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Fitch Rates ACCO's Proposed Unsecured Notes 'BB'/'RR4'

Published 02/03/2021, 01:24 am
Updated 02/03/2021, 01:30 am
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(The following statement was released by the rating agency) Fitch Ratings-New York-01 March 2021: Fitch Ratings has assigned a 'BB'/'RR4' rating to ACCO Brands Corporation's proposed $650 million of senior unsecured notes. The notes will be issued by ACCO Brands Corporation and will rank pari passu with all existing and future senior indebtedness of the company. Proceeds of the issuance will be used to refinance the company's existing $375 million of 5.25% unsecured notes due 2024 and repay a portion of the drawings under the company's revolving credit facility as well as pay related fees and expenses. At Dec. 31, 2020, the company had $332.6 million drawn on its revolver following its purchase of PowerA for upfront consideration of $340 million plus transaction expenses or around 7x projected EBITDA. Fitch estimates gross leverage (gross debt/EBITDA), pro forma for the transaction, of approximately 4.6x, modestly above Fitch's downgrade sensitivity of 4.0x. However, assuming a partial rebound in the base business in 2021 and FCF deployment toward debt reduction, gross leverage could trend toward the mid-3x in 2021. ACCO's 'BB'/Stable ratings reflect the company's historically consistent FCF and reasonable gross leverage, which trended around 3x prior to operating challenges in 2020 related to the coronavirus pandemic. The ratings are constrained by secular challenges in the office products industry and channel shifts within the company's customer mix, as well as the risk of further debt-financed acquisitions into faster-growing geographies and product categories. The company has taken actions over the last few years to manage costs given pressures on U.S. organic growth and has executed well on diversifying its customer base toward higher-growth channels, as well as international markets. The acquisition of PowerA, which sells accessories for the fast-growing video gaming market, is an example of ACCO's good diversification strategy. The impact of the pandemic, including more remote work and remote education activity as well as reduced corporate spending on ACCO's product assortment, drove 2020 EBITDA to around $200 million from $290 million in 2019. Fitch expects a modest rebound toward around $230 million in 2021, with total EBITDA projected around $280 million including a $50 million contribution from the PowerA acquisition. Despite near-term pressures, Fitch expects FCF after dividends of at least $100 million annually, with FCF expected to be deployed toward debt reduction. Key Rating Drivers PowerA Acquisition: In December 2020, ACCO closed on the acquisition of PowerA, a manufacturer of video game accessories, including controllers, audio peripherals and storage accessories, from Bensussen, Deutsche & Associates. The company has licensee arrangements with well-known gaming brands like Nintendo, Xbox and Playstation. The approximately $340 million purchase price plus transaction expenses and working capital investments represents a 7x multiple on estimated 2020 EBITDA of $50 million; revenue in 2020 is estimated in the $200 million range. Assuming some recovery in ACCO's existing business in 2021, PowerA would represent around 10% and close to 20% of pro forma revenue and EBITDA, respectively. ACCO has not projected operating synergies as PowerA is expected to operate mostly independently from the incumbent business. Fitch views the acquisition positively as it provides ACCO some business diversification into a category that is expected to provide good growth. Per ACCO, PowerA's revenue has grown at a 40% CAGR since 2015 and is estimated to have grown around 23% in 2020. Assuming around 10% growth annually, PowerA could support ACCO's top-line expansion by approximately 1% annually. Around 75% of PowerA's revenue is generated in the U.S., compared with around 43% for ACCO's existing business in North America, and could therefore modestly increase ACCO's North America presence. The multiple of 7x projected 2020 EBITDA appears reasonable given the company's historical growth trajectory. ACCO financed the PowerA acquisition largely through a draw on its revolver, which it plans to partly pay down with the proceeds of the current bond offering. Fitch estimates pro forma gross leverage at the end of 2020 at approximately 4.6x, assuming approximately $200 million of EBITDA in the base business and an estimated $50 million EBITDA contribution from PowerA. In 2021, leverage could improve toward the mid-3x range as base business EBITDA recovers from pandemic-related challenges and FCF is deployed toward debt reduction. ACCO has suspended share buybacks and Fitch believes the company could generate around $120 million in annual FCF beginning 2021, after dividends of approximately $25 million or $0.26 per share. Coronavirus Pandemic: ACCO has seen a significant decline in demand for its products in 2020 due to remote work and education arrangements and potential corporate spending pullbacks as companies reduce operating expenses. Revenue in 2020 declined approximately 15% to $1.66 billion from $1.96 billion in 2019. The company has shown good cost control, with operating expenses projected down approximately 12% in 2020. However, gross margins declined over 260bps for the full year on unfavorable product mix, yielding a 30% EBITDA decline to $198 million from $291 million in 