Fitch Upgraes Avago Tech (AVGO) to 'BB+'; Notes Stronger Profile Following Broadcom Acquisition

Fitch Ratings has upgraded the Long-Term Issuer Default Rating (IDR) for Avago Technologies Finance Pte. Ltd. to 'BBB-' from 'BB+' and has upgraded the existing senior secured credit facility to 'BBB' from 'BBB-/RR1'. Additionally, Fitch assigns a 'BBB' rating to Avago Technologies Cayman Finance Limited's proposed $7 billion 7-Year Senior Secured Term Loan B. The Rating Outlook is Stable. Pro forma for the Term Loan, Fitch's actions affect $11.5 billion, including the undrawn revolving credit facility (RCF). A full list of Fitch's actions follows at the end of this release.

Avago will use net proceeds from the Term Loan to fund a portion of Avago Technologies Ltd.'s (Avago) acquisition of Broadcom Corp. (Broadcom). Avago plans to fund a significant portion of the merger with common stock and approximately $23.3 billion with new debt and available cash at the time of closing.

KEY RATING DRIVERS

The ratings and Outlook reflect Avago's strengthened operating profile following the Broadcom acquisition as the acquisition is expected to more than double revenue and diversify Avago's sales and profit mix. Pro forma for the acquisition, Avago will be the third largest U.S. semiconductor provider, with more than $15 billion of annual revenues. The deal also reduces Avago's reliance on smart phones, as the wireless communications segment will decline to 16% of sales after the combination from 38% on a standalone basis.

Fitch believes Avago's more diversified revenue base will reduce operating volatility over the longer-term. Fitch expects Avago will continue to benefit from technology leadership in the Bulk Acoustic Airwave market for smart phones with its premium FBAR filter. However, increased sales from longer-cycle products, including broadband and set-top boxes, will pare volatility associated with model ramps and potential technology disruption longer-term.

The acquisition strengthens Avago's FCF profile. Fitch expects $2 billion to $4 billion of annual FCF through the forecast. Profitability is expected to strengthen from the $750 million of run rate cost synergies that are forecasted to be realized within 18 months following the acquisition's close. Avago's targeted $750 million of annual cost savings are expected to offset lower blended profit margins following the acquisition. Fitch has confidence in Avago's costs synergy roadmap; however, the transaction poses material integration risks, particularly given the targeted cost synergies and research and development (R&D) intensity divergence. Beyond duplicate cost eliminations and purchasing efficiencies, cost cuts center on headcount reductions in Broadcom's comparatively heavier R&D intensity. R&D constituted 22% of LTM revenues versus just 14% for Avago. Fitch expects cash restructuring of roughly $750 million over the course of the next two years. Additionally, Fitch anticipates operating EBITDA margins of 35% to 40% through a normalized semiconductor cycle, versus latest 12 month (LTM) margins of 43% for Avago and 28% for Broadcom.

Avago has committed to using FCF for voluntary debt reduction until the company achieves its long-term total leverage target (total debt to operating EBITDA) of 1.5x to 2x, versus roughly 3x at closing. Given Fitch's expectation for more than $3 billion of annual FCF through the intermediate-term, Fitch expects Avago to reach its total leverage target in fiscal 2016. Fitch anticipates that Avago will limit share repurchases to offsetting dilution until the company achieves its leverage target. Fitch anticipates more aggressive shareholder returns thereafter, given the significant equity issuance to fund the Broadcom acquisition.

Credit protection measures will remain strong for the rating, with total leverage below 2x and gross interest coverage above 10x. FCF to total debt will be roughly 20% at closing and in the 25% - 30% range exiting fiscal 2016. Fitch believes the company will remain acquisitive and expects Avago's acquisition strategy will focus on smaller sized transactions until the company completes the integration of Broadcom.

However, Fitch considers the company's track record of raising secured debt to fund acquisitions. Future debt funded acquisitions could delay debt reduction or replacement of the secured term loans with an unsecured capital structure that is more consistent with an investment grade rating.

On May 28, 2015, Avago announced a definitive agreement to acquire Broadcom for $37 billion, the then largest ever semiconductor deal. The deal combines Avago's leadership in radio frequency (RF) for wireless communications and data center storage solutions with Broadcom's leading positions in broadband and set-top boxes. The acquisition is on track to close in the first quarter of 2016 and is subject to customary regulatory approval.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Avago include:

--The expectation for wireless communications to grow more than 10%, enterprise storage to grow in the low- to mid-single digits, wired infrastructure to grow in the low- to mid-single digits, and industrial and other to grow in the low-single digits annually through the forecast. Fitch expects Broadcom's business to grow at a more mature rate, in the low-to mid-single digits.
--The company achieving its targeted synergies from the Broadcom acquisition, resulting in $750 million of annual cost savings that drive operating EBITDA margins closer to 40% through the horizon.
--Capex as a percentage of revenue declining from nearly 10% in fiscal 2015 to a blended rate of approximately 5%, despite ongoing capacity additions in Avago's FBAR filters.
--Capital allocation being focused on reducing total leverage to 1.5x to 2x, with share repurchases limited to offsetting dilution, dividends stepping up by $250 million in fiscal 2016 and growing 10% annually thereafter, and FCF used largely for debt reduction .

RATING SENSITIVITIES

Positive rating action could occur if:

---Avago replaces secured debt with an unsecured capital structure more consistent with an investment grade rating and Fitch believes the company will manage debt levels to maintain total leverage below 2x; or
--Fitch expects Avago will sustain operating EBITDA margins in the high 30s to low 40s through a normalized semiconductor cycle.

Negative rating actions could occur if:

--Fitch expects total leverage to remain above 3x from the continuation of debt financed acquisitions or the initiation of more aggressive shareholder returns prior to anticipated debt reduction; or
--Avago sustains material market share loss with its leading customers or in aggregate, indicating a loss of technological advantage.

LIQUIDITY

Pro forma the Broadcom acquisition, Fitch believes Avago's liquidity will be solid, supported by:

--More than $1 billion of cash and cash equivalents; and
--Full availability of the company's $500 million senior secured revolving credit facility.

Liquidity is further supported by Fitch's expectation for mid-cycle annual FCF of more than $2.5 billion.

FULL LIST OF RATING ACTIONS

Fitch upgrades Avago Technologies Finance Pte. Ltd.'s ratings as follows:

--IDR to 'BBB-' from 'BB+';
--$500 million Senior Secured Revolving Credit Facility (RCF) to 'BBB' from 'BBB-/RR1';
--Senior Secured Term Loan upgraded to 'BBB' from 'BBB-/RR1'

The Rating Outlook is Stable.

Fitch has assigned the following ratings:

Avago Technologies Cayman Finance Limited:
--$7 billion Senior Secured Term Loan B 'BBB'; Rating Outlook Stable.

You May Also Be Interested In

• Midday movers: Tesla, Li Auto and CNH Industrial fall; Salesforce rises
• KKR & Co. (KKR) agreed to acquire Immedica Pharma
• Hibbett Sports (HIBB) Acquired by JD Sports Fashion for $87.50/sh or $1.1B