TEXT-S&P rates Avaya's term loan, secured notes 'B'
-- U.S. telecommunications solutions provider Avaya Inc. has proposed a term loan B-5 due 2018 and the issuance of secured notes due 2019. The proposed debt will refinance and extend maturities for a portion of Avaya's outstanding B-1 term loan due 2014. -- Standard & Poor's Ratings Services assigned both the term loan and notes its 'B' issue rating with a recovery rating of '2'. In addition, we are affirming our 'B-' corporate credit rating on the company. -- The stable rating outlook reflects our view that the company's operating trends will begin to stabilize during 2013. Rating Action On Dec. 18, 2012, Standard & Poor's assigned Basking Ridge, N.J.-based Avaya Inc.'s proposed term loan B-5 due 2018 and proposed secured notes due 2019 its issue-level rating of 'B' (one notch higher than our 'B-' corporate credit rating on the company) with a recovery rating of '2', indicating our expectation of substantial (70%-90%) recovery for lenders in the event of a payment default. The B-5 term loan will amend and extend a portion of the company's B-1 term loan due 2014. The proposed secured notes will refinance a portion of the B-1 term loan. Both the notes and the loan have a springing maturity of July 2015, conditioned on net leverage, the occurrence of an IPO, or repayment or refinancing of at least $750 million of outstanding notes due 2015. In addition, we are affirming our 'B-' corporate credit rating on Avaya, with the expectation that the company's operating trends will begin to stabilize during 2013 and that it will make progress over the coming year in addressing its maturity profile for 2014-2015. The rating outlook is stable. All existing issue-level ratings on the company's debt also were affirmed, and the existing recovery ratings on this debt remain unchanged. We note, however, that our recovery estimates are currently at the low end of their respective recovery ranges. In the event of a modest diminution of our recovery estimates, our issue ratings on the company's secured debt could be lowered to the same level as or below the corporate credit rating, and the issue ratings on the senior unsecured debt could be lowered to two notches lower than the corporate credit rating. Rationale Avaya reported a 7% year over year revenue decline and negative free cash flow of $84 million for the 12 months ended September 2012. Although the September quarter marked the third consecutive quarter of year-over-year top-line declines, we expect that revenues will begin to stabilize during 2013, supported by recent restructuring initiatives, as well as the company's recent resolution of certain product quality issues. We assess Avaya's business risk profile as "weak," based on the company's challenge to reestablish consistent growth in its core markets of enterprise communications. We note that revenue trends have been volatile over the past several years due to competing technologies, sluggish economies, deferred technology purchases by the U.S. government, and company-specific product quality miscues, which collectively contribute to its lackluster revenue performance. The company's solid position in the customer premises communications industry, as well as a good base of recurring services and maintenance revenues, however, somewhat offset these weaknesses. We expect EBITDA for the next 12 months to be flat to slightly up from $810 million for the 12 months ended Sept. 30, 2012, which treats certain restructuring charges as operational expenses. Free cash flow is likely to remain negative over the next 12 months, as we expect earnings growth to remain elusive and as residual restructuring charges related to rightsizing operations continue, albeit below prior-year levels. We consider the company's financial risk profile to be "highly leveraged" and we view Avaya's management and governance as "fair." Leverage for the company is very high, at about 9.3x for the 12 months ended Sept. 30, 2012, including underfunded pension adjustments and operating lease adjustments. Avaya had about $1.8 billion underfunded pension obligations at Sept. 30, 2012, up slightly year over year. Liquidity We believe Avaya has "adequate" liquidity over the next 12 months. On Sept. 30, 2012, cash amounted to $337 million and the company had collective availability of about $450 million under revolving credit facilities due 2016. We expect cash uses to include about $450 million of cash interest expense (which increases modestly pro forma for the current debt offering), $120 million of capital expenditures, $170 million of pension funding, and about $150 million of cash restructuring costs over the coming 12 months. We believe that current cash balances, coupled with access to existing lines of credit, are adequate to support operations, despite our view that discretionary cash flow is likely to remain modestly negative over the next 12 months. Beyond that time frame, maturities present a continuing challenge that the current proposed issues will mitigate. Following this transaction, roughly two-thirds of the company's funded debt matures during 2014 and 2015, absent satisfaction of covenant conditions to extend maturities. Other factors in our liquidity assessment include: -- Our expectation that cash sources will exceed uses by 1.2x for the next 12 months, and that net sources will be positive in the near term, even with a 20% decline in EBITDA; -- Avaya's benefit from the absence of performance covenants throughout its capital structure; -- The company has no significant debt maturities until October 2014; and -- An expectation for continued modest cash-funded acquisition activity. Outlook The rating outlook is stable. We expect that restructuring charges will diminish over the coming year, EBITDA growth will resume from current levels, and that the company will revive a path toward positive free cash flow and be positioned to continue to address its 2014-2015 maturity profile. A downgrade would likely be the result of a sustained deterioration in operating trends, causing EBITDA generation to decline, free cash flow to remain negative or weak, or cash balances to erode below $200 million, which would heighten refinancing risk for the 2014-2015 maturities. We will not consider an upgrade until Avaya has considerably reduced leverage, to a debt-to-EBITDA level of below 7x on a sustained basis, and makes further progress in addressing its maturity profile beyond this coming year. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Ratings List Ratings Affirmed Avaya Inc. Corporate Credit Rating B-/Stable/-- Senior Secured B Recovery Rating 2 Senior Unsecured CCC+ Recovery Rating 5 New Ratings Avaya Inc. Secured term loan B-5 due 2018 B Recovery Rating 2 Secured notes due 2019 B Recovery Rating 2 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. 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