2019. FCF in 2020 was around $100 million, down from nearly $150 million in 2019 due to EBITDA declines, somewhat mitigated by lower cash taxes and capex. Fitch expects ACCO's base business to rebound somewhat in 2021, as remote work and education arrangements subside. However, ongoing economic challenges could still cause ACCO's commercial customers to limit spending on categories like office and business products. In addition, acceptance of remote work arrangements longer term could limit ACCO's ability to fully rebound to pre-2020 revenue levels. Fitch projects ACCO's standalone sales could improve around 6% to $1.74 billion, with EBITDA rebounding toward $230 million. Revenue and EBITDA growth could be flattish to modestly positive in 2022. FCF could remain around $120 million annually as EBITDA growth is mitigated by higher taxes and capex. Early in 2020 the company suspended share buybacks and indicated its intent to use FCF toward debt reduction. On a standalone basis, Fitch estimates ACCO's leverage to be around 4.0x in 2020 relative to the 3x average over the past four years given EBITDA declines. Limited Organic Industry Growth: The office products industry is experiencing a slow secular decline in mature markets due to a shift toward digital technologies, partially offset by growth in emerging markets. ACCO is also managing a continued shift in channel revenue away from traditional office product superstores such as Staples and Office Depot, and traditional office supply wholesalers towards discounters, e-commerce retailers and the independent channel. These customers have also increased their direct sourcing efforts to grow private label penetration, creating more competition for ACCO's largely branded product portfolio. While ACCO benefits from its market-leading position, the company has been affected by industry pressures. ACCO's U.S. revenue (43.0% of net revenue in 2019) declined 1.5% on a four-year CAGR basis in 2015-2019; operating income declines were modestly higher at 3.6%. Fitch expects flattish to modestly negative growth will continue over the medium term, after the near-term impacts of the coronavirus pandemic. ACCO's international revenue penetration increased to 57% in 2019 compared with 40% in 2015, largely due to acquisitions. Fitch expects modest organic growth in ACCO's international portfolio, given a more favorable secular backdrop coupled with ACCO's ability to expand its geographic and product reach from its current revenue base. ACCO's customer concentration has somewhat eased in recent years, with ACCO's top 10 customers accounting for 42% of revenue in 2019 compared with 56% in 2016. The decline is due to both retail market share shifts and ACCO's proactive efforts to diversify its portfolio through M&A activity. Fitch expects ACCO to continue to seek opportunities to reduce its reliance on traditional office products markets and channels. The proposed PowerA acquisition is an example of these efforts. Acquisitions Drive Growth and Diversification: Given secular challenges in some of ACCO's primary categories and markets, the company has acquired several businesses over the last few years to capitalize on growth in new markets and faster-growing adjacent categories. The acquisitions have contributed to ACCO's revenue growth, margin expansion due to greater scale and improved geographic and customer diversity. The purchase of PowerA is an example of ACCO adding a higher-growth category -- video gaming -- to its business portfolio. In August 2019, ACCO acquired Foroni, a Brazilian manufacturer and marketer of notebooks and other paper products for schools and offices, for $50 million including the assumption of debt. In July 2018, ACCO purchased GOBA, a producer of school and craft products sold under the Barrilito brand in Mexico, for $37 million. These transactions were financed with cash on hand. In February 2017, ACCO acquired Esselte, a predominantly European-focused seller of office machines and organizational products, for $333 million. Annual cost savings from this acquisition exceeded $30 million and this business line contributed $50 million of incremental FCF (of the consolidated total of $147 million) in 2019. In May 2016, ACCO closed the acquisition of the remaining 50% of Pelikan Artline Pty Limited, its joint venture company serving the Australian and New Zealand markets, as well as a buyout of a minority interest in a subsidiary of the joint venture. Strong Expense and Balance Sheet Management: ACCO maintains a tight focus on its cost structure, which has enabled the company to improve profitability in a difficult operating environment. In the U.S., the company continues to reallocate sales efforts to higher-margin independent retailers (who tend to sell higher-price-point, higher-margin products but have a higher cost to serve as well) and away from the declining, lower-margin office superstore channel. Meanwhile, the company's selling, general & administrative expense margin has remained relatively steady in the low-19% range in recent years despite sluggish organic growth and fixed cost inflation. The company's ongoing focus on cost reductions has protected EBITDA in the face of its top-line challenges. ACCO's good balance sheet management is a positive factor in its credit profile. While the company occasionally makes debt-financed acquisitions to optimize its portfolio, the company has demonstrated a willingness to manage its leverage through debt reduction following a transaction, in line with its public commitment to maintain net debt