Fitch Rates Avago Technologies' Cayman Finance Ltd.'s Incremental Term Loans 'BBB'
On Aug. 2, 2016, Avago Technologies entered into amendments under the credit agreement providing for a $2.995 billion Incremental Term Loan A expiring Feb. 1, 2021 and $6.6 billion New Term Loan B-3 expiring Feb. 1, 2023. Proceeds from the Incremental Term Loan A will be used to repay $2.521 billion of amounts outstanding under the Existing Dollar Term Loan B-1 and $474 million of amounts outstanding under the Existing Term Loan A. Proceeds from the New Term Loan B-3 also will refinance remaining amounts outstanding under the Existing Dollar Term Loan B-1.
Aside from also reducing annual interest expense by nearly $100 million, Avago Technologies also amended the agreement with lenders for the A-Loans and Revolving Credit Facility that will provide for the release of the collateral should the company be rated investment grade by at least two rating agencies and the company refinances the Term B Loans with unsecured debt. All other terms of the credit agreement remain substantially the same and the Incremental Term Loan A and New Term Loan B-3 will be guaranteed by the same guarantors and secured by substantially all of the assets of each guarantor.
KEY RATING DRIVERS
--Conservative financial policies: Fitch continues to expect Broadcom will use free cash flow (FCF) for voluntary debt reduction and, given Fitch's expectations for $2 billion to $4 billion of annual FCF through the intermediate term, the company should achieve its long-term total leverage (total debt to operating EBITDA) target of 1.5x-2x in fiscal 2016.
--Strong FCF profile: The acquisition meaningfully strengthens Broadcom's FCF profile, and Fitch expects $2 billion to $4 billion of annual FCF through the intermediate term. Solid profitability should strengthen from up to $750 million of run rate cost synergies 18 months following the acquisition's close and from the company's fab-light manufacturing model.
--Use of FCF: Fitch expects Broadcom will remain acquisitive but remain focused on deals that will enable the company to maintain its long-term total leverage target. Broadcom has committed to foregoing share repurchases beyond offsetting dilution until achieving target total leverage, although Fitch expects more aggressive shareholder returns thereafter. Fitch also expects deals will be smaller in size until the company completes the Broadcom integration.
--Greater diversification: Fitch expects increased revenue diversification will reduce longer-term operating volatility. Fitch expects Broadcom will continue to benefit from technology leadership in the Bulk Acoustic Airwave market for smart phones with its premium FBAR filter. However, increased sales from longer-cycle products, including broadband and set-top boxes will reduce volatility associated with handset model ramps, although Broadcom also continues diversifying wireless customers.
--Cost reduction roadmap: Fitch expects Broadcom will offset lower blended profit margins following the acquisition with significant anticipated cost reductions. Fitch expects operating EBITDA margins of 35% to 40% through a normalized semiconductor cycle, versus low - to mid-30s presently on a blended basis. Broadcom is targeting up to $750 million of annual cost savings on a run rate basis 18 months following the acquisition's close, resulting in cash restructuring of roughly $750 million over the course of the next two years.
--Integration risks: Fitch believes the integration of Broadcom will be a significant challenge, particularly given meaningful target cost synergies and R&D intensity divergence. Aside from typical cuts related to eliminating duplicate costs, the integration will focus on bringing historical Broadcom's greater research and development (R&D) intensity (more than 20% of revenues) closer to in-line with that of historical Avago (mid-teens).
Fitch's key assumptions within our rating case for the issuer include:
--Solid organic top line growth for historical Avago, driven by robust wireless communications demand, enterprise storage and wired infrastructure growth in the low - to mid-single digits and industrial and other growth in the low-single digits annually through the forecast.
--Fitch expects historical Broadcom's businesses will grow at a more mature rate, in the low-to mid-single digits.
--Fitch anticipates the company will achieve targeted acquisition related cost synergies, resulting in $750 million of annual cost savings which drive operating EBITDA margins closer to 40% through the horizon.
--Capex as a percentage of revenue declines from nearly 10% in fiscal 2015 to a blended rate averaging 5%, despite ongoing capacity additions in the company's filters manufacturing footprint.
--Share repurchases only offset dilution, dividends step up by $250 million in fiscal 2016 and grow 10% annually thereafter and FCF used for debt reduction as capital allocation is focused on achieving target total leverage (1.5x-2x).
Positive rating action could occur if:
--Broadcom replaces its secured debt with an unsecured capital structure more consistent with an investment grade rating and Fitch believes the company will manage debt levels to maintain total leverage below 2x; and
--Fitch expects Broadcom will sustain operating EBITDA margins in the high 30s to low 40s through a normalized semiconductor cycle, resulting in annual FCF structurally above $2.5 billion.
Negative rating actions could occur if:
--Fitch expects total leverage to remain above 3x from serial debt financed acquisitions or the initiation of more aggressive shareholder returns prior to anticipated debt reduction; or
--Material share losses resulting in negative revenue growth and lower operating EBITDA margin sustained below 30%, resulting in annual FCF insufficient to achieve targeted debt reduction.
Fitch believes Broadcom's liquidity was solid at May 1, 2016 and supported by:
--$2 billion of cash and cash equivalents; and
--An undrawn $500 million Senior Secured Revolving Credit Facility expiring Feb. 1, 2021.
Fitch's expectation for annual FCF for $2 billion to $4 billion in the intermediate term also supports liquidity.
Pro forma for the Incremental Term Loan A and New Term Loan B-3, as well as debt reduction during the recently ended quarter, total debt was $13.9 billion and consisted primarily of:
--$7.2 billion of Senior Secured Term Loan A due Feb. 1, 2021;
--$6.6 billion of Senior Secured Term Loan B-3 due Feb. 1, 2023; and
--$139 million of legacy Broadcom Senior Unsecured Notes with various maturities.
FULL LIST OF RATINGS
Avago Technologies Cayman Finance Limited:
--Senior Secured Revolving Credit Facility (RCF) 'BBB';
--Senior Secured Term Loan A 'BBB';
--Senior Secured Term Loan B-1 'BBB';
--Senior Secured Term Loan B-3 'BBB'.
The Rating Outlook is Stable.