Fitch Rates Cadence Design Systems' Term Loan 'BBB+'

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings rates has assigned a 'BBB+' rating to Cadence Design Systems, Inc.'s (Cadence) $300 million 3-year term loan A. Cadence's Long-Term Issuer Default Rating (IDR) is 'BBB+'/Stable Outlook. Pro forma for the term loan and Cadence's $50 million draw on its revolving credit facility (RCF), total outstanding debt was $700 million as of Jan. 2, 2015. A full list of ratings follows at the end of this release.

The unsecured Term Loan will be pari passu with Cadence's unsecured notes due 2024. Net proceeds from the Term Loan are expected to be used for general corporate purposes, including potential share repurchases and acquisitions. The covenants for the Term Loan are similar to those of Cadence's existing RCF, including a consolidated leverage ratio of 2.75x and interest coverage ratio of 3x.

KEY RATING DRIVERS

The ratings and Outlook reflect Fitch's expectations for solid operating performance, despite a challenging demand environment. Fitch anticipates low- to mid-single-digit revenue growth over the intermediate term, driven in part by new product introductions (NPI), including strong adoption of the company's Z1 Enterprise Emulation Platform. System design enablement, digital and signoff, as well as intellectual property (IP) businesses should continue growing, driven by increased design complexity and shortened NPI cycles.

Fitch expects profit margins will strengthen due to operating leverage and a richer sales mix, including rapidly growing IP sales. Fitch expects operating EBITDA to remain in the high-20% range over the intermediate term after reaching a Fitch estimated 29.4% for 2015, up from the mid-20%'s in recent years. Fitch expects annual free cash floor (FCF) of $300 million to $400 million through the intermediate term. FCF was $333 million for 2015 with FCF margins expanding to 19.6% from 17.5% for 2014.

Fitch expects Cadence will maintain conservative financial policies and for credit protection measures to remain strong for the rating with total leverage (total debt-to-operating EBITDA) below 2x. The Term Loan issuance follows the repayment of the $350 million convertible notes in June 2015. Pro forma for the term loan and $50 million draw under the RCF, Fitch estimates total leverage declined to 1.4x in 2015 from 1.7x in 2014, driven by 20% year-over-year operating EBITDA growth. Fitch expects interest coverage (operating EBITDA-to-gross interest expense) will remain above 10x over the intermediate term.

The ratings incorporate Fitch's expectation Cadence will fund stock buybacks with a mixture of domestic cash and domestic FCF (estimated at roughly half of total FCF). Fitch assumes Cadence would slow or suspend share repurchases for meaningful acquisitions. Exiting 2015, $960 million of capacity remains under Cadence's current $1.2 billion share repurchase authorization.

The ratings are supported by:

--Cadence's share leadership in the Electronic Design Automation (EDA) industry, with the leading position in Analog and a top-three player in Verification, printed circuit board (PCB) & Packaging, and Digital & Signoff. Fitch believes that NPI, as a result of increasing R&D, recent acquisitions of new technologies, and ongoing trends in the semiconductor industry with regard to outsourcing design IP, will allow Cadence to gain share in the Digital market;

--High switching costs, mission-critical function in enabling semiconductor companies to remain competitive, and growing secular trends favoring design outsourcing support long-term partnerships with customers;

--Subscription-based model enables highly recurring revenue with a +99% renewal rate, supporting high revenue visibility;

--A highly diversified customer base. Fitch also believes an increasing proportion of revenue derived from systems companies will drive further diversification.

Ratings concerns center on Fitch's expectations for:

--Lower market share positioning in Digital, a key market in which its largest competitor dominates. Fitch believes this may shift over time as Cadence wins designs in new higher-end technologies. Fitch believes Mentor Graphics' focus outside of Digital may drive share-gain opportunities for Cadence, including Cadence's recently released enterprise emulation hardware;

--Significant R&D investment requirements in maintaining technology leadership within the EDA industry that will constitute nearly $600 million (roughly 35% of revenues), which is in-line with the broader industry and provides barriers to new entrants;

--Substantial key man risk, given the CEO's significant network within the semiconductor industry, as well as increasing connections in the electronics systems industry;

--The company's relatively small revenue base, although FCF margin are strong for the rating category.

KEY ASSUMPTIONS

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

--Low- to mid-single-digit revenue growth in 2016 and through the intermediate term, despite challenging semiconductor demand, driven by increased complexity and shorter NPI cycles;

--Operating EBITDA margin in the high 20%'s from operating leverage and a richer sales mix;

--Management will slow or suspend share repurchases for a meaningful acquisition.

RATING SENSITIVITIES

Negative rating actions could result from:

--Structurally lower revenue from material share losses resulting in Fitch's expectations for sustained FCF below $200 million;

--Lower base-line operating profitability from increasing price competition or a shifting product mix resulting in Fitch's expectations for sustained total debt-to-operating EBITDA above 2x.

Positive rating action is unlikely, given the company's comparatively smaller revenue and FCF base.

LIQUIDITY

Pro forma for the term loan, Cadence's liquidity was solid and supported by:

--Approximately $1 billion of cash and equivalents, 60% of which was located outside the U.S.;

--$250 million senior unsecured RCF expiring Sept. 19, 2019, $200 million of which was undrawn exiting 2015.

Fitch's expectation for $300 million to $400 million of annual FCF through the intermediate term also supports liquidity.

FULL LIST OF RATINGS

Fitch assigns the following rating:

--Senior unsecured term loan A rated 'BBB+'.

Fitch currently rates Cadence as follows:

--Long-Term Issuer Default Rating (IDR) 'BBB+';

--Senior unsecured RCF 'BBB+;

--Senior unsecured notes 'BBB+'.

Date of Relevant Rating Committee: Dec. 8, 2015

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=999087

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160204006633/en/

Fitch Ratings
Primary Analyst
Jason Pompeii, +1-312-368-3210
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
David Peterson, +1-312-368-3177
Senior Director
or
Committee Chairperson
Sharon Bonelli, +1-212-908-0581
Senior Director
or
Media Relations
Alyssa Castelli, +1-212-908-0540 (New York)
[email protected]

Source: Fitch Ratings

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