Open Text Holdings Inc. — Moody’s places Open Text’s ratings on review for downgrade
Rating Action: Moody’s places Open Text’s ratings on review for downgradeGlobal Credit Research – 29 Aug 2022New York, August 29, 2022 — Moody’s Investors Service (“Moody’s”) placed Open Text Corp.’s (“Open Text”) credit ratings, including its Ba1 Corporate Family Rating (CFR) and the Baa2 and Ba2 ratings for its senior secured credit facilities and senior unsecured notes, respectively, on review for downgrade following Open Text’s announcement that it plans to acquire Micro Focus International plc (“Micro Focus”) in an all-cash transaction for an enterprise value of approximately $6.0 billion. The SGL-1 speculative grade liquidity rating is unchanged.On Review for Downgrade:..Issuer: Open Text Corp…..Corporate Family Rating, Placed on Review for Downgrade, currently Ba1….Probability of Default Rating, Placed on Review for Downgrade, currently Ba1-PD….Senior Secured Bank Credit Facility, Placed on Review for Downgrade, currently Baa2 (LGD2)….Senior Unsecured Regular Bond/Debenture, Placed on Review for Downgrade, currently Ba2 (LGD4)..Issuer: Open Text Holdings Inc…..Senior Unsecured Regular Bond/Debenture, Placed on Review for Downgrade, currently Ba2 (LGD4)Outlook Actions:..Issuer: Open Text Corp…..Outlook, Changed To Rating Under Review From Stable..Issuer: Open Text Holdings Inc…..Outlook, Changed To Rating Under Review From StableRATINGS RATIONALE / FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSMoody’s placed the credit ratings on review to reflect Open Text’s elevated execution risk and its weaker financial profile as a result of the substantial increase in debt to be incurred in connection with the pending acquisition of Micro Focus. Open Text’s high financial risk tolerance is a key driver of the rating action. While acquisitions are integral to Open Text’s growth strategy, Moody’s had expected that Open Text would pursue a balanced financing strategy for its larger acquisitions. This was supported by the company’s use of its common stock in financing the acquisitions of EMC’s Content Division assets and GXS, two of its then-largest acquisitions. The company’s intention to substantially increase debt reflects a shift relative to Moody’s expectations for a balanced acquisition financing strategy. This, along with the operational risks in integrating a large and declining business will result in an elevated risk profile in the 12 to 24 months following the acquisition. If Moody’s determines that the acquisition is highly likely to close based on the proposed terms and assuming no change in Moody’s expectation for financial performance, a downgrade of the CFR to Ba2 is likely.The acquisition of Micro Focus will be Open Text’s largest acquisition to date. Open Text intends to finance the acquisition with $4.6 billion in new debt, $600 million of borrowings under its existing revolving credit facility, and $1.3 billion of cash on hand. As a result, Open Text’s outstanding debt will increase from $4.2 billion to about $9.3 billion after the acquisition. The acquisition is expected to close in the first quarter of 2023. The company expects to increase Micro Focus’ adjusted EBTIDA margins to its target model range of 37% to 39% within six quarters and reduce net leverage (as reported by the company) to 3x within eight quarters of closing the acquisition.Moody’s estimates that pro forma for the acquisition, Open Text’s total debt to EBTIDA (Moody’s adjusted) will increase to mid 4x, from 3.6x at fiscal year ended June 2022, before the $400 million of total cost savings are included in EBITDA. Cash and marketable securities, relative to total adjust debt, will decline from 37% to 10%. Based on Moody’s assumption that Open Text will build-up its cash balances to $1.7 billion its average year-end levels over the past three years Open Text’s Moody’s adjusted total debt to EBITDA will remain above mid 3x at least through fiscal year ending June 2024.The execution risk will be elevated in combining two large companies while implementing $400 million of cost reductions. The total cost reduction amounts include Micro Focus’ $300 million of previously announced cost savings as a stand-alone company. Both companies generate a large share of their revenues from declining and mature products and the challenges are compounded by the highly competitive software segments they operate in that are increasingly adopting cloud software solutions. Organic growth at both companies has significantly lagged the growth of the enterprise software industry. While we expect stand-alone Open Text’s organic growth of about 2% over the next 12 to 24 months driven by growth in its cloud portfolio, Micro Focus’ revenues declined by 7% on a constant currency and continuing operations basis in its fiscal first half ended April 2022, and Moody’s expects revenue declines to persist over the next 2 to 3 years. Micro Focus’ revenues and profitability have underperformed Moody’s expectations since the company acquired HP Enterprises’ software businesses in 2017.Open Text’s credit profile will benefit from its substantial scale and prospective free cash flow levels after the acquisition. The company has a good track record of integrating numerous acquisitions, and improving profitability and deleveraging after larger acquisitions. It has good product and geographic revenue diversity, and approximately 75% of the revenue for the combined companies will come from recurring software maintenance and subscription services. Even before considering the targeted cost savings, Open Text will have strong profitability. The high revenue to free cash flow conversion rates in the software business further supports Open Text’s credit profile and provides capacity to reduce debt. However, Open Text’s low organic growth prospects and reliance on debt-financed acquisitions to drive cash flow growth, limits potential upside to credit metrics, despite its strong free cash flow.Open Text’s existing SGL-1 speculative grade liquidity rating reflects its very good liquidity, though the anticipated use of cash and revolver drawings to finance the acquisition will pressure liquidity which could result in a lower SGL rating upon closing of the transaction. Open Text had $1.7 billion of cash balances and access to an undrawn $750 million revolving credit facility. Excluding the effect of the acquisition, Moody’s expects $750 million in free cash flow (after dividends) in FY ’23.The Baa2 ratings for Open Text’s senior secured credit facilities benefits from a meaningful share of senior unsecured debt in the existing capital structure. The ratings for senior secured credit facilities and the Ba2 rating for the senior unsecured notes will be subject to downward rating pressure from a downgrade of the CFR as well as any increase in the proportion of the first-lien debt in the final capital structure.Moody’s ratings review will focus on: (i) the mix of debt in the final capital structure; (ii) Moody’s assessment of Open Text’s financial strategy, including specific plans to reduce debt and restore cash position after the acquisition, and, (iii) its acquisitions strategy, while financial leverage will be elevated.Open Text is a leading provider of Information Management software and services.The principal methodology used in these ratings was Software published in June 2022 and available at https://ratings.moodys.com/api/rmc-documents/389867. 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Further information on the EU endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the UK and is endorsed by Moody’s Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and to the Moody’s legal entity that has issued the rating.Please see the issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each credit rating. Raj Joshi Senior Vice President Corporate Finance Group Moody’s Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. 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