-- Genpact Ltd. has a “fair” business risk profile and an “intermediate” financial risk profile.
-- We are assigning our ‘BB+’ corporate credit rating to Genpact, a U.S. listed business process outsourcing service provider.
-- We are also assigning our ‘BB+’ rating to the company’s proposed $925 million senior secured bank loan.
-- The stable outlook reflects our expectation that the company will sustain its operating performance and maintain financial discipline despite a one-time large dividend payout.
On Aug. 7, 2012, Standard & Poor’s Ratings Services assigned its ‘BB+’ long-term corporate credit rating to business process outsourcing (BPO) service provider Genpact Ltd. The outlook is stable.
At the same time, we assigned our ‘BB+’ issue rating to the company’s proposed $925 million senior secured bank loan facility including a $675 million seven-year term loan and a $250 million five-year revolver credit facility. We also assigned our recovery rating of ‘3’ to the loan to indicate our expectation of meaningful (50%-70%) recovery in the event of default.
The rating on the bank loan depends on our review of the final issuance documentation.
The rating on Genpact reflects the highly fragmented and increasingly competitive BPO industry. It also reflects the company’s significant segment concentration and high exposure to U.S.-based clients, whose outsourcing budgets and spending remain uncertain. In addition, we view the change in Genpact’s financial policies to increase its leverage in an asset-light industry as a rating weakness. The company announced a large one-time special dividend for 2012. Genpact’s good market position in finance and accounting services, higher value-added offerings, and stronger EBITDA margins compared with most peers’ moderate these weaknesses.
The intensifying competition in an already fragmented market characterizes the BPO industry. Competition comes from both domestic and international BPO service providers and larger integrated information technology (IT) players with growing BPO operations. Uncertainty surrounds outsourcing budgets and spending, particularly in the key markets of the U.S. and Europe, due to an economic slowdown and indirect effects of fiscal tightening. Genpact derives over 70% of its revenues from the U.S.
Genpact is exposed to high concentration in the banking, financial services, and insurance (BFSI) vertical. This segment accounts for about 48% of the company’s revenues after adjusting for its acquisition of Headstrong Corp. in 2011. Nevertheless, we note that Genpact estimates that 50% of the services it provides (such as for finance and accounting) are not specific to a particular vertical, which can slightly mitigate the risk.
We view Genpact’s client concentration risk as moderate despite the company’s top 10 clients (including General Electric Co.: GE; AA+/Stable/A-1+) contributing more than 50% of its revenues. This is based on diversified offerings to different entities of GE, which together account for 30% of revenues. Further, Genpact’s revenues from non-GE clients has been increasing, with the top 10 clients (excluding GE) together accounting for less than 25% of revenues. We estimate that Genpact’s top clients’ average credit quality is high (A category).
In our view, Genpact has an “intermediate” financial risk profile. We expect the company to maintain the ratio of funds from operations (FFO) to debt at 33%-35% and the ratio of adjusted debt to EBITDA of about 2.3x-2.5x over the next two years. We estimate its adjusted EBITDA margin to weaken due to wage inflation but still remain about 20% over the next two years. Genpact has private equity sponsors. Bain Capital Patners is scheduled to acquire 30% of Genpact from Oak Hill Partners and General Atlantic, which are the existing equity sponsors that together own 40% of the company. But we expect the company to strictly adhere to its financial policies (of a net debt-to-EBITDA ratio of 2x) and proposed financial covenants under the oversight of an independent board. We also expect Genpact to restrict its special dividend to 2012 as planned.
Genpact benefits from it market position as one of the leading players providing financial and accounting outsourcing services. We believe the company’s higher-value added offerings across segments compared with peers is a competitive advantage. This is reflected in Genpact’s EBITDA margin of about 20%, and revenue and EBITDA per employee, all of which are higher than that of most pure play BPO peers. The company’s 100% contract renewal rate provides stability to revenues. Management’s estimate of Genpact’s attrition rate of less than 25% is at the lower-end of the industry. We view this as a positive in the people-intensive BPO industry.
In our view, Genpact’s liquidity is “adequate”, as defined in our criteria. We expect the company’s liquidity sources to exceed its uses by about 1.2x for 2012, and by more than 1.2x in 2013. Our liquidity assessment is based on the following factors and assumptions:
-- Sources of funds include cash and short-term deposits of over $410 million as of March 31, 2012, and estimated FFO of $270 million in 2012.
-- Sources also include a proposed senior credit facility of $925 million including a senior term loan of $675 million and revolver of $250 million.
-- Uses of funds include a refinancing of the outstanding existing debt of $341 million, a one-time dividend payout of $500 million, and $150 million for potential unidentified acquisitions. The company will have negligible debt maturity in the next few years under the proposed term loan.
-- We believe the company would be able to meet its outflows even with a 15%-20% drop in its EBITDA.
We expect the proposed financial covenants to have adequate headroom. Genpact is a listed company with access to the U.S capital markets.
We believe any unexpected significant increase in the special dividend amount or acquisitions can put pressure on the liquidity. However, the proposed financial covenants should help enforce financial discipline with progressively increasing mandatory prepayments if the ratio of net debt to EBITDA is more than 2x.
The recovery rating is based on the favorable insolvency regime in the U.S. and a share pledge and guarantee by Genpact’s key operating and holding companies. Most of Genpact’s billing is in the U.S. through the borrowing entities. However, our recovery rating also factors in jurisdictional complexities. Most of Genpact’s operations are carried out of India, while the parent, various holding companies, and guarantors are based in different jurisdictions. In our view, customer relationship contracts and intellectual property rights are Genpact’s most valuable assets. In the absence of specific exclusions from pledging these assets, and despite effective negative liens, we view the overall creditor security as weak compared to our discounted cash flow estimates. Our estimate of recovery is based on a going-concern valuation. We believe that the company would reorganize rather than liquidate following a payment default, given its long-standing, attractive contracts and established delivery capabilities.
In our simulated hypothetical default scenario, a payment default could occur in mid 2019, when Genpact’s term loan falls due for payment. At the time of default, the stressed EBITDA would have fallen about 60% from the $300 million unadjusted EBITDA in 2011. We estimate Genpact’s enterprise value at the simulated point of default at about $0.7 billion. We expect about $907 million in outstandings in the year of default, including $880 million of loans and six months of estimated pre-petition interest.
The stable outlook reflects our expectation that Genpact will sustain its operating performance; generating about 20% EBITDA margins. We also expect the company to maintain financial discipline, despite a one- time large dividend payout and potential mid-sized acquisitions.
We may lower the rating if the company’s FFO-to-debt ratio falls below 30% and the ratio of adjusted debt to EBITDA increases to more than 2.75x. This may happen because of: (1) Genpact following a more shareholder friendly financial policy leading to further dividend payments or share buybacks; or (2) the company’s adjusted EBITDA margin dropping sharply to below 15%.
We believe an upgrade is unlikely over the next 12-18 months. Nevertheless, we may raise the rating if Genpact significantly improves its scale of operations, increasing the business diversity by reducing dependence on the BFSI vertical. The company should sustain its margins and maintain its financial ratios and financial policy in line with our current expectations.
Related Criteria And Research
-- Key Credit Factors: Methodology And Assumptions On Risks In The Global High Technology Industry, Oct. 15, 2009
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Credit FAQ: Knowing The Investors In A Company’s Debt And Equity, April 4, 2006 Ratings List New Rating
Corporate Credit Rating BB+/Stable/--
Genpact International Inc.
US$250 mil Revolving Credit BB+
Facility bank ln due 2017
Recovery Rating 3
US$675 mil Term Loan bank ln due BB+
Recovery Rating 3