to EBITDA around 2.5x (similar on a gross leverage basis given minimal cash balances). Over the four years prior to 2020, gross leverage has trended at 3x, with approximately $100 million of debt reduction in 2018/2019 following the debt-financed Esselte acquisition in 2017. Derivation Summary ACCO's 'BB'/Stable rating reflects the company's good position in the global office and business products industry. The ratings are constrained by secular challenges in the office products industry in North America, Europe and Australia. The company has taken steps over the last few years to manage costs given pressures on U.S. organic growth and has executed well on diversifying its customer base toward higher-growth, higher-margin channels in North America as well as acquisitions in better-performing categories and international markets. The rating also reflects ACCO's good balance sheet management, which has led to gross leverage trending around 3.0x over time. Including a full year contribution from the PowerA acquisition, Fitch projects 2021 gross leverage could trend in the mid-3x, below Fitch's downgrade sensitivity of 4.0x. ACCO is similarly rated to Spectrum Brands, Inc. (BB/Stable), Central Garden and Pet Company (BB/Stable), Tempur Sealy International, Inc. (BB/Stable), and Levi Strauss & Co. (BB/Negative). Spectrum Brands, Inc.'s 'BB' rating reflects the company's diversified portfolio across products and categories with well-known brands, and commitment to maintain leverage (net debt/EBITDA) at or below 3.5x, which equates to a similar gross debt/EBITDA target assuming around $150 million in cash. The rating also reflects expectations for modest organic revenue growth over the long term, reasonable profitability with an EBITDA margin near 15% and positive FCF. These positive factors are offset by recent profit margin pressures across segments and the company's acquisitive posture, which could cause temporary leverage spikes following a transaction. Finally, the rating considers expected near-term business challenges relating to the impact of the coronavirus on Spectrum's manufacturing capabilities, and the impact of a consumer recession on Spectrum's operating segments like hardware and home improvement. Central Garden & Pet Company's 'BB'/Stable rating reflects the company's strong market positions within the pet and lawn and garden segments, ample liquidity supported by robust FCF and moderate leverage offset by limited scale with EBITDA below $300 million. Fitch expects modest organic revenue growth over the medium term supplemented by acquisitions, with EBITDA margins in the 10% range. Gross leverage (total debt/EBITDA) is expected to trend in the 3.0x to 3.5x range, up from 2.6x in fiscal 2020 (ended September) as the company manages leverage in this range over time. Tempur Sealy International, Inc's 'BB'/Stable ratings reflects its leading market position as a vertically integrated global bedding company with well-known, established brands across a wide variety of price points offered through broad distribution channels. The ratings are tempered by the single product focus in a highly competitive, fragmented market that is exposed to potential pullbacks in discretionary consumer spending during periods of macroeconomic weakness. In addition, the mattress industry has been susceptible to periods of irrational pricing, secular shifts in consumer preferences and bankruptcies in both the supplier and distribution side. Over time, Fitch expects the company to manage gross leverage within its targeted range of less than 3x, diverting FCF toward shareholder returns and opportunistic acquisitions. Levi's 'BB' IDR reflects the significant business interruption resulting from the coronavirus pandemic and changes in consumer behavior, which have materially reduced sales of apparel, while the Negative Outlook reflects uncertainty regarding the timing and magnitude of a recovery in operating momentum. Adjusted leverage increased to approximately 6.0x in fiscal 2020 (ended November 2020) from 3.1x in fiscal 2019 as EBITDA declined to approximately $360 million from approximately $750 million in fiscal 2019 on a nearly 23% sales decline to $4.45 billion. Adjusted leverage is expected to be in the high-3.0x in fiscal 2021, assuming sales and EBITDA declines of around 12% from fiscal 2019 levels. Increased confidence in Levi's ability to achieve Fitch's projections and bring adjusted leverage to under 4x would lead to a stabilization in Fitch's Ratings Outlook. Key Assumptions Fitch's Key Assumptions Within the Rating Case for the Issuer --Following a decline of around 15% in 2020, organic revenue could expand around 6% to $1.74 billion in 2021 as remote work and education arrangements ease. Including the contribution from the PowerA acquisition, total 2021 revenue could be around $2 billion. Organic revenue growth could be in the low single digits in 2022 as ACCO is expected to continue to benefit from improving macroeconomic conditions; --EBITDA margins, which declined from approximately 15% in 2019 to 12% in 2020, could rebound to the low-to-mid 14% range on the rebound in sales and the margin accretive impact of the PowerA acquisition. In 2021, legacy ACCO EBITDA could expand to around $230 million as sales rebound, with PowerA adding approximately $50 million in EBITDA. EBITDA in 2022 could grow modestly alongside top-line expansion; --FCF after dividends, which was $147 million in 2019, declined to around $100 million in 2020 as the drop in EBITDA was only partially mitigated by lower cash