Bangkok--28 May--Moody's Investors
Moody's Investors Service has assigned a Ba2 corporate family rating to H3C Holdings Ltd (H3C).
At the same time, Moody's has assigned the following ratings to the secured US$ loans proposed to be issued by H3C and guaranteed by H3C
Technologies Co Ltd:
1) US$230 million Tranche A 3.5-year senior secured amortizing loan - Ba2
2) US$200 million Tranche B 5.5-year senior secured amortizing loan - Ba2
The outlook for these ratings is stable. This is the first time that Moody's has assigned ratings to H3C.
"H3C's ratings reflect its established position as the second largest player in the enterprise networking market in China," says Ken Chan, a Moody's AVP/Analyst, adding, "Its strong R&D capability and regional support network underpins its sustainable competitive advantage enabling it to better serve its customers."
"Moreover, these strengths are supported by H3C's capex-light business model, which enables positive free cash flow generation for debt reduction," says Chan. "Therefore, its credit metrics are projected to improve over the next few years."
At the same time, Moody's believes a Ba2 rating is appropriate in light of H3C's position as a fast-growing and relatively small company in a global technology context, especially with a short operational track record.
"Although Moody's considers the proven execution capability of its management team, H3C faces some degree of challenge in executing its strategic initiatives in its international businesses," says Chan.
Furthermore, concerns are evident over a potential weakening of support and sales from Huawei Technologies, which is no longer a shareholder of H3C after selling its stake. As such, there are concerns over continuity in management and engineering staff as well. However, these concerns are partially mitigated by a Non-Compete Agreement between H3C and Huawei and Equity Appreciation Rights Program put in place to ensure management continuity.
When compared to other rated regional technology peers such as Hynix Semiconductor (Ba3/RUR), United Test and Assembly (Ba3/stable) and STATS ChipPAC (Ba2/RUR), H3C operates in a business segment which is lighter on capex and experiences a longer technology cycle translating to less exposure to industry volatility, while generating positive free cash flow, which supports its Ba2 rating.
H3C is now the wholly-owned subsidiary of 3Com Corporation (3Com). While 3Com has a longer operational track record, it has a relatively weaker operating performance compared to H3C. Moody's notes there are restrictive loan covenants on dividend payments before loan prepayments.
Moody's draws further comfort that 3Com is debt-free with ample cash on balance sheets, and therefore it does not post negative impact to H3C's credit ratings.
The repayment schedule for the US$230 million Tranche A loan is front-end loaded, with 40% repayment after 6 months of drawdown. This pressures balance sheet liquidity and debt service coverage ratio given the need to distribute the one-off EARP payment and $41 million of capital reduction to Huawei which was approved in 4Q2006 and held in an escrow account until it was paid in 1Q2007. Such concern is partially mitigated by its projected strong cash flow generation capability. The US$200 million Tranche B loan has a back-end loaded repayment schedule.
The stable outlook reflects Moody's expectation that H3C will successfully execute its business plans and grow its business after the sell-out by Huawei Technologies, while maintaining its free cash flow generation for debt reduction over the next few years.
A ratings upgrade could evolve over time if the company demonstrates the ability to maintain its expected growth momentum in China, while protecting profitability -- especially after the expiration of the 18-month non-compete agreement. Moreover, the ability to maintain positive free cash flow for debt repayment such that Adjusted TD/EBITDA of below 1.5-2.0x and EBITDA/Int of above 6.0-8.0x over the cycle will be positive for the ratings.
On the other hand, the rating could experience downward pressure if 1) sales growth traction is below expectations over the next few years; 2) the company fails to generate positive free cash flow for debt repayments, such that Adjusted TD/EBITDA exceeds 3.0-4.0x, EBITDA/Int falls below 4.0-5.0x and Debt Service Coverage Ratio falls below 1.5-2.0x over the cycle, and 3) there is evidence of cash leakage to fund affiliated companies.
Headquartered in Hong Kong, H3C Holdings Ltd (H3C) is a leading global supplier of IP networking products and solutions. Its offering includes routers, Ethernet switches, wireless LAN, security, Voice/Video over IP products, SOHO products and network management systems.
H3C has its principal operations in Hangzhou, China and has established branch companies in Japan, the US, South Africa, Korea, Thailand, Russia, India and Malaysia. H3C is a wholly-owned subsidiary of 3Com Corporation.
Hong Kong
Ken Chan
Asst Vice President - Analyst
Corporate Finance Group
Moody's Asia Pacific Ltd.
JOURNALISTS: (852) 2916-1150
SUBSCRIBERS: (852) 2916-1121
Hong Kong
Gary Lau
Senior Vice President
Corporate Finance Group
Moody's Asia Pacific Ltd.
JOURNALISTS: (852) 2916-1150
SUBSCRIBERS: (852) 2916-1121