CHICAGO--(BUSINESS WIRE)--Fitch Ratings, Chicago, 18 March 2016: Fitch Ratings has assigned a 'BBB-' rating to Avnet, Inc.'s (Avnet) offering of $300 million five-year senior unsecured notes. The Rating Outlook is Stable.
Proceeds from the offering are expected to be used to refinance $215 million of debt assumed from the Premier Farnell acquisition and the remainder to be used to repay borrowings under the revolver, term loan or accounts receivable securitization program. The new notes will rank pari passu with other senior unsecured indebtedness of Avnet, and will contain an obligation to repurchase the notes at 101% upon change of control, consistent with the existing notes. The notes are subject to an interest rate step-up provision requiring adjustments to the coupon rate if the notes are downgraded below investment grade and will be subject to further adjustment upon subsequent negative rating actions. The coupon adjustments are defined by schedule within the indenture. This step up provision is not included in Avnet's legacy senior unsecured notes.
KEY RATING DRIVERS
--Fitch expects proceeds from the pending sale of Avnet's Technology Solutions (TS) business to Tech Data Corporation will be used to reduce debt and lower leverage below Fitch's 3.0x gross leverage (unadjusted debt to EBITDA) in the near term. A deviation from Fitch's expectation for the company to reduce leverage below 3.0x would likely result in a downgrade. Following debt reduction, Fitch expects Avnet's capital allocation priorities will focus on M&A and shareholder returns.
--Fitch believes the divestiture of the TS business is a positive given the business' negative revenue growth, lower margins and few synergies with the Electronics Marketing (EM) segment, but is offset by the remaining business having less scale and diversification and more cyclicality of demand. The TS business has had negative revenue growth four of the last five years as technology consumers reduce on premise spending and shift to hyper-converged infrastructure and cloud environments. Fitch estimates the remaining company will have approximately 80% exposure to the broader semiconductor market and will be susceptible to the cyclicality of the industry.
--Avnet's strong market position in the EM segment. Avnet's scale and breadth continues to increase its importance and value in the global supply chain.
--Fitch's expectations for $150 million to $300 million of annual free cash flow (FCF) through the forecast. In a downturn, cash from the liquidation of inventory should offset lower operating EBITDA to support FCF. Fitch's expects Avnet will use FCF for organic growth, small bolt-on acquisitions, and shareholder returns. The ratings incorporate Fitch's expectations that Avnet would moderate share repurchases in the face of pressured FCF.
--Fitch expects Avnet's conservative approach to managing its balance sheet and capital allocation will continue following the close of the transactions and anticipates the company's total adjusted leverage (total debt adjusted for rent expense to total operating EBITDAR) will remain below 3.5x, versus a Fitch estimated 3.2x for the latest 12 months ended Oct. 1, 2016.
--The ratings reflect the key operating characteristics of the distributor model, namely relatively low profit margins and high capital intensity as a percentage of EBITDA, as well as the inherent cyclicality and significant swings in working capital investment. Fitch expects Avnet's EBITDA margins will range from 4% to 5% over the intermediate term versus 4.1% for the latest 12 months (LTM) ending Oct. 1, 2016. In a downturn, Fitch expects operating EBITDA margin could approach 3.5%, as was the case in 2009.
--Fitch believes the company's inorganic growth strategy is also a potential source of event risk for bondholders, since larger acquisitions would also carry integration risk that is amplified/intensified by low profit margins. Fitch expects larger acquisitions likely would be debt-financed, resulting in higher than expected leverage. Such a scenario could pressure ratings if Fitch did not expect Avnet to return leverage to historical levels in the short-run.
--Fitch expects mid-cycle revenue growth in the low-single digits over the intermediate term, driven by increased demand for electronics content.
--Avnet's quarterly dividend plan implemented in 2013 does not impact the ratings but does reduce financial flexibility. This could pressure the investment grade rating in a stressed environment, particularly if share repurchase activity exceeds FCF generation before changes in working capital.
Fitch's key assumptions within the rating case for Avnet include:
--Fitch expects organic revenue growth in the low single-digits;
--EBITDA margin expansion from the divestiture of the lower margin TS business and synergies;
--Fitch expects $80 million of synergies from the TS divestiture;
--Small- to medium-sized acquisitions over the rating horizon to build out the digital platform;
--Fitch expects $1 billion to $1.5 billion of debt repayment over the near-term after the divestiture is completed.
--Quarterly dividend payments and excess cash flow used to repurchase stock.
Negative: Fitch's expectation for adjusted leverage (adjusted debt to EBITDAR) to be sustained above 3.5x or gross leverage (unadjusted debt to EBITDA) to be sustained above 3.0x, most likely due to domestic cash limitations or debt financed acquisitions, or the expectation for mid-cycle FCF to adjusted debt below 5%.
Positive: Upside movement in the ratings is limited given Avnet's thin operating margin profile with significant cyclical demand exposure. Sustained improvement in credit metrics paired with a long-term strategic business rationale and demonstrated commitment from management to maintain a higher rating would be necessary.
Avnet's liquidity is solid and supported by cash of approximately $1.2 billion ($1.15 billion offshore) as of Oct. 1, 2016 and $400 million available under the company's $1.25 billion senior unsecured revolving credit facility, expiring July 2019. Additionally, Fitch expects mid-cycle FCF of $150 million to $300 million through the forecast.
FULL LIST OF RATING ACTIONS
Fitch currently rates Avnet, Inc. as follows:
--Long-Term Issuer Default Rating (IDR) at 'BBB-';
--Senior unsecured debt at 'BBB-'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: Sept. 21, 2016
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--No material adjustments have been made that have not been disclosed in public filings of this issuer.
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage - Effective from 17 August 2015 to 27 September 2016 (pub. 17 Aug 2015)
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