June 27, 2017 / 6:11 AM / 2 months ago

Fitch Affirms HT Global at 'BB-'; Outlook Stable

(The following statement was released by the rating agency) SINGAPORE/HONG KONG, June 27 (Fitch) Fitch Ratings has affirmed HT Global IT Solutions Holdings Limited's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BB-'. The Outlook is Stable. The agency has also affirmed the 'BB-' rating on its USD300 million 7% senior secured notes due 2021. KEY RATING DRIVERS Mid-Tier IT Services Company: HT Global owns a 71% stake in Indian IT service provider Hexaware Technologies Limited. Its ratings reflect Hexaware's mid-tier position in the global IT services industry, relatively small scale and modest cost and technology advantage over peers. However, its ratings are supported by the moderate-to-high costs to its customers of switching to competitors, diversified revenue stream in terms of products and industries served and its profitable niche with a solid customer base willing to work with the company on a recurring basis. HT Global's business profile is weaker than that of Marble II Pte. Ltd. (BB/Stable), given Marble's larger revenue base, better free cash flow (FCF) profile and minimum revenue guarantees from its customers, primarily from Hewlett Packard Enterprise- (HPE, BBB+/Stable) related clients, including DXC Technology Company (BBB+/Stable), HP Inc. (BBB+/Stable) and Micro Focus International plc. However, Marble's stronger business profile is constrained by its weaker financial profile, as its proportionally consolidated Fitch-forecast FFO-adjusted net leverage of 5.0x in 2018 is higher than HT Global's 4.0x-4.3x in 2017 (2016: 5.1x) on a like-for-like basis. Low Ratings Headroom: HT Global's ratings are constrained by leverage that is higher than most IT peers, which typically have minimal debt as these businesses generate stable cash flows and require minimum capex. We analyse leverage by proportionally consolidating Hexaware, given its 29% minority shareholding, and forecast 2017 FFO-adjusted net leverage to improve to around 4.0x-4.3x (2016: 5.1x), around the threshold of 4.25x above which Fitch would consider negative rating action. Except for special dividends and M&A, we expect HT Global's leverage to improve during 2018-2020 given increasing EBITDA and ability to generate annual FCF of USD25 million-30 million. Revenue, EBITDA Growth: We forecast revenue and EBITDA growth of 8%-10% annually during 2017-2018, driven mainly by higher IT spending by existing customers. Growth is driven by new orders primarily in the infrastructure management service business in the Asia-Pacific region. Revenue visibility is high, as repeat customers contribute about 96% of revenue. HT Global has not lost any of its top-20 customers in the last 10 years. It has multiyear contracts worth around USD110 million with two out of its top-five customers, which are on take-or-pay terms. Stable Profitability: We expect HT Global's operating EBITDAR margin to remain stable at around 17.5%-18.0% (2016: 17.9%), as higher utilisation levels and cost savings will likely offset an increase in staff costs. The employee utilisation rate has improved to around 78%-79% during 1Q17 from 70% in 2015-1H16, while the billing rate has been stable at around USD72-76 per hour for onsite billing and USD23 per hour for offshore billing. We believe that a complete US H1B visa ban or major restrictions on outsourcing from the US is unlikely. However, stricter rules or delays in granting visas could increase labour costs for onsite staff. Management believes any adverse legislation will likely be prospective and would only affect the company after 2018. Hexaware intends to reduce its dependence on visas by hiring locals and nearshoring. FCF Usage to Drive Ratings: Use of Hexaware's FCF is a key consideration driving HT Global's ratings. We forecast annual FCF of around USD25 million - 30 million, as capex/revenue will likely fall to about 2% (2016: 6%) as the expansion of facilities in Pune and Chennai nears completion. Hexaware may use its FCF for M&A and shareholder returns. During 1Q17, HT Global distributed USD27 million in dividends to its parent, Baring Asia Private Ltd, as Hexaware completed a USD20 million share buyback. We believe any M&A to acquire newer technologies or expertise would likely be small. Notes Rated Same as IDR: The senior notes are rated in line with HT Global's Long-Term Foreign-Currency IDR, as they represent its direct, unconditional, secured and unsubordinated obligations. The notes are secured by Baring's 100% equity stake in HT Global. The notes are subordinated to any potential debt at Hexaware or other operating subsidiaries. Hexaware and other operating subsidiaries do not currently have any debt and we understand management aims to keep the businesses debt-free. HT Global also has limited capacity to take on additional debt, as there is an incurrence covenant of debt/EBITDA of 3.75x (2016: 3.5x) in the bond documents. DERIVATION SUMMARY HT Global's ratings are constrained by its smaller scale, mid-tier position in the global IT services industry and modest cost and technology advantage over its peers. Its leverage is also higher than most IT peers. However, its ratings benefit from long-established customer relationships, high revenue visibility and no loss of any top-20 customers in the last 10 years. Its ability to generate positive FCF and increase EBITDA will likely improve its leverage. However, higher-than-expected shareholder returns or M&A could negatively affect ratings. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue to grow by 8%-10%. - Operating EBITDAR margin to remain stable around 17.5%-18.0% (2016: 17.9%) on an increase in onsite revenue delivery mix and stable utilisation rates. - Capex/revenue to remain low at around 2.0% during 2017-2018. - M&A and shareholder returns of about USD25 million each year starting 2018. - HT Global to maintain an interest coverage ratio of at least 1.0x, excluding interest reserve accounts. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - An improvement in proportionally consolidated FFO-adjusted net leverage to below 2.5x. - An improvement in market position of Hexaware, demonstrated by higher operating EBITDAR margin. - Growth in Hexaware's FCF of over USD75 million (2017 Fitch-forecast: USD25 million-30 million). Developments that May, Individually or Collectively, Lead to Negative Rating Action - Higher-than-expected shareholder returns, greater competition or loss of key customers leading to deterioration in proportionally consolidated FFO-adjusted net leverage to above 4.25x (2017 estimate: 4.0x-4.3x). - Operating EBITDAR margin declining to below 15% (2017 estimate: 18%) due to lower employee utilisation rate or loss of key customers. LIQUIDITY Adequate Liquidity: At end-2016, HT Global's liquidity was adequate, with a proportionately consolidated cash balance of USD63 million with no short-term debt maturities. The group's only debt is the 7% USD300 million senior secured notes due in 2021. It also had USD42 million in the interest reserve account, which is classified as unrestricted cash to be used to pay for two years of interest on the senior notes. Hexaware is debt-free. Contact: Primary Analyst Nitin Soni Director +65 6796 7235 Fitch Ratings Singapore Pte Ltd. 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