January 3, 2018 / 2:35 PM / in 5 months

Fitch Assigns Barracuda First-Time 'B' IDR; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, January 03 (Fitch) Fitch Ratings has assigned a first-time Long-Term Issuer Default Rating (IDR) of 'B' to Barracuda Networks, Inc. The Rating Outlook is Stable. Fitch has also assigned a 'BB-'/'RR2' rating to the $75 million secured revolving credit facility (RCF) and $555 million first-lien secured term loan; and a 'CCC+'/'RR6' rating to the $205 million second-lien secured term loan. The proceeds, along with equity contributions from Thoma Bravo, and cash on the balance sheet will be used to fund the $1.6 billion acquisition that was announced on Nov. 27, 2017. Fitch's rating actions affect $835 million total debt, including the $75 million RCF. A complete list of rating actions follows at the end of this release. KEY RATING DRIVERS Product Range Supporting Small to Midsize Businesses (SMB) Segment: Barracuda offers products addressing a wide range of IT needs for SMB customers that generally have limited financial and technical resources dedicated to IT management. Its products include Next Generation Firewall, Web App Firewall, Email Security Gateway, Web Security Gateway, Security and Archiving for Office 365, and Backup/Data Protection. The availability of these products through both appliance- and cloud-based platforms enables its SMB customers to simplify IT security and data storage management. Fitch believes the breadth of products available positions Barracuda well in a segment that prefers simplicity over sophisticated solutions. Secular Tailwind Supports Growth: We believe two factors serve as the fundamental demand drivers. Barracuda's cloud-based solutions enable the company to benefit from the steady pace of IT workload migrating from on-premise infrastructure to the cloud. In addition, increasing awareness of IT security threats is leading companies to allocate more resources to protecting their networks and data; some of the high-visibility IT security breaches include data breaches and ransomware that could be costly or cause damage to a company's reputation. High Revenue Retention Rate: Barracuda has maintained a high subscription-revenue retention rate of over 100% for four of the last five fiscal years and that demonstrates its ability to retain active subscribers and upsell additional products. Fitch believes the high level of retention rates generally lead to high level of revenue predictability. Diversified Customer Base: Consistent with the fragmented nature of the SMB segment, Barracuda serves a large set of customers, with approximately 180,000 customers, including 16,000 that use more than three products. Fitch believes the diverse customer base could partially mitigate inherent risks in the SMB segment through the economic cycles. Susceptible to Industry Cyclicality: Barracuda is susceptible to IT security industry cycles, as illustrated by its FY2017 and first half FY2018 (1H18) slowdown in revenue growth. Fitch believes the weakness may have been the result of strong growth in the previous years coinciding with the heightened IT security awareness that propelled overall industry growth. We view the current industry environment as normal and a more realistic base for assessing future growth potential. Nevertheless, Barracuda's focus on IT and data security will continue to expose the company to industry cyclicality. Leverage to Remain Elevated: Pro forma for cost savings and the leveraged buyout by Thoma Bravo, gross leverage will be elevated at 7.2x for FY2019, in line with peers in the 'B' rating category; Fitch expects this to trend down to below 5.5x by FY2021. In addition to debt issuance, Thoma Bravo will be making $715 million in equity contributions; Fitch believes this demonstrates Thoma Bravo's commitment and confidence in the industry and the company. Barracuda has a history of acquiring complementary technologies and products, the most recent being Sookasa and Sonian; Fitch believes the company will remain acquisitive in order to keep pace with the fast-moving industry, limiting its deleveraging to primarily EBITDA growth. DERIVATION SUMMARY Fitch's ratings are supported by Barracuda's focus on IT and data security for the SMB segment and the secular growth trend for the IT security industry. Barracuda's wide range of products are primarily offered as cloud-based, making them easily accessible and manageable by SMB customers that prefer simplicity over sophistication in IT security, as is reflected by its over 180,000 customers. The subscription nature of the products and high revenue retention rates provide a high level of predictability for its revenues. Predictability is marginally tempered by the risks inherent to the SMB segment that Barracuda is exposed to through the economic cycles. At the IT security industry level, Fitch believes the heightened awareness of IT security risks arising from high-profile security breaches in recent years provides support for the secular growth of the industry. The announced $1.6 billion acquisition by Thoma Bravo will be financed with $760 million in term loans, equity contribution from Thoma Bravo, and cash on the balance sheet at closing. Fitch forecasts Barracuda's gross leverage for FY2019 to be 7.2x, gradually declining to below 5.5x by FY2021. Barracuda's industry expertise, revenue scale, and leverage profile are consistent with the 'B' rating category. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer: --Revenue growth in the high single digits; --EBITDA margins in the mid-to-high 20% range after completion of cost reduction measures; --Capex at approximately 2.3% of revenue, consistent with historical trend; --Acquisitions averaging $20 million per year for FY2019-2021, enabling the company to expand product lines and technologies; --No dividend payment through our forecast period. In estimating a distressed enterprise value (EV) for Barracuda, Fitch assumes that in a distressed scenario, customers may elect to switch to competing service providers, leading to revenue decline and margin compression on a reduced scale; resulting in going-concern EBITDA that is approximately 15% lower compared to LTM EBITDA. Fitch applies a 6.5x multiple to arrive at EV of $512 million. In the 13th edition of Fitch's Bankruptcy Enterprise Values and Creditor Recoveries case studies, Fitch notes seven past reorganizations in the Technology sector with recovery multiples ranging from 2.6x to 8.4x. Of these companies, only two were in the Software sector, Allen Systems Group, Inc. and Aspect Software Parent, Inc., which received recovery multiples of 8.4x and 5.5x, respectively. Fitch believes Barracuda's operating profile supports a recovery multiple in the middle of this range. In the current transaction to acquire Barracuda, Thoma Bravo is valuing the company at approximately 17x EBITDA; we believe the high acquisition multiple also supports our recovery multiple assumption. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action: --Expectation for gross leverage sustaining below 5.5x; --Pre-dividend FCF margins sustaining above 10%; --Organic revenue growth sustaining near or above 5%. Developments that May, Individually or Collectively, Lead to Negative Rating Action --Expectation for gross leverage sustaining above 7x, possibly due to debt-financed acquisitions or dividend payment to owners; --Pre-dividend FCF margins sustaining below 5%; --Organic revenue growth sustained near or below 0%. LIQUIDITY Fitch expects the company's liquidity to remain solid over the forecast period. Pro forma for the Thoma Bravo transaction, liquidity will be supported by internal FCF generation, a new $75 million RCF, and over $75 million of readily available cash and cash equivalents post-closing. Barracuda's FCF is supported by normalized EBITDA margins of approximately 25%; Fitch estimates FCF to be initially curbed in large part by restricted stock unit payout, and FCF margins to gradually normalize near 10% and approach $50 million at the end of our forecast period. FULL LIST OF RATING ACTIONS Fitch has assigned the following ratings: Barracuda Networks, Inc. --Long-Term Issuer Default Rating 'B'; Outlook Stable; --$75 million first-lien secured revolving credit facility 'BB-'/'RR2'; --$555 million first-lien secured term loan 'BB-'/'RR2'; --$205 million second-lien secured term loan 'CCC+'/'RR6'. Contact: Primary Analyst Alen Lin Senior Director +1 312-368-5471 Fitch Ratings, Inc. 70 W 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; Benjamin Rippey, New York, Tel: +1 646 582 4588, Email: benjamin.rippey@fitchratings.com. Additional information is available on www.fitchratings.com. 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