Fitch Affirms Convergys' IDR at 'BBB-'; Outlook Stable
Fitch Ratings has affirmed the ratings of Convergys Corporation (Convergys) as follows:
--Long-term Issuer Default Rating (IDR) at 'BBB-';
--Revolving credit facility (RCF) at 'BBB-';
--Junior subordinated convertible debentures at 'BB+';
--Short-term IDR at 'F3';
--Commercial paper (CP) at 'F3'.
The Rating Outlook is Stable.
Approximately $425 million of debt is affected by Fitch's action, including Convergys' undrawn $300 million credit facility.
Convergys' ratings and Stable Outlook reflect:
--Strong liquidity and financial flexibility provided by a net cash position ($602 million), undrawn revolving credit ($300 million), an accounts receivable (A/R) securitization facility ($150 million), consistent free cash flow (FCF) and no significant debt maturities until 2029 ($125 million).
--Improved financial performance of Customer Management (CM).
--Significant recurring revenue base (90% - 92% of total revenue) from long-term CM contracts (2-3 years) partially offset by fluctuations in call volumes with existing clients.
--Long-term customer relationships and high switching costs for existing CM clients to in-source the process.
--Solid credit metrics with total leverage (total debt/operating EBITDA), pro forma for the divestiture of the Information Management (IM) business, below 1 times (x) and interest coverage (operating EBITDA/interest expense) exceeding 16x in the latest 12 months (LTM) ended Sept. 30, 2012.
Fitch believes leverage will remain below 1x through at least 2014 based on the company's strong liquidity position and consistent FCF, which should provide adequate internal funding for acquisitions and/or share repurchases.
Credit concerns center on:
--The lack of revenue diversification as Convergys' customer base is highly concentrated by customer and industry. The three largest clients, AT&T (23.6%), DirecTV (12.4%) and Comcast (12.4%), accounted for 48.4% of total revenue in the nine months ended Sept. 30, 2012 compared with 41.7% and 46.8% in the corresponding year-ago period with and without the IM business, respectively. As a result, the communications industry accounted for nearly 61% of total revenue in this period. Fitch believes client concentration is partially offset by multiple programs within each customer.
--The limited revenue growth outside of Convergys' top three clients. Fitch estimates revenue associated with the top three clients increased 7.8% in the nine months ended Sept. 30, 2012 but only 1.5% outside of the top three clients.
--The substantial and increasing currency market risk exposure as a greater portion of CM services delivery costs are incurred offshore, primarily in the Philippines and India, for contracts denominated in U.S. dollars. This risk is mitigated by currency hedges, primarily through the use of forward contracts.
--The sustainability of call volumes given the uncertain macroeconomic environment.
Fitch believes the sale of IM is credit neutral as the loss of diversification and increased client concentration is offset by:
--The greater management focus on the larger and less volatile CM business;
--A stronger liquidity position as remuneration received from the sale of the IM business exceeded expectations;
--The sale had minimal effect on credit protection measures since a portion of the proceeds was utilized to reduce debt. In the second quarter of 2012, Convergys exercised a $55 million purchase option for a previously leased (capital lease) office complex in Orlando, Florida.
--IM lacked the necessary scale to effectively compete against larger competitors, such as Amdocs and its financial performance was increasingly volatile due to the loss of recurring revenue from data processing contracts with AT&T and Sprint;
Convergys' strong financial flexibility is supported by $729 million of cash as of Sept. 30, 2012 (approximately 75% located in U.S.), an undrawn $300 million RCF and $150 million A/R securitization facility expiring in March 2015 and June 2014, respectively. The company also generates consistent FCF supported by CM's significant recurring revenue base.
Financial covenants in the credit agreement include a minimum interest coverage ratio of 4x on a trailing 12 months basis and maximum leverage of 3x until Dec. 31, 2012 and 2.75x thereafter. The company has ample cushion with respect to the both financial covenants given total pro forma leverage of 0.5x and interest coverage of 16x based on Fitch's estimates.
On May 16, 2012, Convergys closed the sale of its IM business to NEC Corporation for approximately $461 million in cash, equating to an EBITDA multiple of approximately 8x. IM provided convergent billing and business support system (BSS) solutions and services to the telecom and cable industries.
IM accounted for $329 million, or nearly 15%, of Convergys' total revenue and $57 million, or 22%, of total EBITDA in 2011. Profits from the IM business deteriorated significantly in the past five years primarily due to loss of the two aforementioned data processing contracts. The loss of recurring revenue from these contracts also increased the volatility of the IM business, with financial results largely dependent on new sales of perpetual contract licenses and associated services.
As of Sept. 30, 2012, total debt was $127.5 million, primarily consisting of:
--$125 million of 5.75% junior subordinated convertible debentures due 2029; and
--$2.2 million of capital lease obligations.
WHAT COULD TRIGGER A RATING ACTION
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--The loss of any key customer(s), including AT&T, DirecTV and/or Comcast Corporation; and
--Significant debt-financed acquisitions and/or share repurchases.
Positive: Upside movement in the ratings is unlikely in the absence of further customer and industry diversification.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
John M. Witt, CFA, +1 212-908-0673
33 Whitehall Street
New York, NY 10004
Jason Pompeii, +1 312-368-3210
Jamie Rizzo, CFA, +1 212-908-0548
Brian Bertsch, +1 212-908-0549