Fitch Upgrades Convergys' IDR to 'BBB' from 'BBB-'; Outlook Stable.
--Long-term Issuer Default Rating (IDR) to 'BBB' from 'BBB-';
--Senior unsecured bank credit facility to 'BBB' from 'BBB-';
--Senior unsecured debt to 'BBB' from 'BBB-';
--Short-term IDR to 'F2' from 'F3';
--Commercial paper rating to 'F2' from 'F3'.
The Rating Outlook is Stable. Approximately $650 million of debt, including the $400 million undrawn credit facility, is affected by Fitch's action.
The ratings and Rating Outlook reflect Convergys':
--Strong credit protection measures;
--Solid liquidity, supported by a sizeable cash position and increasing free cash flow;
--Recurring revenue provided by long-term customer care contracts and billing software licenses, both of which also have significant switching costs; and
--Continued gradual reduction in customer and industry concentration with remaining customer concentration risk mitigated by staggered expiration dates for long-term contracts across its business segments. The Convergys' revenue base has expanded beyond its historical focus on the communications industry, resulting in substantial revenues from financial services, technology and government agencies. Fitch estimates that non-communication revenue has increased to nearly $1.1 billion, or 38% of total revenue, in the latest 12 months (LTM) ended March 31, 2007 from $773 million, or 31% of total revenue, in 2004.
Ratings concerns center on:
--Potential expansion of shareholder-friendly activities, primarily significant increases in share repurchases;
--Risk of material debt-financed acquisitions and resultant integration risk;
--Execution risk relating to the implementation of several significant Employee Care contracts, given the infancy of the human resources outsourcing (HRO) market, and scope and complexity of these worldwide contracts;
--Convergys' ability to minimize revenue and profitability pressures within the Information Management Group (IMG) following the loss of high profit margin data processing revenue from migrations of Cingular Wireless (Cingular), which was completed in the first quarter of 2007, and Sprint Nextel (Sprint currently rated 'BBB' with a Negative Rating Outlook), through continued growth in billing software license revenue and related professional services;
--Currency market risk exposure resulting in potential profit margin pressure in the Customer Care (CC) segment in the event of a significant long-term decline in the U.S. dollar since the majority of Convergys' long-term contracts are priced in U.S. dollars (USD) with substantial local currency costs, primarily Indian Rupee (IR), Canadian Dollar (CAD) and Philippine Peso (PP). Convergys has partially offset the financial affect through the use of long-term foreign currency forward contracts for all three foreign currencies and a currency call option on CADs with an aggregate notional value of $621 million as March 31, 2007. Fitch estimates the price of the IR, CAD and PP relative to the USD has appreciated approximately 14%, 8% and 17%, respectively, relative to the fixed delivery prices on Convergys' long forward contracts. Assuming the USD relative to these three currencies remains unchanged from current levels or continues to depreciation, the previously hedged portion of Convergys' foreign operating costs translated into USD will increase following the expiration of each forward contract through Feb. 2010, potentially pressuring profit margins.
Due to Convergys' solid free cash flow performance and relatively significant cash position, Fitch believes Convergys will be subject to increasing shareholder pressure to accelerate share repurchases. In the event of a leveraged buyout (LBO), Convergys bondholders have limited protection since the bond indenture lacks a change of control provision that would have otherwise enabled the bondholders to put the bonds to Convergys following a change of control. The indenture does include a limitation on liens covenant, which enables existing unsecured debt to be equally and ratably secure with any new secured debt funding incurred in an LBO in the event that total secured debt, excluding certain permitted liens, exceeds 5% of net tangible assets, or $78 million, as of March 31, 2007, according to Fitch's estimates.
Convergys' top three clients accounted for approximately 31% of total revenue for the quarter ended March 31, 2007 compared with nearly 33% in 2005 and 36% in 2004. As a result of its acquisition of Bell South Corporation (Bell South) in Dec. 2006, AT&T Inc. (AT&T - currently rated 'A' with a Stable Rating Outlook) replaced Cingular, previously a joint venture of AT&T and Bell South, as Convergys' largest client, representing 14.8% of total revenue for the quarter ended March 31, 2007. Convergys provides services to AT&T under IMG, Customer Care and Employee Care contracts. In the first quarter of 2007, Convergys completed the migration of Cingular subscribers off of the AT&T Wireless billing systems that Convergys previously supported onto two in-house systems. Convergys expects to continue to support Cingular's in-house system by providing management and support billing services. Also, Sprint, Convergys' second largest customer, terminated its data processing relationship with Convergys in Jan. 2006 with the intent of completing the migration of subscribers off of Convergys' systems by year-end 2007. Fitch believes the Sprint migration has proceeded significantly slower than anticipated, making it increasingly unlikely that the migration will be completed by year-end. Fitch estimates that Convergys' IMG group generated less than 4% of its total revenues from Sprint in 2006. However, Convergys continues to have a relationship with Sprint on the Customer Care business through a contract between IBM and Sprint whereby Convergys serves as a subcontractor to IBM.
Total debt for Convergys was $327.3 million as of March 31, 2007, primarily consisting of $250 million of 4.875% senior unsecured notes due Dec. 15, 2009 and borrowings from Canadian unsecured credit facilities totaling approximately $49 million, which were utilized for prior cash repatriation efforts. The remainder of total debt includes capital leases and international credit facilities of nearly $11 million. Total adjusted leverage, measured by total debt including operating leases and previous amounts outstanding under the Convergys' terminated accounts receivable securitization program to operating EBITDAR, improved to 2 times (x) as of March 31, 2007 versus 2.5x and 2.7x for year-end 2005 and 2004, respectively, due to improved profitability and elimination of borrowings under Convergys' A/R securitization facility following its termination on June 30, 2006.
As of March 31, 2007, Convergys' liquidity was solid, consisting of $277 million in cash, including $30 million of auction rate securities, an undrawn $400 million revolver expiring Oct. 2011, and relatively consistent free cash flow, which exceeded $200 million in both 2005 and 2006. For the LTM ended March 31, 2007, Convergys' free cash flow increased 31% to $257 million from approximately $196 million in the year ago period as a result of upper single-digit revenue growth, lower capital expenditures and improved working capital offset by gross margin pressure attributable to declining data processing revenues and losses incurred due to unanticipated delays in implementing several complex HRO contracts. Financial covenants for the bank facility consist of a maximum leverage ratio (debt/EBITDA) of 3.25x and minimum interest coverage (EBITDA/interest expense) of 4x.
Convergys has three operating segments: 1) Customer Care: Provides outsourced customer service, technical support, accounts receivable management, sales account management, business process outsourcing and business intelligence solutions, 2) IMG: Provides billing and information software and services that addresses various segments of the communications industry, including wireless, wireline, cable, cable telephony, broadband, direct broadcast satellite, and the Internet, and 3) Employee Care: Provides a range of HRO services, such as benefits administration, human resource administration, learning, payroll administration, and recruiting and staffing.
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|Date:||Jun 14, 2007|
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