Moody's assigns B3 CFR to WatchGuard Technologies, Inc.; outlook stable – Moody's
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New York, August 05, 2022 — Moody’s Investors Service (“Moody’s”) assigned first-time ratings to WatchGuard Technologies, Inc. (WatchGuard), including a B3 Corporate Family Rating (CFR), B3-PD Probability of Default Rating (PDR) and B2 ratings to the proposed $550 million senior secured first lien term loan and $75 million revolving credit facility. The outlook is stable.
The net proceeds from the proposed credit facilities, together with a $200 million second lien term loan (unrated) and a portion of new cash from fund advised by Vector Capital, as well as the rollover equity from Vector Capital and management will be used to finance the acquisition of WatchGuard.
Assignments:
..Issuer: WatchGuard Technologies, Inc.
…. Probability of Default Rating, Assigned B3-PD
…. Corporate Family Rating, Assigned B3
….Senior Secured 1st Lien Term Loan, Assigned B2 (LGD3)
….Senior Secured 1st Lien Multi-Curr Revolving Credit Facility, Assigned B2 (LGD3)
Outlook Actions:
..Issuer: WatchGuard Technologies, Inc.
….Outlook, Assigned Stable
RATINGS RATIONALE
WatchGuard’s B3 CFR reflects the company’s very high leverage at the close of the acquisition. Adjusted for multiple non-recurring expenses WatchGuard’s debt/EBITDA is around 10x (or around 8x on a cash-based leverage including the change in deferred revenue and stock-based compensation minus change in deferred commission) as of March 31, 2022. Moody’s expects that revenue growth in the mid-single digit range, similar to historic growth rates, as well as actioned and planned cost savings will allow WatchGuard to reduce its cash adjusted leverage to around 7x by the end of 2023. The rating is also constrained by the company’s small scale and the highly competitive network security market with short product cycles and rapidly evolving technologies.
The rating is supported by WatchGuard’s good niche market position serving managed service providers (MSPs) in a growing network security market and portfolio of integrated security products for a diverse customer base of small and medium-sized businesses (SMB) as well as distributed enterprises. The company’s MSP-centric model provides operating leverage to cost efficiently reach new customers and expand its offerings with existing customers. The company also benefits from the recurring nature of the subscription revenue base (about 85% in the LTM period ended March 31, 2022). WatchGuard’s typical subscription contract ranges from one to three years with upfront client billings, which support the company’s cash flow generation. With a significant increase in debt balance and rising interest rates, Moody’s projects WatchGuard’s free cash flow to debt in the low single digit range over the next 12 to 18 months.
As a software company, WatchGuard’s exposure to environmental risks is neutral-to-low. Social risks are moderately negative in line with the software sector. Broadly, the main credit risks stemming from social issues are linked to data security, diversity in the workplace and access to highly skilled workers. As a provider of network and endpoint security products, WatchGuard faces risk of reputational harm from potential vulnerabilities in its cybersecurity offerings. Governance considerations are highly negative and include the company’s tolerance for high financial risk and Moody’s expectation for shareholder friendly financial policies.
WatchGuard has adequate liquidity, supported by $20 million of cash at the close of the transaction, a $75 million undrawn revolving credit facility due 2027, and Moody’s expectation of free cash flow to debt in the low single digit range over the next 12 to 18 months. The proposed revolving credit facility is expected to contain a first lien net leverage covenant of 8.5x triggered when 37.5% or more is outstanding. Moody’s does not anticipate the covenant to be tested and expects that WatchGuard will maintain strong cushion over at least the next 12 months.
The stable outlook reflects Moody’s expectation that WatchGuard will generate organic revenue growth in the mid-single digit percentage range over the next 12 to 18 months and will maintain at least adequate liquidity. Moody’s further expects the company’s cash adjusted leverage to decline to around 7x by the end of 2023.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The ratings could be upgraded if WatchGuard’s revenue and EBITDA continue to grow with cash adjusted leverage expected to remain below 6x while free cash flow to debt exceeds 5%.
The ratings could be downgraded if WatchGuard’s revenue growth slows significantly, leverage stays above 8x debt/EBITDA (on a cash adjusted basis), or free cash flow to debt becomes negative.
STRUCTURAL CONSIDERATIONS
The B2 rating on WatchGuard’s proposed senior secured first lien term loan due 2029 and revolving credit facility due 2027 reflects the debt’s senior position in the company’s capital structure, above the $200 million senior secured second lien term loan (unrated) due 2030.
Headquartered in Seattle, WA, WatchGuard Technologies, Inc. is a global provider of network security, endpoint security, secure Wi-Fi and multi-factor authentication. Primarily focusing on the SMB and distributed enterprises, WatchGuard sells its products through a channel of more than 17,000 MSP partners. WatchGuard generated around $295 million of pro forma revenue in the LTM ended March 31, 2022. The company is owned by affiliates of Vector Capital, strategic coinvestors, and management.
The principal methodology used in these ratings was Software published in June 2022 and available at https://ratings.moodys.com/api/rmc-documents/389867. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
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