U.K. Provider Of Payroll And HR Software Colour Bidco Ltd. Assigned #B# Outlook Stable

Stocks and Financial Services Press Releases Friday February 9, 2018 18:21
FRANKFURT--9 Feb--S&P Global Ratings

FRANKFURT (S&P Global Ratings) Feb. 9, 2018--S&P Global Ratings said today that it assigned its 'B' long-term issuer credit rating to Colour Bidco Ltd., the ultimate parent of NGA UK, a leading provider of payroll and human resources (HR) software services in the U.K. small and mid-sized enterprise (SME) market. The outlook is stable.

At the same time, we assigned our 'B' issue rating to the senior secured term loan due 2024 that Colour Bidco issued. The recovery rating of '3' indicates our expectation of meaningful (50%-70%; rounded estimate: 55%) recovery in the event of a default.

The ratings are in line with the preliminary ratings we assigned on Nov. 8, 2018 (see "U.K.-Based Provider Of Payroll And HR Software Colour Bidco Ltd. Assigned Preliminary 'B' Ratings; Outlook Stable," published on RatingsDirect.)

Our rating on Colour Bidco primarily reflects our view of the company's highly leveraged capital structure following Bain Capital's planned acquisition of NGA UK through a carve-out from Northgate Information Solutions Ltd. We take into account the company's S&P Global Ratings-adjusted leverage of 7.1x debt to EBITDA and its relatively limited scale and scope in comparison with peers. However, we also factor in Colour Bidco's well-established niche market position in the U.K.'s fragmented payroll and HR software service market, its good profitability--with adjusted EBITDA margins of about 31%-32% and solid free operating cash flow (FOCF) generation, resulting in an adjusted FOCF-to-debt ratio of above 5%.

Colour Bidco provides integrated HR information system software, which is delivered on premise or as software as a service (SaaS), as well as payroll and business process outsourcing services mainly in the mid-market (MM) segment in the U.K. and Ireland but also including a few larger corporates in its client base. Its main product is "ResourceLink." The company also provides payroll services and web-based HR assistance for SMEs.

In our view, the company's business risk profile is primarily constrained by NGA UK's small scale compared with that of rated peers and limited geographic diversity, since it operates only in the U.K. and Ireland. In fiscal year 2017 (ended April 30), NGA UK generated about GBP138 million of revenues and about GBP50 million of EBITDA. The business risk profile is further constrained by its narrow specialization on HR and payroll products, where the market is very competitive and fragmented with only modest entry barriers, in our view. While NGA UK's payroll software solutions are critical to customers' operations, in our opinion, they are arguably not as embedded in customers' IT strategy as software supporting revenue generation, for instance. NGA UK's customer base also exhibits some customer concentration because the 10-largest customers accounted for about 25% of revenues in fiscal 2017.

This is partly offset by NGA UK's solid EBITDA margins of higher than 30% and good cash conversion. The business risk profile further benefits from a leading position in the HR and payroll services in the U.K. According to management, NGA UK held approximately 19% market share for its MM segment in fiscal 2017, which is twice the market share of the second player in this segment, and about 8% for its small and medium business division. Furthermore, NGA UK's relatively high proportion of recurring revenues provides good visibility on future earnings. In fiscal 2017, 85% of NGA UK's revenues were recurring. The company has a meaningful SaaS penetration among its existing client base, and, based on the company's projections and our forecasts, this share should increase steadily over fiscal 2018-2021.

Our financial risk profile assessment reflects NGA's highly leveraged pro forma capital structure and our expectation that Bain Capital will likely pursue an aggressive financial policy. We consequently calculate NGA UK's leverage on a gross debt basis. We also add to our debt calculation for NGA UK about GBP40 million unfunded pension obligations and adjusted EBITDA for capitalized development costs (about GBP8 million in fiscal 2018). As a result, we estimate that, at the transaction's closing, the company's S&P Global Ratings-adjusted debt-to-EBITDA ratio will be about 7.1x and remain above 6.0x during fiscal years 2018-2020. In addition, we estimate that the ratio of funds from operations (FFO) to debt will be about 8% on a pro forma basis in fiscal 2018 and below 10% in fiscal years 2019-2020.

In our view, NGA UK benefits from relatively good cash conversion thanks to low capital expenditure (capex) requirements, excluding capitalized expenses for research and development (R&D), and limited working capital requirements due to a large recurring revenue base with upfront annual billing. We anticipate solid annual FOCF generation of about GBP20 million-GBP25 million in fiscal years 2018-2020, which corresponds to our forecast adjusted FOCF-to-debt ratio of about 6%-8% over the same period. Nevertheless, this excludes about GBP4.9 million annual contributions to the company's pension plan. Furthermore, under our base case, NGA UK maintains solid EBITDA interest cover of more than 3x in 2019 and 2020 (assuming a full year of interest for fiscal 2019).

In our base case, we assume:
Revenue growth of about 2%-4% in fiscal years 2018 and 2019, mainly stemming from cross and up-sell opportunities within its existing client base and further SaaS transition.

Adjusted EBITDA margin of about 31%-32% in fiscal years 2018 and 2019, after our estimate of about 33% in fiscal 2017, primarily due to additional overhead following the carve-out. We expect a modest margin improvement thereafter, due to some offshoring and further cost saving initiatives.

Modest capex of about GBP1 million-GBP2 million annually (excluding capitalized R&D expenses).
Cash taxes of about GBP3.5 million-GBP5.0 million in fiscal years 2018 and 2019.
About GBP4.9 million contracted cash outflow for pension obligation funding.
No acquisitions.Based on these assumptions, we arrive at the following credit measures:

Adjusted debt to EBITDA of about 7.1x at closing of the transaction in fiscal 2018, declining to just above 6.0x over the next two years, mainly due to EBITDA growth and the additional funding of the pension obligations.

Adjusted FFO to debt of about 8.5%-9.0% in fiscal years 2019 and 2020, compared with our estimate of about 8.0% in 2018 on a pro forma basis.
Adjusted cash from operations to debt of 7.0%-8.5% in fiscal years 2018 and 2020
Adjusted FOCF to debt of 6%-8% in fiscal years 2019 and 2020.

EBITDA cash interest cover of 2.5x–3.0x in fiscal years 2019 and 2020.The stable outlook reflects our expectation that NGA UK will successfully maintain or expand its well-established market position and achieve organic revenue growth of 2%-4%, with adjusted EBITDA margins of more than 30%. We think this will enable NGA UK to generate positive FOCF generation of about GBP20 million over the next 12 months. We expect that S&P Global Ratings-adjusted debt to EBITDA will remain well above 6x in fiscal 2019.

We could lower the rating if the company's revenues and EBITDA margins start declining due to meaningful customer losses or heightened competition. We would also consider a negative rating action if we saw an increase in leverage to more than 7.5x or if the FOCF-to-debt ratio fell to below 5%. This could materialize through a worsening of the company's operating environment or a sizable debt financed acquisition, which we do not assume under our base case.

Although unlikely at this point, we could consider an upgrade if NGA UK was able to materially deleverage beyond our current base–case expectations. Specifically, we would consider a positive rating action if S&P Global Ratings-adjusted debt to EBITDA fell below 5.5x and if the FOCF-to-debt ratio increased to above 10%. An upgrade would be subject to our view that these credit metrics are sustainable.


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