NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the ratings for TE Connectivity Ltd. (NYSE:TEL; TE Connectivity) and its wholly owned subsidiary, Tyco Electronics Group S.A. (TEGSA) following the company's announcement that it has agreed to acquire Creganna Medical group (Creganna) for a total value of $895 million (14.9x 2015 EBITDA). The Rating Outlook is Stable.
The ratings affect $3.7 billion of total existing funded debt, prior to consideration of incremental debt that the company plans to use to fund part of the acquisition. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The rating affirmation and Outlook reflect Fitch's view that the acquisition rationale is consistent with the company's strategy of increasing focus on harsh environment solutions, building on its medical device capabilities following the acquisition of AdvancedCath in 2015. Fitch estimates pro forma leverage (total debt/operating EBITDA) as of Dec. 25, 2015 of about 1.5x, which is consistent with Fitch's expectation that TE Connectivity will manage debt below 2.0x.
TE Connectivity's revenue diversification will improve slightly following the acquisition. Fitch estimates that the Industrial Solutions segment will increase from about 26% to 27% of total revenue and the automotive business will decrease to about 38% from 39%. Notwithstanding the high exposure to the automotive market, Fitch believes several secular demand drivers (new emissions standards, increased safety requirements, hybrid and electric cars) position the company to outperform automotive vehicle production growth over the medium to long term, despite the potential for cyclical downturns temporarily impacting revenue and margins.
The acquisition supports Fitch's expectation for mid-cycle net sales growth in the mid-single digits, based on Creganna's high single digit revenue growth. Fitch believes secular demand drivers for harsh environment electronic content and sensors and the prospect of integrated product offerings containing both connectors and sensors increases confidence that TE Connectivity can sustain this level of growth.
Creganna's 24% EBITDA margin should be accretive to TE Connectivity's margin of about 22% (Fitch adjusted). Fitch expects mid-cycle operating margins to continue to trend toward the upper teens based on continued restructuring initiatives and operating leverage. Operating margins in fiscal 2015 increased 80 basis points (bps) to 16.3%, due mainly to efficiency programs and an increasing mix of harsh environment revenue, which increased from 70% to 80% following the sale of Broadband Network Solutions (BNS) and a few harsh environment acquisitions in fiscal 2015.
Fitch believes TE Connectivity's comparatively large R&D budget and embedded relationships with global OEM leaders across a variety of industries enables the company to remain ahead of the technology curve. As the largest connector company in North America and Europe, and one of the largest in China, TE Connectivity has significantly more capital for research, development and engineering compared with the thousands of local and regional connector companies that comprise about 40% of industry revenue. Further, technology innovations by competitors may only be relevant for a select number of products, or a single generation of products, resulting in only a temporary and potentially immaterial loss of business.
While TE Connectivity is a clear leader in the connector industry and is gaining scale in sensors, Fitch notes some risk associated with the increased scope beyond connectors and sensors of recent acquisitions. Fitch anticipates TE Connectivity will operate Creganna largely as a standalone business, which should reduce risks around potentially expanded regulatory requirements and investment profiles.
Fitch believes the company's liquidity will remain solid after funding the transaction based on a pre-transaction cash balance of $2.2 billion as of Dec. 25, 2015, undrawn $1.5 billion revolver which fully supports the company's $1.25 billion commercial paper (CP) program and Fitch's expectation for annual free cash flow approaching $1 billion (within the context of mid-single digit revenue growth). Fitch believes TE Connectivity's countercyclical working capital needs also support cash generation of about $1 billion during a downturn supported by inventory and accounts receivable liquidation; in 2009, inventory and accounts receivable reductions contributed about $1.3 billion to cash from operations. Cash pension obligations are minimal over the next few years, and the company expects to settle its obligations related to its tax sharing agreement with Tyco International and Covidien for about $147 million-$163 million in fiscal 2016.
Fitch expects TE Connectivity's financial policies will remain largely unchanged. The company targets returning two thirds of free cash flow (FCF) to shareholders in the form of dividends and share buybacks. The company has publicly stated that it will complete its $3 billion of share buybacks from the BNS sale proceeds in fiscal 2016.
