Moody's Cuts Pactera Technology (PACT) to 'B2'; Remains on Review for Downgrade
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Moody's Investors Service has downgraded the corporate family rating of Pactera Technology International Ltd. (Nasdaq: PACT) to B2 from B1.
Moody's has also downgraded to B2 from B1 the senior secured debt rating on the notes issued by BCP Singapore VI Cayman Financing Company Ltd (BCP Financing Co.) and guaranteed by Pactera.
Both ratings are on review for downgrade.
"The downgrade of Pactera's corporate family rating to B2 reflects our concerns that ongoing operational challenges will continue to pressure the company's operating margin below the levels expected for the B1 rating category," says Lina Choi, a Moody's Vice President and Senior Credit Officer.
Since 1Q 2015, Pactera has reported operating profit margins below 3%, as against previous levels of 5%-10%. Moody's had earlier expected that Pactera's profitability would recover starting at end-2015. Moody's notes that Pactera has continued to face a high cost base and increasing working capital needs in China.
Persistently weak operating margins and working capital outflows have negatively affected Pactera's cash flow generation and raised its short-term debt. Moody's estimates that the company's funds from operations to debt will stay below 8%-10% over the next 12-18 months; a result which would no longer support a B1 rating.
"The review for downgrade reflects our concerns over Pactera's ability to meet the potential notes repayment of $275 million, given that the announced exit of The Blackstone Group, a shareholder with a majority stake, will trigger the change of control clause and mandatory notes redemption offer," adds Choi, who is also the Lead Analyst for Pactera.
On 22 August 2016, Pactera announced that Blackstone and certain other shareholders had entered into a share purchase agreement with the HNA Group (unrated), pursuant to which the HNA Group would purchase substantially all of the issued and outstanding shares of BCP Financing Co.'s parent company.
The completion of the transaction remains subject to regulatory approvals and the satisfaction of certain other closing conditions, but is expected to close prior to mid-2017. There has been no disclosure about the funding plan of this transaction.
Based on the indenture of the secured notes issued by BCP Financing Co. and guaranteed by Pactera, the share purchase transaction would trigger the change of control clause. The change of control clause stipulates that if current shareholders sell down more than 50% of BCP Financing Co.'s voting stock, BCP Financing Co. may need to offer to repurchase the full amount of the notes within 30 days of the completion of the deal.
At 30 June 2016, Pactera reported cash of $52 million and accounts receivables totaling $338 million. Based on the average 159 days for accounts receivables, these cash sources are insufficient to cover the potential notes redemption requirement of around $275 million in a timely manner.
Moody's is also concerned that the instability of the capital structure will further exacerbate operational challenges for Pactera and cause business disruptions.
Moody's points out that Pactera's ability to service its financial obligations depends mainly on the intentions and ability of HNA Group, and that such factors remain uncertain. A prolonged delay in finalizing funding sources could result in a multiple notch downgrade of Pactera's rating.
Moody's review will focus on:1) further information becoming available regarding the terms of the share purchase agreement with HNA Group; 2) a clear funding framework from the HNA Group, with a specific time line to service financial obligations associated with the change of control; and 3) whether or not Pactera's capital structure is stable over the long term, which would in turn depend primarily on the financial capability of the HNA Group and the potential new shareholder's willingness to support Pactera.
The principal methodology used in these ratings was Business and Consumer Service Industry published in December 2014. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.
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