processing revenues have progressed by 10.7% and 15.8%
respectively between 2012 and 2016 on a CAGR basis whilst group EBITDA
grew by 9.2%. Software EBITDA has grown by double
digits in percentage terms over the period and its margin has reached
just under 50% in 2016, which is in line with banking software
industry leaders. However, the profitability of the transaction
processing segment has turned negative in 2015 owing to heavy investments
in setting up processing centres in Singapore and Germany, whilst
the Swiss part of the segment grew its profitability. Even taking
into account the one-off nature of the set-up costs,
the transaction processing segment remains unprofitable, which reflects
its lack of volume, particularly outside Switzerland.
In the next two years, Avaloq will face the challenge of replacing
terminated transaction processing contracts which contributed more than
CHF 110 million of revenues and CHF 75 million of EBITDA in 2016.
Contract attrition is generally related to shifts in technology strategy
on the part of new owners in the wake of M&A activity rather than
execution or product issues. It represents an inherent risk for
Avaloq, given its customer concentration and because Moody's
views the current low yield environment as conducive to consolidation
in the wealth and asset management industry. Moody's expects
that the group will continue to grow its revenue in both segments (before
the known contract attrition) but the rating agency forecasts that it
will take at least 24 months from closing for Avaloq to replace lost EBITDA
from terminated contracts.
Moody's estimates that Avaloq's leverage, measured by
Moody's adjusted gross debt to EBITDA, stood at approximately
4.3x at the end of 2016, pro-forma for the proposed
transaction. Owing to the run-off of certain contracts in
the period 2017-19, Moody's expects that adjusted leverage
will not decrease in the next 18 months, particularly in the absence
of mandatory debt repayments. As a result, the rating agency
anticipates that leverage would only reduce in the event of voluntary
debt repayments.
Moody's forecasts that Avaloq will record good free cash flow generation
going forward, which could support debt repayments. The group
typically consumes little working capital and capex (including the capitalisation
of software development costs) will reduce, albeit slowly,
following the peak in investment for the Singaporean and German processing
centres. The 2017 EBITDA contribution from contracts yet to run
off and a large one-off working capital inflow in 2018 will temporarily
result in high FCF/debt for the rating category of above 10% in
2017-2018 but Moody's expects that Avaloq's underlying
FCF/debt in these two years will reach approximately 5%.
Moody's views Avaloq's liquidity profile as good. It
will be supported by a large opening cash balance of over CHF 100 million,
compared to the size of the business and proposed transaction.
The group's liquidity will also be supported by a CHF 60 million
RCF which we expect will remain undrawn at closing and throughout the
year as well as positive free cash flow generation of at least CHF 30
million per annum. Senior bank facilities will have one springing
net leverage maintenance covenant, to be tested if the RCF is utilised
at 35% or more.
The senior secured first lien term loans and RCF are the only financial
debt instruments in the capital structure, hence they are rated
in line with the CFR.
RATIONALE FOR STABLE OUTLOOK
The stable outlook on Avaloq's ratings assumes (1) no material revenue
or customer loss beyond the known contract attrition as of the date of
syndication, (2) Reported EBITDA of at least CHF 70 million per
annum, translating into Moody's adjusted leverage well below
5.5x (6.5x before the capitalisation of software development
costs), (3) free cash flow to debt of at least 5% as well
as good liquidity, and (4) no debt-funded acquisitions or
further shareholder distributions. Furthermore, the stable
outlook assumes that the Arizon joint venture will go live without material
further investments required.
WHAT COULD CHANGE THE RATING UP/DOWN
Moody's could consider a positive rating action should Avaloq (1)
see its 2018-2019 EBITDA exceed the 2016 level, (2) sustainably
decrease Moody's adjusted gross debt to EBITDA to below 4.0x,
and (3) FCF to debt reached around 10% on a sustainable basis.
Any positive rating action would also incorporate a review of the market
dynamics in Switzerland.
Conversely, Avaloq's ratings could come under negative pressure
if the criteria for a stable outlook were not to be met, in particular
if FCF/debt declined towards 0% on a sustainable basis or Avaloq's
liquidity position deteriorated.
PRINCIPAL METHODOLOGY
The principal methodology used in these ratings was Software Industry
published in December 2015. Please see the Rating Methodologies
page on www.moodys.com for a copy of this methodology.
Headquartered in Switzerland, Avaloq is a banking software and services
provider, which serves approximately 150 private banking and asset
management clients, primarily in Switzerland, German-speaking
countries and Asia. The group has over 2,000 employees and,
for the fiscal year ended December 2016 ('fiscal 2016') reported
revenues and EBITDA of CHF 533 million and CHF 82 million respectively.
Avaloq is majority-owned by its founders and management whilst
funds ultimately controlled by financial investor Warburg Pincus are in
the process of acquiring a large minority stake in the group.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides certain regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt 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.
Regulatory disclosures contained in this press release apply to the credit
rating and, if applicable, the related rating outlook or rating
review.
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.
Frederic Duranson
Analyst
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Richard Etheridge
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
