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Fitch Upgrades Broadcom Cayman Finance Ltd. to 'BBB' from 'BBB-'; Outlook Positive
January 11, 2017 / 4:30 PM / 10 months ago

Fitch Upgrades Broadcom Cayman Finance Ltd. to 'BBB' from 'BBB-'; Outlook Positive

(The following statement was released by the rating agency) CHICAGO, January 11 (Fitch) Fitch Ratings has taken the following rating actions on Broadcom Limited (Broadcom) wholly-owned subsidiary, Broadcom Cayman Finance Limited, following the subsidiary's $12 billion unsecured senior notes private placement including: --Long-Term Issuer Default Rating (IDR) upgraded to 'BBB' from 'BBB-'; --$12 billion senior unsecured notes rated 'BBB'. Fitch also revised the Rating Outlook to Positive from Stable. See the full list of rating actions at the end of this release. Pro forma for the private placement, Fitch's actions affect $14.3 billion of total debt, including the $500 million revolving credit facility (RCF). Broadcom will use net proceeds from the senior unsecured notes to repay the senior secured term loan B-3 in full, as well as repay a portion of the term loan A. As a result of repaying the term loan B-3 in full, the security under the 2016 credit agreement (as amended on Aug. 1, 2016) is released and results in a completely unsecured, pari passu capital structure. The upgrade reflects the release of the security, which constrained the company's IDR at 'BBB-'.The Positive Outlook reflects Fitch's increased confidence in Broadcom's commitment and ability to achieve target total leverage (total debt/operating EBITDA) near 2x in the 12-24 months after closing the Brocade Communications Systems Inc. (Brocade) acquisition. The Outlook also reflects Fitch's expectation that Broadcom will organically fund tuck-in acquisitions or, should the company incur debt to fund larger deals, use cash flow for debt reduction to return total leverage to 2x over the subsequent near-term period. KEY RATING DRIVERS Proposed Brocade Acquisition: Fitch believes the proposed $6 billion acquisition of Brocade, the market leader in fibre channel storage area network (FC SAN) switching, strengthens Broadcom's enterprise storage portfolio and potentially increases share gains from significant customer overlap with its leading positions in fibre channel integrated circuits (IC) and fibre channel host bus adapters (HBA). Broadcom will divest Brocade's internet protocol (IP) networking business and apply net proceeds to repay a portion of anticipated debt incurred to fund the transaction. Aside from further diversifying the company's end market portfolio, Brocade's more profitable revenue will be accretive to Broadcom, which resulted in the company recently increasingly its long-term operating margin targets to 45% from 40%. Strengthening FCF Profile: Fitch expects Broadcom's FCF profile will continue strengthening from increased scale and diversification away from more volatile wireless communications revenue. Fitch expects $3 billion to $4 billion of annual FCF through the intermediate term, versus $2 billion for fiscal 2016. Capital spending will be elevated again in fiscal 2017, driven by the completion of campus construction and replacing 6-inch with 8-inch wafers in the company's Fort Collins fabrication facility. Higher revenue levels, the realization of $750 million of run rate cost synergies related to Broadcom and the company's otherwise fab-light manufacturing model should bolster FCF. Increasing End Market Diversification: Fitch expects increased revenue diversification away from wireless will reduce longer-term operating volatility. In addition, Broadcom should continue to benefit from technology leadership in the Bulk Acoustic Airwave market for smart phones with its premium FBAR filter. However, increased sales from longer-cycle products, including broadband and set-top boxes will reduce volatility associated with handset product cycles or model ramps, although Broadcom also continues diversifying wireless customers as well. As a result of the Brocade acquisition, enterprise storage revenue will increase to more than 20% of total revenue from mid-teens currently, modestly diversifying significant wired infrastructure and wireless communications exposure. Acquisition Risk: Fitch expects Broadcom will remain acquisitive through the foreseeable future, potentially delaying pre-payable debt reduction and increasing integration risks if targets require significant cost take-outs. However, fewer large meaningfully complementary targets exist after the latest wave of semiconductor consolidation. In addition, Fitch increasingly expects Broadcom's growing scale enables it to fund deals with FCF, largely mitigating Fitch's concerns. Strong Market Positions: Fitch expects Broadcom's #1 market positions in FBAR filters for handsets, and wired infrastructure markets, including ethernet switching, fibre optic components and set-top boxes, will drive less volatile operating results. With the Brocade acquisition, Broadcom also gains the leading and most comprehensive platform of components for enterprise storage. Fitch believes the company's commitment to high research and development (R&D) investment is supporting technology leadership and solid profit margins across its product portfolio. Public Financial Policies: Broadcom's publicly articulated financial policies are conservative and increasingly in-line with strong investment grade ratings, in Fitch's view. Fitch believes Broadcom could achieve its articulated 2x total leverage target through a combination of profitability growth and reducing pre-payable debt. Broadcom remains committed to growing its dividend, which could approach $2 billion for fiscal 2017, but will refrain from share repurchases until it achieves its 2x target leverage. In addition, the company articulated a commitment to maintaining $3 billion of cash on the balance sheet (nearly