Fitch Rates Broadcom's Proposed Senior Exchange Notes 'BBB-'

Reuters · 03/16/2021 13:45
Fitch Rates Broadcom's Proposed Senior Exchange Notes 'BBB-'

(The following statement was released by the rating agency)

Fitch Ratings-Chicago-16 March 2021:

Fitch Ratings has assigned 'BBB-' ratings to Broadcom, Inc.'s senior notes exchange offering. In a leverage-neutral transaction, Broadcom will offer to exchange up to $2 billion of new notes due 2033 and up to $3 billion of notes due 2034 plus a cash payment for a first pool of existing senior notes with 2025 maturities and a second pool of existing notes with 2024, 2026 and 2027 maturities, respectively.

The ratings and Stable Outlook reflect Broadcom's revenue diversification with an increasing mix of recurring software revenue, solid positions in focus markets and sector leading profit margins. Its outsourced manufacturing model may temper near-revenue term growth in the face of chip capacity shortages but supports its solid cash flow profile, even after its hefty cash dividend policy. The rating and Outlook are constrained by Fitch's expectation that Broadcom will remain acquisitive in the software space, likely requiring at least partial debt funding and limiting meaningful credit metric strengthening.

The proposed exchange consists of Broadcom offering up to $2.0 billion of new notes due 2033 in exchange for, in order of priority, Broadcom Corp.'s $1.0 billion of 3.125% notes and the company's $2.25 billion of each of 4.7% and 3.15% notes. Broadcom will also offer up to $3.0 billion of new notes due 2034 in exchange for a second pool of notes consisting of, in order of priority, $1.4 billion of 3.625% notes due January 2024, $1.0 billion of 3.625% notes due October 2024, $2.5 billion of 4.25% notes due April 2026, $4.8 billion of 3.875% notes due January 2027, $350 million of 4.7% notes due March 2027 and $1.7 billion of 3.459% notes due September 2026.

The exchange notes will be pari passu with Broadcom's existing senior unsecured obligations, including full and unconditional guarantees by Broadcom Technologies, Inc. and Broadcom Corp. on an unsecured and unsubordinated basis.


Key Rating Drivers

Acquisitive Nature: Fitch expects Broadcom will remain acquisitive in the infrastructure software space, given still considerable industry fragmentation and lower political and regulatory risk compared with that of semiconductors. The company's track record suggests that at least partially debt-financed mid- to large-scale acquisitions are more likely than organically funded tuck-in deals. Nonetheless, Fitch expects Broadcom to use post-deal FCF to return credit metrics to within long-term ranges consistent with investment grade ratings over the subsequent 12-24 months.

Growth Profile: After stronger than forecasted operating performance in fiscal 2020, Fitch expects another year of solid organic revenue growth for Broadcom driven by end markets recovering from the onset of the coronavirus pandemic and supply constraints that have lengthened lead times since last year. Double bookings remain a concern for the semiconductor sector, but Fitch believes broad-based recovery will augment secular semiconductor content growth, and Broadcom's all-you-can-eat software model over the near term.

Software Revenue Diversification: Broadcom's increasingly diversified revenue portfolio should reduce longer-term operating volatility. Its increasing revenue exposure in subscriptions and services, which Fitch estimates was roughly 30% in fiscal 2020, is highly recurring and meaningfully offsets product-driven volatility associated with Broadcom's consumer business. Meanwhile, its semiconductor product exposure is largely to DC and service providers, providing meaningful customer and end-market diversification, as well as longer lifecycle products such as broadband and set-top boxes.

Strong Profit Margins: Broadcom's profit margins are among the industry's highest, due to software assets and leading positions across a broad set of infrastructure markets and wired infrastructure markets, such as ethernet switching, fiber-optic components and set-top boxes. The company's acquisitions shifted the sales mix away from FBAR filters for handsets, in which it has very strong share but less leverage with a consolidated customer set. Broadcom's software acquisitions also increased predictability of profiles, given considerable recurring maintenance and support revenue.


Derivation Summary

Fitch believes Broadcom is appropriately rated at 'BBB-' with its strong operating profile offset by a track record for debt-funded acquisitions weighing on credit metrics. The company's operating profile is strong for the 'BBB-' category due to robust profit margins, end-market and customer diversification and leading market share positions. Broadcom's financial structure remains weak for the 'BBB-' rating on an operating EBITDA basis due to recent debt-financed acquisitions, but strong for the rating on a cash flow basis in part due to the company's low capital intensity. Fitch expects pre-dividend FCF to total debt of more than 25% and total debt to operating EBITDA below 3.0x through the forecast period.

Broadcom's operating profile is stronger than those of its peers, including Micron Technology Inc. (BBB-/Stable), which is more cyclical and capital-intensive but also more conservatively capitalized. Compared with NXP Semiconductors N.V. (BBB-/Stable), Broadcom's greater financial flexibility and stronger profitability offset NXP's comparatively conservative financial policies. When compared with Marvell Technology Group Ltd. (BBB-/Stable), Broadcom's financial structure should remain less conservative despite more recent partially debt-funded acquisitions by Marvell.


Key Assumptions

--Mid-single-digit revenue growth in fiscal 2021 from the continuation of software growth and solid semiconductor demand;

--Modest positive revenue growth through the remainder of the forecast period from moderating semiconductor and slowing software growth;

--Near-term operating EBITDA margin expansion from revenue growth and a higher mix of software sales.

--Flattish profit margins through the remainder of the forecast, driven by slowing organic revenue growth.

--Dividends equal to 50% of pre-dividend FCF and stock buybacks only with sustained excess cash balances;

--Smaller acquisitions funded with cash flow or mixed funding for larger deals with the expectation Broadcom will use post-close cash flow to reduce financing debt.

--Non-acquisition-related debt maturities are refinanced.


RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

--Expectations that Broadcom will maintain total debt to FCF closer to 3.0x and total debt to operating EBITDA of 2.5x, from a combination of debt reduction and profitability growth.

--Operating EBITDA margin expansion from continued positive organic revenue growth.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

--Expectations for total debt/FCF in excess of 8.0x or total leverage above 3.0x, driven by acquisitions without sufficient profitability or subsequent debt reduction.

--Expectations for shrinking organic revenue or market share losses, likely from overly aggressive cuts to R&D.


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

Solid Liquidity: Fitch expects liquidity will remain solid for the rating and, as of Jan. 31, 2021, was supported by $9.6 billion of cash and cash equivalents and an undrawn $7.5 billion revolving credit facility expiring 2026. Fitch's expectation for $4 billion-$6 billion of annual FCF also supports liquidity.


Summary of Financial Adjustments

Fitch made no material adjustments to the published financial statements of Broadcom Inc.


Date of Relevant Committee 22 September 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.

Broadcom Inc.
----senior unsecured; Long Term Rating; New Rating; BBB-

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