Fitch Ratings - Toronto - 13 Nov 2024: Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Avaya Holdings Corp. and Avaya LLC (collectively, Avaya) at 'CCC+'. Fitch has also affirmed the 'B-' with Recovery Rating of 'RR3' ratings on Avaya's first lien secured term loan. Avaya LLC is the issuer of debt.
The ratings primarily reflect Fitch's expectation that Avaya will generate negative FCF in the near term. The company faces significant ongoing restructuring costs and the need for further investment as it transitions to cloud-based/hybrid contact center and customer experience offerings. Avaya's cash balance, which is projected to exceed $500 million at FYE 2024, provides it with moderate financial flexibility to execute its strategy. However, Fitch believes there is execution risk given the intensely competitive environment in the contact center and customer experience markets.
Key Rating Drivers
Weak FCF Generation: Fitch expects Avaya to generate negative FCF over the rating horizon, burning about $95 million in FY25, due to a heavy interest burden, high restructuring expenses, and the continued shift away from perpetual software license and maintenance contracts to cloud-based and hybrid offerings. Fitch's EBITDA calculations exclude certain add-backs that Avaya makes, including normalized revenue that eliminates GAAP revenue and EBITDA cyclicality.Fitch does capture the cash movements of these adjustments in our FCF forecasts. Fitch expects the company to be able to sustain its cash burn rate without requiring support from external partners given its large cash balance, and the FCF burn rate should improve over time if the company successfully executes on its transformation plan.
Top Line Pressure: Fitch expects fiscal year 2025 revenue to decline in the high single-digit to low double-digit range due to customer attrition mainly in the unified communications (UC) space, planned exits from certain regions, and the effect of the continuing shift away from on-premise product solutions to subscription and cloud-based solutions.Due to intense competition in the UC space, Avaya is shifting its focus toward the contact center (CC) market. Fitch predicts that revenue will remain under pressure until a stable base of customers, primarily in the CC market and key regions, is established. However, Avaya's meaningful base of recurring revenues, which are typically under contract, provide some level of stability. Avaya generated approximately 76% of total revenues from recurring contracts in FY24.
On-going Cost Savings Program: Fitch expects positive EBITDA for FY24 and beyond due to ongoing cost optimization measures and bottoms-up reorganization. Avaya's management is focused on right-sizing the company's cost structure, implementing a plan in 2023 aimed at saving approximately $525 million in annualized costs and rolling out additional initiatives targeting an additional $270 million of cost reduction in the near-term. Fitch expects lower costs to support improved EBITDA generation in 2025 despite revenue declines.
Manageable Execution Risk: Fitch believes there is sufficient operational flexibility for Avaya to continue to achieve positive EBITDA within the next two years. However, this achievement depends on the successful development and expansion of competitive cloud-based CC offerings, as well as Avaya's new management team's ability to implement cost control and achieve operating efficiency. Operating profitability is still likely achievable in the mid-term despite taking a conservative view of Avaya's ability to grow revenue and its effectiveness in cost-saving under Fitch's forecast assumption.
Diversified Customer Base: Avaya's revenue base is diversified from a customer, geographic and industry perspective. Retention of large customers also remained high pre-and post-emergence. Avaya's indirect channel, with more than 8,000 active channel partners including agents at the end of fiscal 2024, extends the company's sales reach to about 180 countries worldwide. Avaya had approximately 53,000 customers at the end of fiscal 2024. Approximately 43% of total revenue is generated outside the U.S.
Post-Emergence Capital Structure: Avaya's restructuring materially strengthened its balance sheet. Outstanding debt decreased by more than 75% to approximately $810 million from approximately $3.4 billion at the time Avaya sought Chapter 11 protection in March 2023. Still, leverage remains high at around 7.0x in FY24 based on Fitch's forecast. Liquidity is solid, with available cash of about $550 million as of Sept. 30, 2024 and access to an undrawn $128 million ABL subject to letters of credit outstanding and the borrowing base.
Derivation Summary
Avaya faces numerous competitors given its cloud-based, on-premise and hybrid solutions for CC and UC applications. Avaya is a large vendor in the global UC industry but is substantially smaller and less diversified than its primary competitors in the enterprise market: Zoom, Cisco, and Microsoft. Additional competitors in the enterprise market include NEC, Atos Unify, Alcatel-Lucent Enterprise and Huawei. In the mid-market UC industry, competitors include Mitel, NEC, Cisco and Microsoft.
Cloud-based offerings generated strong growth in small and medium-sized enterprises and mid-market segments, and are penetrating enterprise clients. Companies are shifting to cloud-based solutions, which provide for lower total cost of ownership and increased deployment speed.
Avaya's primary competitors in cloud products and services include Cisco, Microsoft, RingCentral, 8x8, Mitel, Zoom, LogMeIn and others. Avaya's business is shifting toward private, public and hybrid cloud offerings from traditional premise-based infrastructure models. The company expects to continue supporting on-premise business models where required by the customer. support of customers that have requirements and/or business models primarily on-premise offerings allowed the company to maintain a relatively strong position among large enterprises.
Key Assumptions
- Revenue declines in the high single digit to low double-digit range in fiscal 2025 before returning to modest growth as the effects of the transition to the cloud/subscription model tapers off;
- EBITDA margin improving gradually to the low teen range as cost saving initiatives take hold;
- Capex representing 3.5%-4.0% of revenue;
- Fitch assumes the following SOFR base rates for 2024, 2025, 2026 and 2027: 5.2%, 4.3%, 3.7% and 3.5%;
- Fitch forecasts FCF deficits during the rating horizon due to the drag from the shift to subscription-based offerings and high interest rate environment.
