Overview -- U.S. e-learning company SkillSoft recently announced its intention to acquire MindLeaders PLC (unrated) and is adding $50 million to its existing $90 million incremental senior secured term loan B to help fund the acquisition. -- We are affirming our 'B' corporate credit rating on the company and lowering our bank loan rating on its first-lien secured debt to 'B+' from 'BB-', while revising the recovery rating to '2' from '1'. -- The stable outlook reflects our expectation that the company will successfully integrate MindLeaders, and realize cost synergies over the next 12 months. Rating Action On Sept. 17, 2012 Standard & Poor's Ratings Services lowered its issue-level rating on Nashua, N.H.-based SkillSoft Ltd.'s first-lien senior secured debt to 'B+' from 'BB-'. We also revised the recovery rating on the debt to '2' from '1'. The '2' recovery rating reflects our expectation of substantial (70%-90%) recovery of principal in the event of payment default. The proposed addition of first-lien debt to SkillSoft's capital structure results in lower first-lien recovery prospects, but does not alter our negligible recovery expectations for the senior unsecured debt. We affirmed our 'B' corporate credit rating and the existing 'CCC+' issue-level rating on the outstanding $310 million of senior unsecured notes. The '6' recovery rating on the notes remains unchanged as well and indicates expectations for negligible (0%-10%) recovery of principal in the event of payment default. Rationale The ratings on SkillSoft reflect the company's "highly leveraged" financial profile and "weak" business risk profile. Although the proposed acquisition of MindLeaders, also an e-learning company, will expand SkillSoft's customer base and geographic diversity, ratings continue to reflect the company's narrow business profile and niche market position. SkillSoft focuses exclusively on the e-learning industry, primarily in the corporate training market. It provides on-demand e-learning and performance support solutions as well as training in business skills, IT, desktop applications, and compliance issues. The company also offers its services to governments and educational institutions. MindLeaders, with 2011 revenue of $28 million, provides business skills, IT skills, and compliance and certification products to small-to-midsized businesses (SMBs) in the U.S., Europe, and Asia. In 2011, SkillSoft acquired Element K, another e-learning company, with $43 million in revenues. The acquisitions do not materially improve SkillSoft's market position, but will provide opportunity for additional cross-selling and market growth. SkillSoft's weak business risk profile reflects its modest position in the global corporate training market. While e-learning is the fastest-growing corporate training segment, many of SkillSoft's competitors typically operate in the significantly larger instructor-led training (ILT) market or compete via a blended ILT and e-learning model. Further, while individual courses and materials may be proprietary, there is little or no protection from competitors producing superior courses on the same or similar topics. These factors are offset partly by SkillSoft's diverse, contractually bound installed base of more than 5,000 accounts worldwide, inclusive of Element K. This provides a large portion of recurring revenues, which allowed the company to demonstrate relative operating performance stability through the recent weak economy. Pro forma for fair value adjustments to its deferred revenues, SkillSoft's revenues grew in the low-double digits for the 12 months ended July 2012, reflecting some organic growth as well as revenues arising from the Element K acquisition. Modest organic revenue growth reflects increased competition for reduced customer training budgets, resulting in longer sales cycles and smaller training and IT outlays. As a result, Standard & Poor's expects near-term growth in the low- to mid-single-digit area. EBITDA margins declined to 33% for the latest 12 months ended July 2012 (down from 39% in 2010) due to increased R&D and sales and marketing-related expenditures, which have yet to result in a meaningful increase in sales. We view SkillSoft's financial risk profile as highly leveraged, reflecting incremental acquisition-related debt. Standard & Poor's adjusted leverage of 6.2x as of July 2012 compares with a fiscal 2011 level of 5.3x. Pro forma for the MindLeaders acquisition, we expect fiscal 2013 (ending January 2013) leverage to rise to the mid-6x area. We expect EBITDA growth and internal cash flow, in part reflecting anticipated cost synergies, to provide for moderate leverage reductions over the intermediate term. The company's private-equity ownership structure and acquisitive growth strategy are likely to preclude sustained de-leveraging. Liquidity We view SkillSoft's liquidity as "adequate." Liquidity is provided by the company's $53 million cash on hand as of July 2012 (to be reduced by $19 million that it will use for the acquisition) and availability under its undrawn $40 million revolver. We expect the company to generate positive free cash flows in fiscal 2013, benefiting from improving margins, and modest capital expenditures and working capital needs. There are no significant maturities until 2017. Additional relevant aspects of SkillSoft's liquidity are: -- We expect coverage of cash sources to uses to be more than 2x in the intermediate term. -- Net sources are likely to be positive, even if EBITDA were to decline more than 20% from the current level. -- No additional material acquisitions are incorporated into the current rating. -- The bank covenant calculation adds the full expected cost synergies to EBITDA. As a result, we expect SkillSoft to maintain adequate covenant headroom. Recovery analysis For the complete recovery analysis, please see Standard & Poor's recovery report on SkillSoft, which will be published shortly on RatingsDirect. Outlook The stable outlook reflects our expectation that the company will successfully integrate MindLeaders and realize cost synergies over the next 12 months. Pro forma leverage somewhat high for the rating, ongoing margin pressures, and uncertainty surrounding SkillSoft's ability to accelerate revenue growth and improve margins all currently limit a possible upgrade. As a result, we do not expect leverage to return to fiscal year 2011 levels over the outlook horizon. On the other hand, we could lower the rating if additional acquisitions, integration issues, or further margin pressure caused leverage to exceed the mid-7x level for a sustained period. 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Senior Secured B+ BB- Recovery Rating 2 1 Ratings Affirmed; Recovery Ratings Unchanged SSI Co-Issuer LLC SSI Investments II PLC Senior Unsecured CCC+ Recovery Rating 6 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.