Bangkok--20 Feb--Standard & Poor's
NEW YORK (Standard & Poor's) Feb. 19, 2013--Standard & Poor's Ratings Services today assigned its 'CCC+' issue-level rating to U.S.-based Avaya Inc.'s proposed second-lien notes due 2021. The recovery rating is '5', reflecting our expectation of modest (10% to 30%) recovery for second-lien debt holders in the event of default. The company's existing ratings, including the 'B-' corporate credit rating, are unchanged. The outlook is stable.
The proposed notes will rank equally with all of Avaya's future second-lien debt and junior to existing and future senior secured debt. The company plans to use the proceeds from this offering to retire its senior unsecured notes due 2015. As of Feb. 19, 2013, approximately 90% of 2015 unsecured noteholders have agreed to exchange their notes for the second-lien notes at par plus an incentive fee.
The ratings reflect Avaya's business risk profile, which we characterize as "weak," based on the company's challenges to reestablish consistent growth in enterprise communications core markets. The ratings also reflect its "highly leveraged" financial risk profile; leverage remains very high, at about 10x for the 12 months ended Dec. 31, 2012, including underfunded pension adjustments, operating lease adjustments, and certain recurring restructuring costs. We view Avaya's management and governance as "fair". Based on our expectations for a gradual improvement to revenue performance and steady margin trends, we expect EBITDA margins will improve toward 20% over the coming year. We also expect cash payments for restructuring to subside, as well as capital expenditures and pension funding to remain steady over the coming year, resulting in a moderation of negative free cash flow and leverage, as well as maintenance of more than $200 million quarter end cash balances over the coming 12 months. In the December quarter, Avaya reported an 11% year-over-year revenue decline, about a 300 basis point sequential improvement to its gross margins, flat sequential operating expenses, and negative free cash flow of $24 million. We believe Avaya has "adequate" liquidity over the next 12 months. On Dec. 30, 2012, cash amounted to $285 million and the company had collective availability of about $450 million under revolving credit facilities expiring in 2016. We expect cash uses to include about $430 million of cash interest expense, $120 million of capital expenditures, $170 million of pension funding, and about $135 million of cash restructuring costs over the coming 12 months. Completion of the current debt transaction will void springing maturity conditions applicable to first-lien debt and, as a result, weighted average debt maturities for loans and notes extend by almost two years to 2017. The company's next significant debt maturity will be its first-lien term loan due October 2014 (approximately $580 million principal outstanding as of Dec. 31, 2012).
The rating outlook is stable. We expect that over the coming year EBITDA growth will resume from current levels and that the company will revive a path toward positive free cash flow and that this performance should position it to meet its 2014 refinancing requirements. A downgrade would likely be the result of a sustained deterioration in operating trends, causing EBITDA generation to decline, free cash flow to remain negative or weak, or cash balances to erode below $200 million, increasing refinancing concerns for 2014 maturities. We will not consider an upgrade until Avaya has considerably reduced leverage, to a debt-to-EBITDA level of below 7x on a sustained basis.
For the corporate credit rating rationale on Avaya, see the research update published Dec. 18, 2012.