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Rating Action:

Moody's assigns B2 ratings to Avaloq; outlook stable

01 Jun 2017

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

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