taxes and capex. FCF is projected to be in the $120 million range beginning 2021, as EBITDA growth is mitigated by higher taxes and capex; --The acquisition of PowerA is expected to have a modestly positive impact on ACCO's FCF in 2021 and 2022, in the range of $10 million to $15 million annually. Fitch expects ACCO will deploy FCF toward debt reduction but could resume its share buyback program at some point in 2021. Dividends are projected at around $25 million, or approximately $0.26 per share, in line with ACCO's history; --Gross debt/EBITDA, which averaged around 3x over the past four years, increased to the 4x area in 2020 excluding the revolver draw at year end to fund the PowerA acquisition. Pro forma for the acquisition, leverage is approximately 4.6x, assuming a $50 million EBITDA contribution. Gross leverage could return to the mid-3x by 2021 assuming an EBITDA rebound at the legacy business and some FCF deployment toward debt reduction. RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: --An upgrade beyond 'BB' is possible if the company makes favorable acquisitions that change its business mix toward less cyclical or higher growth prospects while maintaining total debt/EBITDA below 3x. However, an upgrade is not anticipated in the near term given existing business model and industry issues. Factors that could, individually or collectively, lead to negative rating action/downgrade: --Sustained gross leverage at or above 4x, generating annual FCF of less than $25 million, or a large debt-financed acquisition without a concrete plan to reduce gross leverage to 4x in a 24-month time frame could lead to a negative rating action; --A sustained acceleration of revenue declines in North America relative to the modestly negative trend prior to 2020. Best/Worst Case Rating Scenario International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579. Liquidity and Debt Structure Adequate Liquidity: Liquidity is ample, and is supported by the company's consistent FCF generation, albeit seasonally skewed to the second half of the year. As of Dec. 31, 2020, ACCO had $36.6 million of cash on hand and $257 million of revolver availability, net of $10.6 million outstanding LCs and $333 million of borrowings under its $600 million revolver. Assuming the bond deal is executed as proposed, Fitch expects the proforma revolver draw to decline to $78 million resulting in availability of $512 million. ACCO had $1,137 million of debt outstanding as of Dec. 31, 2020, consisting primarily of a $287 million euro senior secured term loan A, $93 million outstanding on the U.S. dollar senior secured term loan A, $43 million under the Australian dollar senior secured term loan A and $333 million of revolver borrowings (all of which mature in May 2024), and $375.0 million of unsecured notes due December 2024. Annual amortization across ACCO's capital structure is approximately $30 million annually through 2023. Assuming the bond deal is executed as proposed, Fitch expects the $375 million of notes due December 2024 to be fully retired with the $650 million of new bonds expected to mature in 2029. Financial covenants include maintenance of funded indebtedness (net of cash) to EBITDA less than 3.75x (increasing to 4.25x for up to three quarters following an acquisition) and interest coverage (EBITDA divided by interest expense) greater than 3.0x. In conjunction with the PowerA acquisition, ACCO amended its credit facility to increase permitted acquisition pro forma leverage to 4.5x from 3.5x; the company also increased its maximum net leverage covenant by 0.5x through the second quarter of 2022. Consequently, maximum net leverage would be 4.75x at the end of 2020, 5.25x at the end of the first and second quarters of 2021, 4.75x at the end of the third quarter of 2021 and 4.25 at the end of 2021. The maximum net leverage would step down to 3.75x at the end of the third quarter of 2022. Recovery Considerations Fitch has assigned Recovery Ratings (RRs) to the various debt tranches in accordance with Fitch criteria, which allows for the assignment of RRs for issuers with IDRs in the 'BB' category. Given the distance to default, RRs in the 'BB' category are not computed by bespoke analysis. Instead, they serve as a label to reflect an estimate of the risk of these instruments relative to other instruments in the entity's capital structure. Fitch rates ACCO's first-lien secured debt one notch above the IDR, reflecting outstanding recovery prospects (91%-100%) given default (RR1). Unsecured debt will typically achieve average recovery, and thus was assigned an 'RR4', or 31%-50% recovery. Summary of Financial Adjustments Historical financials have been adjusted for stock-based compensation, transaction expenses and integration expenses. Date of Relevant Committee 09 November 2020 REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. ESG Considerations Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. ACCO Brands Corporation ----senior unsecured; Long Term Rating; New Rating; BB Contacts: Primary Rating Analyst David Silverman, CFA Senior Director +1 212 908 0840 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Rating Analyst Lyle Margolis, CFA Director +1 646 582 3589 Committee Chairperson John Culver, CFA Senior Director +1 312 368 3216 Media Relations: Sandro Scenga, New York, Tel: +1 212 908 0278, Email: sandro.scenga@thefitchgroup.com Additional information is available on www.fitchratings.com Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). 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