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Rating Action:

Moody's changes outlook on Micro Focus' ratings to negative; affirms ratings

22 Mar 2018

London, 22 March 2018 -- Moody's Investors Service has today changed the outlook to negative from stable on Micro Focus International plc's ratings. Concurrently, Moody's affirmed the B1 corporate family rating (CFR), B1-PD probability of default rating (PDR) and B1 instrument ratings for the US$ 5 billion senior secured term loans and US$ 500 million senior secured revolving credit facility.

RATINGS RATIONALE

The outlook change to negative reflects the increased execution risks and heightened uncertainty regarding revenue and EBITDA development for 2018 and beyond, following Micro Focus' announcement of greater than expected challenges in integrating the HPE Software business. The attrition in the sales personnel and resulting pressure on revenue may also take some time to address. As a result of the changed company guidance for year to October 2018, challenges on the sales side and greater uncertainty regarding the achievability of the original target of US$600 million of identified annual cost savings over the three years following closing of the acquisition in September 2017, Moody's now sees more risk that deleveraging below 3.5x on a Moody's-adjusted basis is not achieved in 2019. For the year to October 2018, Moody's now expects leverage to remain above 3.5x.

In addition, while Micro Focus appears likely to remain free cash flow positive after interest, dividends and restructuring costs, Moody's believes there is also some risk that free cash flow, as defined by Moody's, could fall below US$300 million p.a. for 2018.

On 19 March 2018, Micro Focus announced that the rate of year-on-year revenue decline has been greater than anticipated and hence it revised the constant currency revenue guidance for the twelve months ending 31 October 2018 to minus 6% to minus 9% compared to its previous guidance of minus 2% to minus 4% provided at the interim results on 8 January 2018. Achieving the revised revenue guidance already implies progress on reversing the minus 9 to minus 12% of revenue decline expected by the company for the interim period to April 2018.

The company also said that the overall cost saving target until 2020 is under review and that the timing of the second phase, originally planned for November 2018 (the transition of the legacy Micro Focus business onto the new IT platform), is under review. The company cited IT issues and challenges on the sales side, such as higher attrition, sales execution and disruption at certain global accounts at the former HPE Software. The company also mentioned efforts to invest and strengthening its sales teams after the higher attrition, but this may take time as new staff is hired and trained. While these issues mostly affected license revenues and the North America business, revenues were also below expectations for maintenance revenues and in other regions, according to the company. Moody's continues to believe that during the integration phase in 2018, revenue performance will remain more volatile, but also that progress on profitability improvements should offset the impact from revenue decline. However, there is now considerably greater uncertainty around those expectations and a stabilization of revenue performance is required for rating maintenance.

The CFR and instrument ratings, affirmed at B1, already incorporated to a degree the meaningful challenges to integrate the HPE Software acquisition, particularly until closing of its first joint year in October 2018, and the related execution and uncertainty around identified cost savings.

The CFR also continues to reflect the (i) the ongoing challenge to generate stable or improving revenue in the context of the company's product portfolio of mainly mature software applications, absent acquisitions, and (ii) consequently the need to generate sufficient cash flows that can be applied to debt reduction to cope with declining parts of its application portfolio. Moody's also notes the company's acquisitive track record, although acquisitions now appear less likely given the challenges in the existing business.

However the B1 CFR also reflects Micro Focus' position as the second largest European enterprise software company with a broad range of customers and products, global foot print and good recurring revenue base. It also reflects (i) the company's past track record (ie Attachmate) in integrating large and transforming acquisitions, and (ii) Moody's current expectation that, notwithstanding the current issues and now greater uncertainty, the company is in a position to deliver some EBITDA and margin growth in 2018 and 2019 from applying its profitability focused approach, particularly regarding R&D and marketing spending, to the acquired operations and combined company.

Liquidity Profile

Moody's views Micro Focus' liquidity profile as sufficient for its needs. As of October 2017, the company had $472 million of cash on the balance sheet, adjusted for certain payments required between HPE and Micro Focus (gross $730 million cash). In addition, the company had access to the $500 million undrawn committed revolving credit facility (RCF) due 2022. Moody's would also expect the company to remain visibly free cash flow positive despite sizeable restructuring costs and dividend payments. Aside from ca. $50 million of annual debt amortisation the next larger debt maturity will be the $1.5 billion of term loans due 2021. There is also one net leverage financial maintenance covenant, that is tested if the RCF is more than 35% drawn, under which Moody's expects the company to retain sufficient headroom.

What Could Change the Rating Up/Down

The outlook could be stabilized in case of continued progress in integrating the HPE Software acquisition, evidenced by stabilising revenue, visibly growing EBITDA and free cash flow, so that Moody's-adjusted debt/EBITDA moves sustainably to 3.0x. An active application of cash flows towards debt repayment would also result in positive pressure assuming the integration and operating challenges have been resolved. Conversely, the ratings could be downgraded if integration and operating challenges persist and the substantial revenue decline continues. In any case, a prolonged decline in revenue, EBITDA or cash flow, particularly if there has not been a material reduction in debt and leverage, so that Moody's-adjusted debt/EBITDA remains above 3.5x, could result in a downgrade. Inability to generate free cash flows (as Moody's-adjusted, after interest, dividends and investments) of around $300 million p.a. from fiscal year 2018 (October 2018) onwards or a material deterioration in the company's liquidity profile could also put negative pressure on the rating. Any larger or debt-funded acquisitions during the HPE Software integration and stabilisation could also negatively weigh on the rating.

Affirmations:

..Issuer: MA FinanceCo., LLC

....Senior Secured Bank Credit Facilities, Affirmed B1

..Issuer: Micro Focus International plc

.... Probability of Default Rating, Affirmed B1-PD

.... Corporate Family Rating, Affirmed B1

..Issuer: Seattle Spinco, Inc.

....Senior Secured Bank Credit Facility, Affirmed B1

Outlook Actions:

..Issuer: MA FinanceCo., LLC

....Outlook, Changed To Negative From Stable

..Issuer: Micro Focus International plc

....Outlook, Changed To Negative From Stable

..Issuer: Seattle Spinco, Inc.

....Outlook, Changed To Negative From Stable

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.

UK-based Micro Focus International plc is an enterprise software company with $4.2 billion of annual revenue for the twelve months to October 2017. It is listed both on the London Stock Exchange and the New York Stock Exchange.

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.

Tobias Wagner
Vice President - Senior 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

Peter Firth
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

No Related Data.
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