Recovery Analysis
Key Recovery Rating Assumptions
- The recovery analysis assumes that Avaya would be reorganized as a going-concern in bankruptcy rather than liquidated;
- Fitch has assumed a 10% administrative claim and the $128 million secured ABL is partially drawn;
- In estimating a distressed EV for Avaya, Fitch contemplates a scenario in which default may be caused by continued secular pressure in premise-based offerings, and setbacks in its subscription/cloud-based products arising from heightened competitive pressures. Under this scenario, revenue decreases to $1.5 billion and Avaya's EBITDA margin stabilizes at approximately 8%, resulting in $120 million of going concern EBITDA;
- Fitch assumes that Avaya will receive a going-concern recovery multiple of 5.5x. The estimate considers several factors, including the recurring nature of Avaya's revenue, favorable customer retention, and the competitive dynamics within the industry.
The Enterprise Valuation multiple is supported by:
- Historical bankruptcy case study exit multiples for technology peer companies, which have ranged from 2.6x to 10.8x;
- Of these companies, five were in the software sector: Allen Systems Group, Inc (8.4x), Avaya, Inc. (2023: 7.5x, 2017: 8.1x), Aspect Software Parent, Inc. (5.5x), Sungard Availability Services Capital, Inc. (4.6x), and RiverbedTechnology Software (8.3x).
Fitch estimates a distressed enterprise valuation, net of administrative fees, of $594 million. After covering ABL claims, the remaining value is allocated to Avaya's first lien secured term loan, resulting in 'B-'/'RR3/57%' ratings on it.
RATING SENSITIVITIES
Developments That May, Individually or Collectively, Demonstrate Credit Improvement
- Fitch's expectation of a trend toward sustained positive FCF in the rating horizon.
- (CFO-Capex)/Debt sustained above 0%;
- EBITDA interest coverage sustained above 1.5x;
Developments That May, Individually or Collectively, Demonstrate Credit Weakening
- Accelerating negative FCF;
- Meaningful liquidity deterioration.
Liquidity and Debt Structure
Adequate Liquidity: Avaya has been facing pressure on cash from its transition to cloud-based/subscription services. Fitch believes Avaya has adequate liquidity in the near-term based on approximately $550 million cash balance as of Sept. 30, 2024. Liquidity is also supported by an undrawn $128 million ABL facility.
Debt Structure: As of the end of September 2024, Avaya's debt consists of an outstanding $845 million term loan maturing in 2028 and an undrawn ABL loan of approximately $128 million maturing in 2026. Avaya prepaid $25 million of the term loan in the quarter ending September 2024. For the term loan, Avaya had the option to pay part of the interest in kind (PIK) from the closing date until June 2024, with an interest rate of S+150 payable in cash plus 700 basis points PIK. The company utilized the PIK option for the first year, and the debt transitioned to cash pay (S+750) effective Q4 FY24.
Issuer Profile
Avaya LLC provides digital communications products, solutions and services, including contact center and unified communications and collaboration products and services. Its primary customers are enterprises and midmarket businesses. Avaya operates in approximately 180 countries and has about 53,000 customers.
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.
MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS
Click here to access Fitch's latest quarterly Global Corporates Macro and Sector Forecasts data file which aggregates key data points used in our credit analysis. Fitch's macroeconomic forecasts, commodity price assumptions, default rate forecasts, sector key performance indicators and sector-level forecasts are among the data items included.
ESG Considerations
Avaya has an ESG Relevance Score of '4' for Governance Structure due to private equity ownership, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
RATING ACTIONS
Entity / Debt
Rating
Recovery
Prior
Avaya LLC
LT IDRCCC+ Affirmed
CCC+
senior secured
LTB- Affirmed
RR3
B-
Avaya Holdings Corp.
LT IDRCCC+ Affirmed
CCC+
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PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
Parent and Subsidiary Linkage Rating Criteria (pub. 16 Jun 2023)
Corporate Rating Criteria - Effective 3 November 2023 to 6 December 2024 (pub. 03 Nov 2023) (including rating assumption sensitivity)
Sector Navigators – Addendum to the Corporate Rating Criteria - Effective from 21 June 2024 to 6 December 2024 (pub. 21 Jun 2024)
Corporate Recovery Ratings and Instrument Ratings Criteria (pub. 02 Aug 2024) (including rating assumption sensitivity)
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
Corporate Monitoring & Forecasting Model (COMFORT Model), v8.1.0 (1)
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Avaya Holdings Corp. EU Endorsed, UK Endorsed
Avaya LLC EU Endorsed, UK Endorsed
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ENTITIES
Avaya Holdings Corp.
Avaya LLC
ISSUER CONTENT
Avaya Holdings Corp.
Avaya Holdings Corp.
Fitch Assigns First-Time IDR to Avaya of 'CCC+'
Fitch Withdraws Avaya's Ratings
Fitch Downgrades Avaya's IDR to 'D'
Fitch Downgrades Avaya Inc.'s IDR to 'CC' and Senior Secured Debt to 'CC'/'RR4'
Fitch Downgrades Avaya Inc.'s IDR to 'CCC-' and Senior Secured Debt to 'CCC'/'RR3'
Fitch Downgrades Avaya Inc.'s IDR to 'CCC+'
Avaya Inc.
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