Fitch: Avago's 'BB+' Rating and Stable Outlook Unaffected by Emulex Acquisition
Avago announced it will acquire Emulex for \$606 million, or \$609 million net of acquired cash and debt. Emulex is a leading supplier of fiber channel and related products and should complement Avago's enterprise storage offerings. Emulex will add \$250 million to \$300 million of annual revenues at higher operating margins exiting fiscal 2016.
Avago will fund the acquisition with available cash, which was \$2.6 billion at the quarter ended Jan. 31, 2015. The acquisition is expected to close in the second half of fiscal 2015 and is subject to customary closing conditions and approvals.
KEY RATINGS DRIVERS
The ratings and Outlook reflect Fitch's expectations for solid operating performance over the longer-term and strengthening credit protection measures from voluntary debt reduction with free cash flow (FCF). Despite expectations for continued cyclicality, accelerating LTE adoption should drive secular demand, including higher smartphone shipments, increasing complexity, growing internet bandwidth demands and greater storage requirements.
Fitch expects operating profit margin will modestly strengthen over through the intermediate-term from restructuring and benefit in the nearer-term from high capacity utilization. Fitch estimates operating profit margin was 28% for the LTM ended Feb. 1, 2015 and will remain in the mid- to high-20% range over the intermediate-term.
Fitch expects mid-cycle annual FCF will average more than \$500 million, driven by growing profitability although, healthy inventory levels through the supply chain, and lower cash restructuring and pension contributions. Nonetheless, capital spending could remain elevated over the intermediate-term to alleviate FBAR and laser capacity constraints even after the company recently completed a multi-year capacity expansion.
Fitch expects improving credit metrics after Avago borrowed to complete its \$6.6 billion acquisition of LSI in fiscal 2014. Fitch estimates total leverage (total debt to operating EBITDA) was 3 times (x) for the latest 12 months (LTM) ended Feb. 1, 2015 and will remain below 3x over the longer-term. Fitch estimates interest coverage (operating EBITDA to gross interest expense) was 11.2x for the LTM period and will remain above 10x over the longer-term.
Avago's use of FCF for voluntary debt reduction or higher profitability from the achievement of cost synergies resulting in total leverage approaching 2.5x could result in positive rating actions, as Fitch believes the company will have the FCF capacity for debt reduction. Negative rating actions could result from: i) market share erosion at a leading customer or in aggregate, indicating an loss of technological advantage or ii) the degradation of profitability and FCF, resulting in expectations for total leverage sustained near 4x.
The ratings are supported by Avago's : i) leadership positions in secular growth markets, ii) strong profitability with expectations for profit margin expansion from cost synergies, and iii) consistent and solid annual mid-cycle FCF, providing ample financial flexibility for debt reduction.
Rating concerns center on: i) improved but still substantial customer and end market concentration, with wireless communications and wired infrastructure representing roughly half of revenues and Avago's top 10 customers accounting for 57% of revenues., ii) potential integration challenges, given disparate research and development (R&D) investment profiles and iii) expectations for ongoing and potentially significant acquisition activity.
As of Feb. 1, 2015, Fitch believes liquidity is solid and consists of: i) \$2.6 billion of cash and cash equivalents and ii) a \$500 million undrawn senior secured RCF expiring 2019. Consistent annual FCF also supports liquidity. Cash location is not a concern for Avago, given the company's incorporation in Singapore.
Total debt is \$5.4 billion and consists of: i) \$4.6 billion senior secured term loan B maturing in 2021 and ii) \$1 billion of the privately placed convertible note due 2021. The term loan B amortizes at \$46 million (1%) annually until the bullet maturity in 2019.
Fitch currently rates Avago Technologies Finance Pte. Ltd. as follows:
--\$4.6 billion Senior Secured Term Loan B 'BBB-'; and
--\$500 million Senior Secured Revolving Credit Facility (RCF) 'BBB-'.