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Fitch Assigns TierPoint First-Time 'B+' IDR; Outlook Stable
April 17, 2017 / 9:47 PM / 8 months ago

Fitch Assigns TierPoint First-Time 'B+' IDR; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, April 17 (Fitch) Fitch Ratings has assigned a 'B+' first-time Long-Term Issuer Default Rating (IDR) to TierPoint, LLC. The Rating Outlook is Stable. Fitch has also assigned 'BB/RR2' first-time ratings to the senior first lien secured revolver and senior first lien secured term loan, and a 'B-/RR6' to the senior second lien secured term loan. The $920 million proceeds from the term loans will be used to repay the company's existing debt. A full list of rating actions follows at the end of this release. Fitch's rating actions affect approximately $1.1 billion of total debt, including the $175 million revolving credit facility. The ratings and Outlook are supported by our view that the secular data center growth will provide tailwinds for TierPoint's revenue growth. With the post-acquisition integration efforts being mostly completed, Fitch expects margin expansion starting in 2018. Fitch also expects TierPoint's free cash flow (FCF) will remain negative through 2018 because of the capital expenditures required to operate its data center business. We expect gross leverage to gradually decline as a result of EBITDA growth. KEY RATING DRIVERS Secular Demand Drivers Balance Oversupply Risk: Fitch believes data center traffic growth, combined with an increasingly positive enterprise sentiment toward hybrid infrastructure deployments, will favor carrier-neutral data center providers. Even amidst this favorable backdrop, the fragmented nature of the data center industry has made it susceptible to pockets of pricing pressure, often the result of excess capacity from new-builds or sudden large-customer churn events. While builds are not nearly as speculative as they were in the past, oversupply will remain a risk as long as there is a need to commence building months or years ahead of signing new customers. Fitch believes TierPoint is better protected against this risk as it primarily serves smaller markets where competitive intensity is less severe. Diversified Customer Base: TierPoint strategically targets secondary markets where competition is lower and focuses on serving small- to medium-sized enterprises (SMEs) in these markets. This results in a fragmented customer base where its top 10 customers make up 12% of total revenues. The fragmented customer base effectively reduces customer concentration risk and earnings volatility. TierPoint operates 40 facilities in 20 markets, and serves approximately 5,000 customers. Fitch views this favorably as it enhances the predictability of the company's future financial performance. High Proportion of Recurring Revenue: Fitch estimates that 98% of TierPoint's revenue is recurring in nature with typical service contracts extending for three years, creating a high level of visibility into future revenue and cash flow streams. Fitch believes stability of the IT infrastructure is critical for enterprise customers; switching data center providers creates a high risk of disrupting the customer's IT infrastructure that could affect critical business operations. This results in a high proportion of recurring revenues for data center operators and a lengthy sales cycle. Balanced Exposure to Retail Colocation & Managed and Cloud Services: TierPoint generated 52% of its total revenue from retail colocation, and the balance from managed and cloud services. Fitch believes the company is strategically shifting toward managed and cloud services as it encompasses a larger part of the industry value chain and attracts a larger set of potential customers. The increased exposure to a greater part of the value chain is expected to increase customer stickiness. The shift toward managed and cloud services would also increase capital efficiency, as it tends to be less capital intensive; this should lead to stronger FCF margins as revenue mix shifts toward managed and cloud services. Potential Debt-Funded M&A: Mergers and acquisitions have played a critical role in the company's growth over the past seven years, with approximately $1.4 billion being spent across six acquisitions over the past four years alone. Fitch expects these transactions to continue to be funded through an equal blend of both debt and equity. The company's acquisitive strategy introduces a meaningful amount of integration risk to its operational profile, and larger than normal amount of reliance on management's ability to structure and execute on deals appropriately. Despite these risks, the company has had a good track record in efficiently integrating its acquired assets. High Leverage: TierPoint's strategy of expanding its footprint and capacity through acquisitions has led to elevated leverage ratios. Fitch estimates year-end 2016 pro forma leverage to be 6.9x, up from 5.6x in 2015. Within Fitch's base case, we incorporate our expectation that management will continue to execute on deals, with funding through a balanced mix of debt and equity. Fitch forecasts gross leverage declining below 6.0x by the end of FY 2019, and to 5.0x by the end of FY 2020 as a result of EBITDA growth. Total debt is expected to continue to rise as the company continues to execute on acquisitions over the forecast. Capital Intensity Constrains FCF: TierPoint's total capex has remained near 30% of revenues over the last two years, contributing to negative FCF during the period. Fitch expects FCF to remain negative through 2018 as the company continues to invest in organic expansions. FCF should gradually turn positive by 2019 as the growth rate moderates. Building new capacity is capital intensive; construction can take from a few months to several years, with no guarantee that breakeven cash flow will be reached on schedule. KEY ASSUMPTIONS --Revenue growing from $350 million in 2016 to $879 million in 2020, as a result of (i) organic growth near 10%, and (ii) $450 million of incremental acquisitions per year at revenue multiples of 5.0x in 2018, 2019, and 2020; --EBITDA margin expansion to near 40% as a result of operating efficiency improvements; --Transaction and non-recurring expenses resulting from historical and future acquisitions near $10 million over the forecast, in line with comparable deals and management's expectations going forward; --Capital expenditures near 20% of revenue over the forecast, reflecting the improving scale efficiency, and inclusive of approximately $10 million of integration related expenditures in 2018, 2019, and 2020; --$200 million of acquisitions in the second half of 2017, and $450 million each in 2018, 2019, and 2020. Fitch expects these deals to be funded with an equal split between debt and equity. RATING SENSITIVITIES Positive Sensitivity: Future developments that may, individually or collectively, lead to a positive rating action include: --Fitch's expectation for leverage to decline to below 5.0x; --Expectation for FCF sustaining in positive territory; --EBITDA margin expansion starts in FY2018. Negative Sensitivity: Future developments that may, individually or collectively, lead to a negative rating action include: --Fitch's expectations for leverage to sustain above 6.0x by FY2019; --Acquisition funded by higher proportion of debt vs. equity, and/or delays in deleveraging expectations; --Expectation for FCF remaining negative beyond FY2018; --EBITDA margins weaker than Fitch's expectations resulting from poor operating efficiency. LIQUIDITY Liquidity Profile: TierPoint's liquidity profile has been pressured by its consistently negative FCF, causing the company to fund deficits with its revolver. Going forward, Fitch expects the company will have an adequate amount of liquidity as a result of its $175 million revolver, and positive FCF starting in 2019. FULL LIST OF RATING ACTIONS Fitch has assigned the following ratings: TierPoint, LLC --Long-Term IDR at 'B+'; --Sr. first lien secured revolver due 2022 at 'BB/RR2'; --Sr. first lien secured term loan due 2024 at 'BB/RR2'; --Sr. second lien secured term loan due 2025 at 'B-/RR6'. Contact: Primary Analyst Alen Lin Senior Director +1 312-368-5471 Fitch Ratings, Inc. 70 West Madison St. Chicago, IL 60602 Secondary Analyst Allen Dilallo Analyst +1 312-368-3337 Committee Chairperson David Peterson Senior Director +1 312-368-3177 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. 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