Frankfurt am Main, July 30, 2021 -- Moody's Investors Service, ("Moody's") has
today placed on review for downgrade the B3 corporate family rating (CFR)
and the B3-PD probability of default rating (PDR) of NorthPole
Newco S.a r.l. (NSO), the top entity of the
restricted group of Israeli-based cyber security and intelligence
software provider NSO Group. Concurrently, Moody's has placed
on review for downgrade the B3 instrument rating of the $300 million
senior secured term loan B1 (TLB1) and €177 million senior secured
term loan B2 (TLB2) facilities both maturing in March 2025 and the $30
million senior secured revolving credit facility (RCF) maturing in March
2024. The outlook on all ratings has changed to ratings under review
from negative.
RATINGS RATIONALE/FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF
THE RATINGS
The review for downgrade reflects the high uncertainty of NSO's
performance in the second half of 2021 amidst recent allegations regarding
reported misuse of its core product Pegasus and the related negative impact
on the company's ability to sell new licences which is critical
to restore operating performance and credit metrics more in line with
the requirements for the current rating category. Furthermore the
review reflects unchanged risks from the weak liquidity situation and
a possible breach of the maintenance covenant under its current loan documentation.
In case the company is not able to receive lenders consent to waive a
covenant breach this might ultimately lead to a default. We expect
only limited support from the private equity sponsor.
More general, NSO's B3 corporate family rating (CFR) reflects the
group's medium term performance potential, evidenced in the solid
performance in the past few years, characterised by EBITDA growth
and consistently high margins. NSO's free cash flow generation
was negative in 2020 driven by the lower revenues as well as a shareholder
distribution but we expect FCF potential around €45 million in a
usual business environment. The large addressable market in which
the group operates, the limited known competition and the material
barriers to entry also support NSO's credit quality.
NSO's credit profile is weakened by its high Moody's-adjusted leverage
of around 5.4x in 2020 which has further weakened during the course
of 2021, its product and customer concentration, and susceptibility
to cyberattacks as well as ongoing lawsuits. In addition,
the recurring revenue base is lower than that of its enterprise software
peers and remains dependent upon the conversion to and renewal of maintenance
contracts with a comparably low duration of 12 months, although
we acknowledge its high renewal rates of over 90%.
RATING OUTLOOK
The rating review will focus on (1) the company's operating performance
over the next quarter including the ability to sell new licences and maintain
high margins, (2) its ability to generate free cash flow and secure
liquidity, and (3) likelihood of shareholder support and potential
changes in the ownership structure.
Previously, Moody's has stated that for a positive rating action
NSO should demonstrate a prudent financial policy and absence of dividend
recapitalisations in the next 18 months and (1) continue to reduce its
customer concentration, (2) further increase the proportion and
improve the quality of recurring revenue streams with EBITDA margin levels
in the 40 percentages, (3) decrease Moody's adjusted gross debt
to EBITDA sustainably below 4.0x, (4) maintain FCF to debt
at least around 10% on a sustainable basis and (5) strengthen the
headroom under maintenance covenant.
Conversely, Moody's has previously stated that NSO's ratings
could come under negative pressure if Moody's adjusted gross debt to EBITDA
moves above 5.5x in the next 12-18 months, low single-digit
FCF/debt in the next 12-18 months and if business risk increased
or if the group's liquidity position deteriorated.
LIQUIDITY ANALYSIS
We view NSO's liquidity as weak based on the risk of a covenant breach
in 2021. As of June 2021, unrestricted cash was estimated
around $29 million. The company has a fully drawn $30
million RCF and has received additional funds from the sponsor in form
of a shareholder loan of $14 million which we expect to be converted
into equity.
The group has one net leverage based covenant, with tight headroom
as of June 2021. The sequential step downs to 4.00x by year-end
2021 will create further pressure. We therefore see a risk of a
covenant breach that might lead to a default.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
The coronavirus outbreak, the government measures put in place to
contain it, and the weak global economic outlook continue to disrupt
economies and credit markets across sectors and regions. Our analysis
has considered the effect on the performance of corporate assets from
the current weak economic activity and a gradual recovery for the coming
months. Although an economic recovery is underway, it is
tenuous and its continuation will be closely tied to containment of the
virus. As a result, the degree of uncertainty around our
forecasts is unusually high. We regard the coronavirus outbreak
as a social risk under our ESG framework, given the substantial
implications for public health and safety.
In addition, NSO is facing allegations over the inappropriate use
of its surveillance software which raises concerns over the company's
control mechanisms and sales approach.
Finally, Governance considerations include the track record of the
company being owned by a private equity company with a tolerance for high
leverage.
STRUCTURAL CONSIDERATION
The senior secured term loan and RCF are the only financial debt instruments
in the capital structure; hence, they are rated in line with
the CFR. The temporary shareholder loan of $14 million that
has been granted in Q2 2020 is treated as 100% debt and ranks pari
passu with the TLB and RCF in the absence of the documentation.
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.
COMPANY PROFILE
NorthPole Newco S.a r.l. is a provider of cybersecurity
and intelligence software solutions to government agencies. Its
offering is focused on mobile end point and location capabilities,
as well as tactical or field solutions and lawful interception for high-value
targets. NSO operates primarily out of Israel, Bulgaria and
Cyprus, with close to 750 employees who serve more than 60 customers
in over 35 countries. In 2020, NSO reported revenue of $243
million and Moody's-adjusted EBITDA of €99 million.
NSO is majority owned by funds ultimately controlled and managed by Novalpina
Capital.
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.
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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