While the Creganna acquisition does not meaningfully change the company's leverage profile, future acquisitions that increase leverage above 2.0x on a non-temporary basis would likely result in a negative rating action. Fitch does not expect this would occur under the company's existing capital allocation policy.
The acquisition is expected to close in the third quarter of fiscal 2016 and will be funded with a combination of balance sheet cash and debt. Creganna reported sales of approximately $250 million in 2015 and is a portfolio company of Permira Funds. Fitch last affirmed TE Connectivity's ratings on Jan. 26, 2016, and also assigned an 'A-' rating to the company's $350 million 10-year unsecured notes at that time.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
--Low- to mid-single-digit organic revenue growth in fiscal 2016, mid-single digits thereafter;
--60 bps of operating margin expansion per 5% organic revenue growth; operating margin approaches 18%;
--One third of FCF spent on acquisitions beginning 2017;
--Aggregate dividend growth of 10% per year beginning fiscal 2017;
--Total share repurchases of $2.7 billion in fiscal 2016 (representing the remainder of the BNS sale proceeds following fiscal Q4 buybacks); beginning in 2017, remaining FCF after M&A and dividends used for repurchases;
--Capex of 5% of total revenue;
--One time cash outflow of $155 million in 2016 for settlement related to tax sharing agreement.
RATING SENSITIVITIES
Fitch believes further positive rating action is unlikely in the absence of a commitment to more conservative financial policies, including leverage closer to 1.0x, which Fitch does not expect serves TE Connectivity's flexibility. Fitch believes the company will want to maintain the financial flexibility to pursue consolidation opportunities in the fragmented sensor and industrial markets.
Conversely, negative rating actions could occur if Fitch expects:
--Operating profit margins will remain below the 10%-15% range beyond the short term, driven by TE Connectivity's inability to offset pricing pressures or commodity price volatility with new product introductions and productivity gains;
--Total leverage sustaining above 2.0x, potentially due to more aggressive shareholder returns or leveraged acquisitions; or
--Fitch's expectations for annual FCF sustaining below $750 million.
LIQUIDITY
Liquidity as of Dec. 25, 2015 was solid with a cash balance of $2.2 billion and an undrawn $1.5 billion senior unsecured revolving credit facility, which fully supports the company's $1.25 billion commercial paper (CP) program. Fitch's expectation for annual FCF approaching $1 billion also supports liquidity.
The ratings and Outlook accommodate cash for pension contributions and assume a one-time cash settlement payment of $155 million in 2016 related to the company's obligations under its tax sharing agreement with Tyco International and Covidien.
Total unadjusted funded debt as of Dec. 25, 2015, pro forma for the $350 million unsecured notes and repayment of the $500 million floating rate notes due Jan. 29, 2016, and prior to consideration of incremental debt that the company plans to use to fund part of the acquisition, was approximately $3.7 billion and primarily consisted of:
--$1,250 million CP program ($0 outstanding);
--$1,500 million unsecured senior revolving credit facility due Dec. 9, 2020 (undrawn);
--$708 million of 6.55% senior unsecured notes due Oct. 1, 2017;
--$325 million of 2.375% senior unsecured notes due Dec. 17, 2018;
--$250 million of 2.35% senior unsecured notes due Aug. 1, 2019;
--$250 million of 4.875% senior unsecured notes due Jan. 15, 2021;
--$500 million of 3.5% senior unsecured notes due Feb. 3, 2022;
--$600 million (EUR550 million) of 1.1% senior unsecured notes due March 1, 2023;
--$250 million of 3.45% senior unsecured notes due Aug. 1, 2024;
--$350 million of 3.7% senior unsecured notes due Feb. 5, 2026;
--$477 million of 7.125% senior unsecured notes due Oct. 1, 2037.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the ratings for TE Connectivity and TEGSA as follows:
TE Connectivity:
--Long-term Issuer Default Rating (IDR) at 'A-';
--Short-term IDR at 'F2'.
Tyco Electronics Group S.A.
--Long-term IDR at 'A-'
--Short-term IDR at 'F2';
--CP program at 'F2';
--Senior unsecured credit facility at 'A-';
--Senior unsecured notes at 'A-'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: Feb. 02, 2016.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=998907
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