CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BB' final Long-Term Issuer Default Rating (IDR) and senior secured rating to Russell Investments US Institutional Holdco, Inc. and Russell Investments US Retail Holdco, Inc. Fitch has also assigned a 'BB' final long-term IDR to Emerald Acquisition Limited, the holding company for the combined organization (collectively referred to as Russell Investments). The Rating Outlook is Stable.
The ratings have been assigned following the separation of Russell Investments from the London Stock Exchange Group (LSEG) and the execution of the secured funding facilities, which were completed in a manner consistent with Fitch's expectations.
A full list of rating actions follows at the end of this press release.
KEY RATING DRIVERS - IDRS and SENIOR SECURED DEBT
The final ratings reflect the company's strong franchise, asset under management (AUM) diversification across geographies and product sets, scalable business model and demonstrated track record of delivering strong fund performance relative to benchmarks. Additional strengths include the company's experienced management team and a well-articulated and reasonably achievable long-term operating strategy including maximum leverage and minimum liquidity targets.
Primary rating constraints include higher initial leverage as measured by Fitch-calculated Debt/EBITDA, lower initial interest coverage as measured by Fitch-calculated EBITDA/interest expenses, lower margins as measured by Fitch-calculated gross EBITDA margins and the company's fully-secured wholesale funding profile. Other rating constraints include the sensitivity of the investment management business model to external markets, lack of operating history as a stand-alone entity and Russell Investments' private equity ownership by TA Associates and Reverence Capital Partners.
Private equity ownership introduces the potential risk of more equity-oriented actions, particularly if the related fund(s) are approaching the end of their stated fund lives. In addition, the acquisition includes $150 million of installment payments due to LSEG from Russell Investments between 2017 and 2020. Fitch recognizes that Russell Investments' private equity sponsors have committed their funds to backstop these installment payments, however, were the funds to be unable to meet these obligations, this would further constrain Russell Investments' financial flexibility. These concerns are partially mitigated by the track record of Russell Investments' private equity owners in the investment management and financial services sectors.
As of Dec. 31, 2015, Russell Investments had $241.8 billion of AUM, spread across single/multi-asset products and derivate overlay products offered to retail and institutional investors in the U.S., EMEA, APAC and Canada. The company primarily derives revenues from traditional investment management activities but also provides investment services (exposure management, transitions, etc.) and consulting services, which are moderate diversifiers of revenue. From a profitability perspective, Fitch-calculated gross EBITDA margins are expected to initially be in the 15% range in 2016, which is weaker than more highly rated peers. Depending on the extent to which Russell Investments is able to improve cost efficiencies and achieve scale efficiencies through AUM expansion, EBITDA margins could improve.
Upon closing the transaction, Russell Investments incurred $650 million of senior secured debt while obtaining an undrawn $50 million revolving credit facility for liquidity purposes. On this basis, Fitch-calculated pro forma gross debt to EBITDA (including 12-month run-rate cost savings) was 3.9x excluding the $150 million of installment payments or 4.8x including the $150 million of installment payments. These levels are consistent with Fitch's quantitative benchmark for 'BB' category of 3.0x to 5.0x. In both instances, Fitch's calculations do not give credit to performance fees, which have been a modest contributor to earnings in the past but can be more variable. Management has indicated a long-term leverage target (on a net debt basis) of less than 2.0x. Were progress to be made on this, it could contribute to positive rating momentum.
EBITDA coverage of interest expense is expected to be approximately 4.0x in FY 2016 (including required amortization of term-loan principal) and is within Fitch's quantitative benchmark for the 'BB' category of 3.0x to 6.0x.
From a liquidity perspective, Russell Investments is expected maintain approximately $40 million in cash, along with $50 million of revolver capacity. This level of liquidity is viewed as weaker than more highly rated peers, although Fitch does recognize the cash flow generative nature of the business model.
The rating of the senior secured debt is equalized with the long-term IDR reflecting Fitch's belief that the debt would have average recovery prospects in the event of default.
The Stable Rating Outlook reflects Fitch's expectation that Russell Investments' franchise, diversified platform and strong cash flow generation should provide it with the ability to begin to reduce elevated leverage and manage execution risk associated with the ownership transition
RATING SENSITIVITIES - IDRS and SENIOR SECURED DEBT
Fitch believes positive rating momentum is possible over the longer term, provided the company successfully executes on its deleveraging, cost improvement and margin expansion plans. Specifically, ratings could be positively influenced by debt/EBITDA approaching or below 3.0x, gross FEBITDA margins approaching or above 20%, EBITDA/interest approaching or above 6.0x and favorable investment performance and asset flows. Additional positive influences include successful execution of strategic objectives, an improvement in diversity of funding as to include a meaningful amount of unsecured debt and successful execution of the transition to a stand-alone business.
Ratings could be negatively influenced by a sustained increase in cash flow leverage beyond 5.0x, a decrease in FEBITDA margins to below 10%, a decrease in EBITDA/interest expenses below 3.0x, or sustained material investment underperformance or AUM outflows. Failure to execute on articulated strategic objectives would also be viewed negatively.
The senior secured debt rating would be primarily sensitive to changes in the long-term IDR of Russell Investments, and to a lesser extent, the recovery prospects of the instrument.
Fitch has assigned the following ratings:
Russell Investments US Institutional Holdco, Inc. (co-borrower)
Russell Investments US Retail Holdco, Inc. (co-borrower)
--Long-term IDR 'BB';
--Senior secured debt rating 'BB'.
Emerald Acquisition Limited (guarantor)
--Long-term IDR 'BB'.
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com
Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)
Dodd-Frank Rating Information Disclosure Form