S&P Downgrades TSYS (TSS) to 'BBB-' Amid TransFirst Deal

Standard & Poor's Ratings Services said that it lowered its corporate credit and debt ratings on Total System Services Inc. to 'BBB-' from 'BBB+'. The rating outlook remains stable.

We base our downgrade primarily on the material increase in adjusted leverage to the high-3x area, pro forma for the debt-financed acquisition of TransFirst, from about 1.5x as of Dec. 31, 2015. Over the next two years, we expect the company to adhere to its stated goal of applying much of its excess free cash flow to debt reduction.

With 2015 total revenues of about $2.8 billion, TSS holds a defensible market position as one of the major outsourced service providers to the U.S. card issuing community. Its largest and most profitable segment, North America Services, comprising about 50% of total revenues, has exhibited double-digit revenue growth over the last several years and, considering about 80 million Bank of America client accounts on file added during 2015, we expect this growth to moderate to the high single digits in 2016 and 2017, with continuing support from new client adds, a generally favorable consumer credit environment, and a continued market shift toward wider adoption of electronic payments. Conversely, with about a 2% share and growing modestly, TSS maintains a market position as the 11th-largest U.S. merchant acquirer based on processing volume, according to Nilson's March 2015 report.

TransFirst is a domestic payment processor with 2015 EBITDA of about $150 million serving small-to-midsize business (SMB) merchants. The acquisition will augment TSS' existing merchant processing business with incremental clients and processing volume and double its merchant processing business EBITDA, supporting the company's growth strategy. SMB merchant processing remains one of the more profitable segments of the payment industry, though it is subject to considerable competition from similarly sized and positioned companies, as well as better-capitalized large-scale payment rocessors, like TSS, that serve a broader range of merchants through both direct and indirect relationships. We expect TransFirst's below-industry attrition rates, around 12% as measured by processing volume, and diverse distribution channels ranging from bank referrals, integrated sales partners, and independent sales organizations will continue to contribute to mid- to high-single digit merchant segment revenue growth over the next two years.

On a combined basis, we expect the company's competitive advantage in technology, improved scale, and established processing efficiency will bolster mid-single digit revenue growth and relatively stable EBITDA margins over the coming two years. Additionally, we expect outsourced card issuing related businesses will continue to be the major cash flow driver comprising approximately 60% of total EBITDA, pro forma for the acquisition. Nonetheless, financial institution client concentration, pricing pressure, the evolution of mobile commerce and industry disintermediation remain key risks and considerations over the longer term.

The stable outlook reflects our expectation for mid-single digit organic revenue growth and relatively stable EBITDA margins over the next two years. We also expect good liquidity and consistent free cash flow generation which will support rapid deleveraging.

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