all readily available). Credit Protection Measures Strengthening: Fitch expects incremental profitability growth from higher revenue levels, the realization of annual Broadcom deal-related cost synergies, accretive profit margins from the Brocade acquisition and divestiture proceeds from the IP networking business sale. Fitch estimates total leverage was 2.2x exiting fiscal 2016 after factoring in a full year of Broadcom revenue and we forecast total leverage near 2x exiting fiscal 2018. The company's FCF/debt also should improve to the mid-teens from historical levels of 10%, driven by meaningful expected FCF growth. Fitch affirmed the ratings following Broadcom's Nov. 2, 2016 announcement it would acquire Brocade, the market leader in FC SAN switching, for $5.9 billion plus $400 million of net debt. Broadcom continues to expect the acquisition will close in the second half of the fiscal 2017 (ended Oct. 31, 2017), pending approval of Brocade's shareholders and subject to certain regulatory approvals and customary closing conditions. FC SAN business should add $1.4 billion of highly profitable annual revenue. Despite mid-single-digit negative growth for the FC SAN switching market from workload migration to the public cloud, higher average selling prices (ASP) from storage upgrades to support customers' mission-critical data will offset lower unit demand. More fully integrated component platforms also should drive increased customer penetration for Broadcom. As a result, Fitch expects at least low-single-digit organic growth for Broadcom through the intermediate-term. Brocade should be immediately accretive to Broadcom's profitability, given Brocade's more than 70% gross profit margins, versus Fitch's estimate of gross profit margins (adjusted for the impact of purchase price accounting, restructuring and stock-based compensation) in the mid-50s for Broadcom. Fitch expects Broadcom's profitability will continue expanding from incremental cost savings from ongoing acquisition-related restructuring. Brocade could add as much as $900 million of operating EBITDA (upon divestiture of the IP networking business), resulting in a Fitch estimated $7.6 billion of combined operating EBITDA at closing. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Broadcom include: --Broadcom continues more than low-digit organic revenue growth through the intermediate term, driven by broad-based demand across its businesses. --Broadcom closes the Brocade acquisition and enters into an agreement to divest the IP Switching and associated Services business during fiscal 2017 and both close at the end of fiscal 2017. --Brocade's revenue growth is flat with higher ASPs from product upgrades offsetting lower unit volume from workload migration. --Broadcom continues using annual FCF for debt reduction, resulting in total leverage approaching 2x exiting fiscal 2018. --Fitch expects operating EBITDA margin in the low 40x range, with ongoing benefits from acquisition-related restructuring offset by modestly net dilutive profit margins from future acquisitions. --Fitch assumes 10% annual dividend growth and no share repurchases over the intermediate term. --Annual FCF (includes dividends) of $3 billion-$4 billion through the intermediate term organically funds incremental acquisitions. RATING SENSITIVITIES Positive rating action could occur if: -- Broadcom can achieve and sustain total leverage near 2x in the near term, driven by a combination of repayment of Term Loan A borrowings and operating EBITDA growth from higher revenue and cost synergies related to the legacy Broadcom and Brocade acquisitions; --Structurally higher annual FCF will organically fund incremental acquisitions; --Fitch expects Broadcom will sustain structurally higher revenue levels, which will sustain operating EBITDA margins in the high 30s to low 40s through a normalized semiconductor cycle, resulting in annual FCF structurally above $3 billion. Negative rating actions could occur if: --Fitch expects total leverage to remain closer to 3x, likely from serial debt-financed acquisitions or the initiation of more aggressive shareholder returns; --Material share losses resulting in negative revenue growth and lower operating EBITDA margin sustained below 30%, resulting in annual FCF insufficient to sustain target total leverage. LIQUIDITY Fitch believes liquidity was solid as of Oct. 30, 2016 and supported by: --$3.1 billion of cash and cash equivalents, nearly all of which was readily available given the company's Singapore domicile; --$500 million undrawn RCF expiring Feb. 1, 2021. Fitch's expectation for $3 billion to $4 billion of annual FCF also supports liquidity. Pro forma for the senior notes offering and anticipated application of proceeds, total debt at Oct. 30, 2016 was: --$1.7 billion of senior unsecured Term Loan A; --$12 billion of senior unsecured notes with various maturities. The ratings and Outlook incorporate potential for Broadcom to flex up the senior notes offering but Fitch expects net proceeds would be used for additional Term Loan A reduction of pre-funding the Brocade acquisition. FULL LIST OF RATING ACTIONS Broadcom Cayman Finance Limited -- Long-term IDR Upgraded to 'BBB' from 'BBB-'; -- RCF affirmed at 'BBB'; -- Term Loan affirmed at 'BBB'. Fitch has assigned the following rating: -- Senior unsecured notes 'BBB'. Contact: Primary Analyst Jason Pompeii Senior Director +1 312-368-3210 Secondary Analyst David E. Peterson Senior Director +1 312-368-3177 Committee Chairperson William Densmore Senior Director +1 312-368-3125 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Date of Relevant Rating Committee: Jan. 10, 2017 Summary of Financial Statement Adjustments - Fitch made no financial statement adjustments that depart materially from those contained in the published financial statements of Broadcom Limited were made. 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