TEXT - S&P revises FTI Consulting outlook to negative
Overview -- West Palm Beach, Florida-based FTI Consulting plans to issue $300 million of senior unsecured notes due 2022. The company also plans to enter into a new $350 million revolving credit facility due 2017. -- We expect weakened operating performance and modest leverage reduction over the next 12 months, following a peak in leverage at year-end 2012. -- We are revising our rating outlook on FTI Consulting to negative from stable and affirming the corporate credit rating at 'BB+'. We are assigning a 'BB' issue-level rating and a '5' recovery rating to the proposed notes. We are not rating the revolver. -- The negative outlook reflects the possibility that we could lower our ratings on FTI Consulting if it becomes apparent that 2013 operating performance will be weaker than our expectation, causing debt leverage to exceed 3.0x-3.1x. -- Rating Action On Nov. 9, 2012, Standard & Poor's Ratings Services revised its rating outlook on FTI Consulting Inc. to negative from stable. The corporate credit rating remains at 'BB+'. At the same time, we assigned the company's proposed $300 million senior unsecured notes due 2022 our 'BB' issue-level rating (one notch below the corporate credit rating) with a recovery rating of '5', indicating our expectation of modest (10% to 30%) recovery for lenders in the event of a payment default. FTI Consulting will use the proceeds to refinance its existing $215 million senior unsecured notes due 2016 and repay outstanding revolver borrowings. As part of the transaction, FTI Consulting will enter into a new $350 million revolving credit facility due 2014. We are not rating the revolving credit facility. Rationale Our 'BB+' corporate credit rating on FTI Consulting is based on our expectation that debt leverage will stabilize to near 3x over the next 15-18 months through EBITDA growth and that covenant compliance will remain adequate. Pro forma for the proposed transaction, FTI Consulting will have substantial availability under its $350 million revolving credit facility and about $125 million of cash and cash equivalents as of Sept. 30, 2012. We view FTI's business risk profile as "fair" because of the company's dependence on highly mobile and sought-after senior staff, and some earnings variability associated with its restructuring practice. The restructuring practice is a significant contributor to the company's overall revenues and profitability, but its performance can exhibit volatility with business cycles. Positive factors including FTI Consulting's segment diversity, businesses not strictly tied to the economic cycle, and discretionary cash flow generation support our assessment. We view the company as having "significant" financial risk because of its aggressive acquisition growth strategy and financial policy. FTI Consulting has five main practice areas: forensics and litigation, corporate finance/restructuring, technology, economic consulting, and strategic communications. FTI Consulting's performance is highly dependent on its senior managing directors, whose expertise is sought by clients, and whose work commands high billing rates and often repeat engagements. Retaining these leaders is critical to the company's reputation and success. Although the company has been successful in retaining its most senior professionals, this will remain a key factor that we will continue to monitor. Maintaining high utilization of consultants and the ability to increase the hourly rate charged to clients are additional factors essential to profitability growth. FTI Consulting has kept utilization rates steady in recent years--about 70% to 80%, depending on the segment--by reassigning some employees to new projects in different business segments and reducing headcount to better match demand. The company has expanded its service offerings over the past few years through acquisitions, with increasing focus on certain specialized industries, such as energy, health care, and telecommunications. This strategy has further strengthened the company's competitive position. Under our base-case scenario, we expect 2012 revenue to decline at a low-single-digit percentage rate from 2011. In 2013 and 2014, we expect revenue increases at a low- to mid-single-digit percentage pace. We forecast 2012 full-year EBITDA to decline at a low- to mid-teen percentage rate because of staff reduction charges and weak performance in the technology, forensic and litigation consulting, and strategic communications segments. We expect low-teens percent EBITDA growth in 2013 (mainly as a result of the absence of significant restructuring charges) and mid-single-digit percent growth in 2014. We believe the restructuring, forensic litigation, and economic consulting practices will each grow in 2013 and 2014, which should offset further decline in the technology segment. We expect the EBITDA margin will recover somewhat over the next two to three years but remain in the mid-teens percentage area. Recovery to the low-20% level of 2009 is unlikely because of the current business mix (reduced weighting in technology) and competitive pressures that are contracting the technology segment's margins. The restructuring business performed better than expected through the first three quarters of 2012 as a result of opportunities in Europe and North America. This, combined with the growth of the economic consulting practice, largely offset softness at other business segments, particularly the technology segment. During the third quarter of 2012, revenues decreased 6.7% while EBITDA (excluding noncash special charges) fell 16.9%, reflecting higher personnel costs. The technology practice's EBITDA margin has declined over the past two years. The technology segment contributed about 18.5% of