Fitch Affirms Gen Digital at 'BB+'; Outlook Remains Negative

Fitch Ratings has affirmed Gen Digital Inc.'s (fka NortonLifeLock Inc.; NYSE: GEN) Long-Term Issuer Default Rating (IDR) at 'BB+'.

Fitch has also affirmed GEN's senior secured term loans and the secured revolver at 'BBB-'/'RR1' and its senior unsecured notes at 'BB+'/'RR4'. The Rating Outlook remains Negative.

The Negative Outlook reflects GEN's leverage which remains elevated following September 2022 acquisition of Avast plc (Avast) for approximately $8.5 billion, which was largely funded with debt. GEN is a significant generator of FCF, and Fitch forecasts that the company's leverage (as defined by Fitch) will remain higher than the negative rating sensitivity of 3.5x for the next few quarters.

GEN is committed to having long-term net leverage (as defined by the company) of approximately 3.0x, down from 3.9x at the end of 2QFY24 and Fitch believes the company can achieve this by balancing debt reduction with its share repurchase plan. Failure to repay debt over the next few quarters to reduce leverage below 3.5x (as defined by Fitch) on a sustained basis would likely result in a one notch downgrade of the IDR to 'BB'.

Key Rating Drivers

Debt Repayment to Accelerate Deleveraging: Fitch defined leverage for the LTM ending Sept. 30, 2023 was 4.4x and Fitch projects it to remain close to that by the end of FY24 (FYE March 31). Fitch forecasts EBITDA growth and with mandatory amortization payments and expectations for the early repayment of debt, Fitch expects leverage to be close to 3.5x at FYE 2025 (FYE March 31). If the company does execute on debt reduction, leverage could be around there or lower which would result in the Outlook being revised to Stable. If Gen Digital does not, leverage will be above the negative rating trigger of 3.5x.

Capital Allocation Strategy: Fitch estimates Gen Digital will generate $800 million to $900 million of FCF before dividends in FY24 and FY25. Gen Digital intends to utilize FCF for debt repayment and shareholder friendly activities including share repurchases and dividends. Fitch believes the company will reduce debt but the extent of debt repayments is uncertain. Over the LTM ending Sept. 30, 2023, voluntary debt repayments were $400 million and in October, it paid down $200 million more.

For the LTM ending Sept. 30, 2023, it paid out $325 million in dividends and repurchased $541 million of shares. Share repurchases have slowed in the past two quarters with only $41 million repurchased in 1QFY24 and none in 2QFY24. Gen Digital's stated long-term target is to reduce its diluted share count to pre-Avast merger levels. For the merger, 94 million shares were issued.

High Interest Expense Burden: Given rising interest rates, Gen Digital will have a significant amount of cash directed toward interest expense. Prepayment of debt will reduce the interest expense burden and help the company reach its publicly stated target of having net leverage, as defined by the company, of approximately 3.0x by fiscal YE 2027.

Somewhat Diverse Offerings: For the quarter ending Sept. 29, 2023, 64% of Gen Digital's revenue came from consumer security solutions, such as Norton 360 Security, Avast Security offerings, Norton Secure VPN, Avira Security and other consumer security offerings. Almost 35% of revenue was from identity and information protection, including revenue from Norton 360 with LifeLock offerings, LifeLock and other privacy offerings. The remaining 2% of revenue derived from legacy revenue. Approximately 65% of revenue was from the Americas while 25% was from EMEA and the remaining 10% was from Asia-Pacific and Japan for the quarter.

Avast Acquisition Strategy: Avast's focus was more on cyber privacy, and it did not have a strong presence in North America. Norton has more of a focus on cyber security, and LifeLock has a focus on identity, and both of these offerings are largely in the U.S. and Canada. Gen Digital plans to continue its focus on its cross-selling and upselling opportunities. In addition, Gen Digital has been successful in improving the retention rate to 77% in 2QFY24, up two points year over year. Overall improvement came from better retention rates at Avast while Norton and LifeLock had stable retention rates.

Derivation Summary

Gen Digital's 'BB+' rating reflects its significant size, strong brand recognition, operating profile and EBITDA margins in the mid-to upper 50% range. With a strong focus on the consumer market, the company had actively looked to grow and expand its international presence. The Avast acquisition helps Gen Digital achieve these goals.

The company's rating is the same as Open Text Corporation which has a Stable Outlook reflecting its announced asset divestiture which accelerates the company's deleveraging plan. Its leverage at the end of FY24 and FY25 is forecasted to be in the range of 3.0x to 3.5x. Gen Digital may reduce leverage to around 3.5x at the end of FY25 but only if it directs FCF toward voluntary debt repayments. Open Text's revenues are less than double of Gen Digital's and Open Text's EBITDA margins are in the mid 30's.

Gen Digital is rated below other technology peers, including Constellation Software, Inc. (BBB+/Stable) and Cadence Design Systems Inc. (A-/Stable). These are rated above Gen Digital due to their stronger credit profiles. However, Gen Digital has consistently had stronger EBITDA and FCF margins, which benefit from its strong consumer market position.

Key Assumptions

Revenue grows by double digits in fiscal 2024, reflecting the Avast acquisition, and by strong single digits thereafter, reflecting Fitch's assumptions for consumer appetite for cybersecurity software, privacy and identity protection;

Gross margins are in the low 80%;

EBITDA margins in the mid- to upper 50% range, reflecting increased operating efficiencies longer term;

FCF is directed toward debt repayment, and shareholder returns continue through flat dividends and share repurchases;

The company may be acquisitive once leverage is reduced to its target net leverage, as defined by Gen Digital, of 3.0x.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, lead to a Stable Outlook

--(CFO-capex)/debt above 10% on a sustained basis;

EBITDA leverage, defined by Fitch, below 3.5x over the next several quarters.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

--(CFO-capex)/debt above 17.5% on a sustained basis;

Fitch's expectation of leverage below 2.5x on a sustained basis.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

--(CFO-capex)/debt below 10% on a sustained basis;

Fitch's expectation of leverage above 3.5x on a sustained basis;

Evidence of negative organic revenue growth or erosion of EBITDA and FCF margins;

Significant debt-financed acquisitions or share repurchases that significantly weaken the company's credit profile for a prolonged period of time.

Liquidity and Debt Structure

Liquidity Expected to Remain Solid: As of Sept. 29, 2023, Gen Digital had $2.1 billion in liquidity, including $629 million of cash on the balance sheet and a fully undrawn, secured $1.5 billion revolving credit facility due 2027.

Gen Digital has approximately 62% of its debt as floating-rate debt, and the remaining 38% is fixed-rate debt reflecting $1 billion of interest rate hedges. Gen Digital's term loan A2 amortizes at 5% per annum while term loan B amortizes at 1% per annum. The nearest debt maturity is in 2025, when $1.1 billion of senior notes come due. Given the company's strong FCF, Fitch expects Gen Digital's liquidity to remain robust.

Issuer Profile

Gen Digital, Inc. (fka NortonLifeLock, Inc.; NYSE: GEN) is a global provider of consumer cyber safety solutions, with more than 500 million users in over 150 countries. The company offers consumers both premium and 'freemium' software. Gen Digital provides solutions for cybersecurity, privacy and identity protection.

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

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.