OREANDA-NEWS. More-->S&P Global Ratings today affirmed its 'BB-' long-term corporate credit rating on Netherlands-based security software company Avast Holding B. V. (Avast) and the group's financing subsidiary Avast Software B. V. The outlook is stable.

We affirmed the issue rating on the existing senior secured debt issued by Avast Software and expect to withdraw the ratings following the redemption at closing of the transaction.

We also assigned our 'BB-' issue rating on the proposed $1.685 million senior secured debt to be issued by Avast Software.

We removed all ratings from CreditWatch with negative implications, where they were placed on July 12, 2016.

The affirmation follows our review of Avast's business plan and financial policy after its announced acquisition of AVG Technologies for a total consideration of $1.3 billion. In our view, integration risks and the expected material increase in leverage to about 4.5x-5.0x at closing (as adjusted by S&P Global Ratings) are offset by the company's increased scale, significant cost synergy potential, and strong ability to deleverage quickly below 4x in 2018 thanks to is solid free operating cash flow (FOCF) generation and high EBITDA growth. We understand that Avast targets a significant headcount reduction in the combined workforce in the next two years. We also understand that the targeted net leverage is between 2.0x-2.5x, which corresponds to about 3x-4x S&P Global Ratings-adjusted leverage. In our view, key shareholders of Avast, including its founders, will pursue a moderately conservative financial policy.

Avast is planning to fund the acquisition through committed debt financing of $1.685 billion, which we understand will also include an undrawn revolving credit facility and the refinancing of the outstanding loan at Avast of about $260 million and about $85 million net debt at AVG.

Despite private equity firm CVC's more than 40% stake in Avast, we do not consider that it has control of the company. This primarily reflects our view that the company's other shareholders (including the founders), who own about 45% of the company, are not financial sponsors. We also note CVC's lack of push rights on the group's strategy or financial policy, as well as its lack of control over the board of directors.

We continue to assess Avast's business risk as weak. We think that there is a meaningful execution risk in integrating AVG, which is a larger company by revenues and number of employees. Furthermore, in our view the product diversification remains limited and SMB and enterprise revenues are only modest even after merging with AVG. The combined group's revenues and EBITDA continue to be reliant on the niche consumer security software segment, representing more than 60% of the combined revenues on a pro forma basis. In our view, consumer security software is much less "sticky" than the enterprise segment. In addition there is a relatively low free-to-premium-user conversion, although we think this provides prospects for improvement over the medium term. We also note that Avast operates in the highly fragmented security software market, where there is strong competition from much larger companies.

These risks are partly mitigated by the combined group's increased scale and global diversification. Avast is stronger in some emerging markets like Brazil, while AVG has a better position in some developed English speaking countries like the U. S. With about 265 million PC users, the combined group will be the world's largest provider of freemium consumer security software, and number 3 globally by revenue after Symantec and Intel. The group will be better positioned to monetize mobile customers thanks to AVG's carrier relationships and increased customer base to attract advertisers (together, 165 million mobile users). We also think that the combined group will continue to benefit from Avast's solid operating efficiency, supported by its online sales model and highly automated detection process, which translates into higher-than-average profitability.

Our base case assumes:

The acquisition of AVG will be completed by the end of 2016. Figures for 2016 are pro forma and include AVG for the full year. A continued shift in demand to smartphones and tablets away from PCs, leading to a decline in the PC user base. This is mitigated by the continued increase in conversion of free-to-premium PC users, resulting in an annual consumer PC antivirus subscription revenue growth of about 5%-7% in 2016-2018.Mobile revenues growing annually by about 20%-30% but still representing less than 20% of the total revenues in 2018.Declining platform revenues mainly due to the decrease in browser clean-up sales. Flattish SMB revenues on the back of fairly small size compared to large competitors. Some increase in underlying operating expenditure mainly because of investment in marketing to compete especially Chinese competitors. We expect Avast to quickly integrate AVG, including harmonizing of products, streamlining R&D and optimizing overhead functions, resulting in about $40 million cost synergies in 2017, increasing to at least $100 million in 2018.About $80 million integration costs, mainly in 2016 and 2017, included in EBITDA, and about $90 million transaction costs at closing, excluded from EBITDA. Annual capital expenditure (capex) to sales of about 4% and modest cash inflows from working capital thanks to the deferred revenue model. Based on these assumptions, we arrive at the following S&P Global Ratings-adjusted credit measures in 2016-2018:EBITDA margin percentage of 40%-45% in 2016, 45%-50% in 2017, and further increasing to 55%-60% in 2018 once the integration is mostly completed. FOCF to debt above 13% in 2017 and above 18% in 2018.EBITDA interest coverage of about 4x in 2017 and more than 5x in 2018.Gross debt to EBITDA of about 4.5x-5.0x on a pro forma basis at closing, 4.3x-4.7x in 2017, and about 3.3x-3.6x in 2018.

We assess Avast's liquidity position as strong. This is primarily supported by our forecast of meaningful FOCF generation and limited debt amortizations. As of March 31, 2016, we anticipate that Avast's sources of liquidity will cover its uses by more than 2x in the following 24 months. However, given that Avast is a private company, with no publicly traded debt or equity, we do not view its standing in credit markets as high. Therefore we do not assess Avast's liquidity as exceptional.

Avast's main liquidity sources are:Cash balances of $187 million as of March 31, 2016;Undrawn backup revolving credit facility of $40 million, to be increased to $85 million;Annual FFO of $150 million-$170 million pre-acquisition of AVG, and well above $200 million including AVG; andModest positive working capital inflows thanks to the deferred revenue model. Avast's main liquidity uses are:Net cash outflow of about $140 million-$150 million relating to the acquisition of AVG;Annual capex of about $30 million including AVG; andModest scheduled annual debt amortization of $80 million post-issuing the new debt to acquire AVG.

The stable outlook reflects our assumption that Avast will be successfully integrating AVG. In addition, we expect that continued solid growth prospects for software security solutions, coupled with improving margins post-closing due to meaningful cost synergies and free cash flow generation, will reduce the group's leverage comfortably below 4x in 2018.

We could lower the rating if Avast is not successful in integrating AVG reasonably quickly, resulting in revenues not growing in line with our base case or materially lower cost synergies, and leading to significantly lower margins than we expect. We could also lower the rating if we considered that Avast's financial policy would not support a reduction in adjusted leverage below 4x due to aggressive shareholder distributions or additional debt-financed acquisitions.

We could raise the rating if Avast successfully integrates AVG and diversifies its revenue portfolio meaningfully outside traditional consumer PC antivirus segment, while improving its adjusted EBITDA margin back to about 60%. A potential upgrade would assume gross leverage of less than 4x on a sustainable basis, and FOCF to debt of about 20%.