Moody's Investors Service has assigned a Baa2 rating to SunGard Data Systems' new $600 million senior unsecured credit facility due 2009 and proposed sale of $500 million senior unsecured notes.
The rating outlook is stable, says Moody's, which issued the following statement:
"Proceeds from the note offering will be used to fund the pending acquisition of Systems & Computer Technology Corporation ("SCT"). On December 10, 2003, SunGard signed an agreement to acquire SCT for approximately $584 million in cash. SCT is a leading global provider of e-Education technology solutions for colleges and universities and will increase SunGard's presence in higher education. The acquisition is not expected to have a material impact on SunGard's financial results and is expected to close sometime in the first quarter of 2004.
"The Baa2 rating reflects SunGard's: 1) solid market position in the industries of business process outsourcing and disaster recovery, 2) recurring revenue base from processing fees and multi-year outsourcing contracts, which provide cash flow consistency as well as good visibility into the company's future revenue, 3) consistent cash flow to debt metrics, and 4) widely diversified customer base (no one customer accounted for more than 3% of SunGard's 2002 revenue).
"However, the rating also reflects: 5) integration challenges associated with SunGard's aggressive acquisition history and strategy, 6) a weakened IT purchasing environment within the U.S. financial services industry, 7) customer migration to internal solutions as a result of their own excess IT infrastructure, which has recently impacted SunGard's Availability Services (AS) business (39% of revenues and 32% of operating income in the quarter ended September 30, 2003), 8) revenue concentration in the financial services industry, and 9) the threat of competition to SunGard's Investment Support Solutions (ISS) business (54% of revenues and 17% of operating income in the quarter ended September 30, 2003) from large financial services institutions which provide IT services similar to those provided by SunGard.
"The stable rating outlook reflects Moody's expectation that SunGard's: a) cash flow growth will support business growth and fund the majority of SunGard's future acquisitions, b) ISS business will continue to provide an attractive value proposition against the competition, including large financial institutions and smaller software vendors, and c) AS business will continue to perform consistently in the current economic environment, given the increasing popularity of disaster recovery and business continuity.
"Evidence of substantial traction in all of SunGard's new and existing product and service offerings and maintenance of low leverage and high free cash flow (defined as cash flow from operations less capital expenditures less dividends) could result in upward rating pressure. However, the rating would come under pressure if SunGard's organic revenue growth were to remain depressed, profit margins were to weaken, if SunGard were unable to successfully integrate acquisitions, if acquisition growth were to continue to outpace free cash flow, or if accelerated consolidation in the financial services industry were to result in major client losses such that free cash flow were to materially weaken.
"In some cases, SunGard's customers have found themselves with excess data center capacity because of the economic downturn and have decided to take their high availability solutions systems in-house resulting in reduced demand for SunGard's AS services. The trend toward high-availability solutions, which provide greater control and faster response to processing interruptions than SunGard's traditional recovery solutions, will continue to pressure SunGard's AS operating profit margins. Recurring revenues from availability services, processing services, software support and rentals, professional services, broker/dealer fees and hardware rentals comprise roughly 90% of company revenues. Within ISS, Moody's believes that SunGard's broad product portfolio of integrated solutions for financial institution business process outsourcing will continue to provide a competitive advantage against the competition.
"In 2003 and 2002, SunGard's revenue growth came almost entirely from acquisitions. During 2003, the company completed nine acquisitions for an aggregate cash purchase price of roughly $425 million, net of cash acquired. Consequently, acquisition spend has exceeded free cash flow for the twelve months ended September 30, with acquisition costs 1.2 times greater than free cash flow. Moody's expects that SunGard's internally generated cash flow will continue to support company growth and fund the majority of its future acquisitions, though Moody's notes that internal revenue (revenue from businesses SunGard's owned for at least one year) in the quarter ended September 30, 2003 was flat. These acquisitions are extensions to SunGard's processing services, including brokerage. The acquisition of Andover Brokerage, LLC in March 2003 enabled SunGard to increase its brokerage ownership to four brokers, of which only two are clearing brokers. Moody's expects SunGard will continue to manage risk within its brokerage business by managing risk at the trading broker and institutional levels for processing and margin lending.
"SunGard's total revenue in the third quarter ended September 30, 2003 increased 13% to $742 million. Operating margin in the quarter was 21% versus 22% in the comparable prior year quarter and free cash flow was ample at approximately $118 million. SunGard's debt proforma for the current offering is modest at $713 million, as evidenced by proforma debt to last twelve months EBITDA of 0.79 times. Moody's expects SunGard to continue to operate with a modestly levered balance sheet and to fund the majority of future acquisitions from stock and internally generated cash flow.
"SunGard's sources of liquidity include available cash balances, predominantly U.S. domiciled, of $306 million at September 30, 2003 as well as a new $600 million revolver ($175 million drawn at the close of the transaction) expiring January 2009 which contains MAC language as a condition to borrowing. The credit facility contains financial covenants which require the company to maintain an EBITDA to interest coverage ratio of no less than 4 times, and total debt to EBITDA of no more than 2.5 times."