EBITDA for the 12 months ended Sept. 30, 2012, down from about 23% for 2011. FTI Consulting continues to see increased competition in the technology sector, which has led to lower prices and volume. The EBITDA margin has steadily declined over the past three years, and was 15.5% for the 12 months ended Sept. 30, 2012. The margin decline has been the result of one-time staff reduction expenses, pricing pressure in the technology segment, increased spending, higher compensation expenses, and lower margins at acquired businesses. Pro forma for the proposed transactions, for the 12 months ended Sept. 30, 2012, the ratio of total debt to EBITDA (including cash expenses to reduce workforce) was 3.2x, above our threshold of 3x for the company at the current rating. We expect leverage to rise modestly by the end of 2012 and then drop to close to 3x by year-end 2013. For the 12 months ended Sept. 30, 2012, pro forma EBITDA coverage of interest expense was 4.6x, and conversion of EBITDA to discretionary cash flow was 41%. We expect the conversion of EBITDA into discretionary cash flow for 2012 and 2013 to remain healthy, at around 50%. We expect FTI Consulting will continue to use its discretionary cash flow to fund acquisitions and stock buybacks. FTI Consulting is very acquisitive, having made numerous acquisitions since 2005. The company's goal is to increase its international revenue contribution to about 30% of consolidated revenue in two years. International operations are profitable, but their margins are typically lower than those in the U.S. because of scale. As of Sept. 30, 2012, FTI Consulting operated in 24 countries, accounting for 26% of total revenues, compared with 10 countries in 2006. Despite its success in incorporating acquisitions into the business, the company's aggressive acquisition strategy and integration risks remain potential negative factors. In June 2012, the company announced a $250 million share repurchase program to be executed over the next two years. The company generates good discretionary cash flow and has excess cash to finance both the buyback program and ongoing operating needs. As of Sept. 30, 2012, the company had repurchased $20 million of shares. We will continue to closely monitor the company's financial policy with regard to its share buybacks and sizable acquisitions. Liquidity FTI has adequate liquidity to cover its needs over the near-to-intermediate term, even in the event of moderate unforeseen EBITDA declines. Our assessment of FTI Consulting's liquidity profile incorporates the following expectations, assumptions, and factors: -- We expect sources to cover uses for the upcoming 12 to 24 months by 1.2x or more. -- We also expect cash sources will continue to exceed cash uses, even with a 20% drop in EBITDA over the next 12 months. -- The company has adequate covenant headroom for EBITDA to decline by 15% without breaching coverage tests. -- Because of the company's high conversion of EBITDA to discretionary cash flow, we believe it could absorb low-probability, high-impact shocks. -- In our opinion, the company has a generally high standing in the credit markets. Pro forma for the refinancing transaction, liquidity sources include a cash balance of about $127 million and substantial availability on the company's $350 million revolving credit facility. We expect about $130 million of discretionary cash flow in 2012 and $135 million in 2013. FTI Consulting's next debt maturity is the $350 million revolving credit facility, which matures in 2017. The proposed credit agreement contains financial covenants, including a maximum total and senior leverage ratio as well as a fixed charge coverage ratio. The 4x total debt leverage covenant steps down to 3.75x on March 31, 2016, and the 3x senior debt leverage covenant steps down to 2.75x on March 31, 2016. The maximum total leverage ratio is the most restrictive covenant. Based on our assumptions for 2012 through 2014, we expect the company to maintain an adequate margin of compliance over the near-to-intermediate term. While working capital usage can fluctuate with revenue growth, capital expenditures as a percentage of EBITDA are typically low, at between 9% and 12%, and should not impede cash flow generation. Recovery Analysis We are assigning a 'BB' issue level rating (one notch below our 'BB+' corporate credit rating on FTI Consulting) to the proposed senior notes, with a recovery rating of '5', indicating our expectation for modest (10% to 30%) recovery for lenders in the event of a payment default. Outlook The negative outlook reflects the possibility that we could lower our ratings on FTI Consulting if it appears that the company's 2013 performance will not meet our expectations, rendering year-end leverage above 3.0x-3.1x. We believe this would most likely occur as a result of accelerated declines in the technology segment, along with negative operating trends in the company's other businesses, and debt-financed acquisitions, combined with major share repurchases. We could also lower the rating if the EBITDA margin falls below 14%. We believe this could happen if the technology segment declines further as a result of increased competition and if the corporate finance/restructuring business experiences a steep decline in business. We could revise the rating outlook to stable if FTI Consulting were able to reduce and maintain debt leverage below 3x, while preserving adequate liquidity. Related Research And Criteria -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 Ratings List FTI Consulting Inc. Ratings Affirmed; CreditWatch/Outlook Action To From Corporate Credit Rating BB+/Negative/-- BB+/Stable/-- FTI Consulting Inc. New Rating $300 mil sr unsecd nts due 2022 BB Recovery Rating 5
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