OREANDA-NEWS. Fitch Ratings has affirmed IHS Inc.'s (IHS) 'BBB' long-term Issuer Default Rating (IDR) following the March 21, 2016 announcement that it is merging with Markit Ltd. (Markit) in an all-stock deal. The combined company will be named IHS Markit and be headquartered in London with key operations remaining in Englewood, CO.

Fitch views the merger with Markit positively. Markit provides IHS with access to a new vertical in the financial services space. The merger reduces IHS's existing exposure to the resources space, which is being negatively affected by current low oil prices, from 40% of consolidated revenues to 27% pro forma for the merger. This reduced exposure was further helped by IHS's Feb. 11, 2016 acquisition of Oil Prices Information Services, which introduced IHS into a segment that is less affected by low oil prices. It provides a CEO succession plan, with Markit's current CEO set to become IHS Markit's CEO at the end of 2017. And finally, the merger represents a delevering event for IHS given its structure as an all-stock deal: following the merger, IHS's total leverage declines from 3.7x to 3.0x, in line with its existing total leverage target of 2.0x-3.0x and Fitch's expectations for the current rating. IHS Markit has stated it will maintain this target leverage.

On March 21, 2016, IHS announced an all-stock merger of equals with Markit. The transaction values Markit at $6.2 billion including assumed debt, which represents a 12.2x multiple of Markit's fiscal year end (FYE) Dec. 31, 2015 EBITDA of $495 million. IHS existing shareholders will own approximately 57% of the new company while Markit existing shareholders will own approximately 43%.

Markit provides pricing indexes, processing services, risk management tools, and other financial data products to financial institutions worldwide. Its primary focus is to help its customers manage risk, increase transparency and improve efficiency. The company services more than 3,500 institutional customers including banks, hedge funds, asset managers, regulators, exchanges, clearing houses and others from 19 locations. For its FYE Dec. 31, 2015, Markit generated $1.1 billion of revenues and $495 million of EBITDA.

On a combined basis for the last 12 months (LTM) ended Dec. 31, 2015, Fitch estimates that IHS and Markit generated approximately $3.3 billion in revenue, $1.2 billion in EBITDA, and $756 million in free cash flow (FCF). Following the merger, IHS Markit will provide products and services to more than 50,000 customers, including 75% of the Fortune Global 500, 35 of the 50 largest U.S. banks and 46 of the 50 largest global asset managers.

Management has identified synergies across the merged entity. They are expecting to realize $100 million of revenue synergies driven by cross-selling opportunities and new product development. They have also uncovered $125 million of potential expense synergies driven primarily by eliminating Markit's public company costs, optimizing real estate, and integrating corporate functions. Fitch believes the company will realize most of the synergies, especially the expense reductions given their nature and relative size. Regardless, synergies were excluded from IHS Markit's total leverage calculations.

KEY RATING DRIVERS

Operating Profile Strength: The ratings reflect IHS's strong business profile, long-standing client relationships and core competencies, which leverage deep industry expertise and integrated service delivery platforms to provide data, analytics and research. IHS focuses on six global, capital-intensive industries with highly connected supply chains: Energy & Natural Resources, Chemicals, Technology, Automotive, Aerospace & Defense, and Maritime. The merger with Markit will add a new vertical in the financial services space.

High Barriers to Entry: Fitch believes IHS's business model creates high barriers to entry associated with its core businesses and that the capital needed and operational disruption to customers caused would make it challenging for competition to replace IHS. This is also true for Markit, which has established itself as a market leader in the provision of financial data to some of the world's largest financial institutions. The merged company will continue to focus on various workflows within the industries it serves, making its data, analytics and researches an important component of customers' workflows and input for decisionmaking.

Recurring Revenue Stream: Recurring, subscription-based revenues accounted for 81% of IHS's consolidated 2015 revenues and provide significant visibility, stability and predictability to the company's FCF generation. Following the merger, subscriptions will increase to 85% of the combined company's revenues. The subscription-based business model capitalizes on long-standing client relationships with nominal account churn.

Capital Allocation Strategy: IHS's capital allocation strategy has focused on investments in its core business and strategic acquisitions while maintaining a strong balance sheet. IHS Markit is expected to maintain this focus, as evidenced by the establishment of a target leverage of 2.0x-3.0x, which mirrors IHS's existing target leverage. IHS Markit stated they will execute $1 billion of share buybacks in each of 2017 and 2018. Fitch expects FCF to fund the majority of these buybacks, with the company issuing additional debt under debt capacity created through EBITDA growth for a portion to the extent that leverage remains below Fitch's 3.0x total leverage threshold for the 'BBB' rating.

FCF Generation: IHS's significant FCF generation affords the company meaningful financial flexibility and deleveraging capacity. Through the LTM period ended Feb. 29, 2016, FCF was $468 million. Fitch expects EBITDA-to-FCF conversion to remain strong at around 65% over the ratings horizon, driven by the low capital intensity of the business.

KEY ASSUMPTIONS

--Low-single-digit revenue growth with moderate annual margin expansion;
--Share buybacks of $1 billion in 2017 and 2018;
--Fitch expects buybacks to be subdued, with larger acquisitions in order to de-lever;
--FCF in excess of $800 million during the rating horizon.

RATING SENSITIVITIES
Positive Rating Action: Positive rating actions would likely coincide with:
--IHS, or IHS Markit after the merger, publically adopting a more conservative financial policy highlighted by an unadjusted gross leverage target of 2.5x or lower (under Fitch's calculation);
--Positive operating momentum coupled with growing diversity of its client base; and/or maintenance of FCF/gross debt above 15%.

Negative Rating Triggers:
--Material acquisitions that increase leverage over 4x without the expectation of deleveraging below 3x within 18 months would pressure the ratings.
--Shareholder-friendly actions that drive leverage over 3.5x and/or a weakening of IHS's operating profile, or that of IHS Markit after the merger, as signalled by a persistent decline in the company's FCF/gross debt metric approaching 10%, deteriorating operating margins and revenue growth erosion also might trigger a downgrade.

LIQUIDITY

IHS's financial flexibility and liquidity position are solid considering its ability to generate consistent levels of FCF. During the LTM period ended February 2015, the company generated approximately $468 million of FCF. The company's liquidity position is further supported by $60 million of cash as of Feb. 29, 2016, and available borrowing capacity under the company's $1.3 billion revolver. Commitments under the revolver are set to expire during October 2019.

IHS's maturity schedule is manageable and Fitch believes that the company has sufficient financial flexibility through expected FCF generation, available borrowing capacity from the revolver, and capital market access to address near-term maturities. Near-term scheduled maturities are minimal and consist primarily of scheduled amortization from the company's term loans.

FULL LIST OF RATING ACTIONS

Fitch affirms the following:

IHS, Inc.
--IDR at 'BBB';
--Senior unsecured notes at 'BBB'.

The Rating Outlook is Stable.