IBM
Fitch Ratings has assigned a first-time Long-Term Issuer Default Rating (IDR) of 'B' to
The Rating Outlook is Stable. Fitch has also assigned a 'BB-'/'RR2' rating to Rocket's existing and incremental first-lien secured indebtedness and a 'CCC+'/'RR6' rating to the existing unsecured notes. Rocket will fund the
The ratings reflect Rocket's strengthened consolidated operating profile post AMC's acquisition, which offsets the near-term increased leverage profile since the transaction is expected to be primarily funded by debt. Fitch expects EBITDA margins to improve to mid-50%, driven by AMC's higher margin business and cross-selling opportunities. The ratings are supported by Rocket's very sticky business model, recurring revenues, and high retention rates that are consistent with enterprise infrastructure software peers. Fitch expects the company to prioritize tuck-in acquisitions as part of its growth strategy over accelerated deleveraging.
Key Rating Drivers
Resilient Operating Profile: Fitch forecasts Rocket to grow its organic revenue in the low to mid-single digits while maintaining above-industry average EBITDA margins in the 50%-range supported by its resilient business model. Rocket's products provide solutions for critical business needs, ensuring interoperability between mainframe workloads and cloud-based workflows. Fitch believes the alignment across Rocket's focused strategy and operations enhance the resiliency and predictability of its business segments, particularly with over 70% of total revenue being derived from subscriptions and fixed duration maintenance contracts.
AMC Acquisition: With the acquisition of AMC, the combined company will have an annualized total revenue of over
High Switching Costs Drive Strong Retention: Consistent with mission-critical enterprise software products, Rocket has gross retention in the mid-90% and net retention of over 102% as it benefits from cross-selling and up-selling opportunities. Rocket's client base consists predominantly of large, conservative enterprises (government, banking, insurance, healthcare) that exhibit hesitancy towards adopting new technological advancements, particularly concerning their vital IT infrastructure and critical-highly regulated data. The substantial costs, regulations and complexities tied to transitioning away from mainframe systems, coupled with the imperative to sustain critical operations, result in high switching costs and high customer retention rates for Rocket.
Moderate Financial Leverage: Fitch expects Rocket's leverage to gradually decline to approximately 6.0x, driven by good recurring revenue and above-industry average EBITDA margins. Given the private equity ownership that is likely to prioritize ROE, Fitch does not anticipate accelerated debt repayment. Fitch expects capital to be used for acquisitions to accelerate growth or for dividends to equity owners with financial leverage remaining at moderate levels.
Strong FCF Generation: Fitch expects fiscal 2024 free cash flow generation to be weaker due to AMC's acquisition. However, driven by strong profitability, sticky business model, and high retention rates, FCF margins should normalize at low to mid-teens through Fitch's forecast period. This results in (CFO-Capex)/Debt ratios approaching 5% through the forecast period. The strong FCF generation provides Rocket with ample financial flexibility for investments to further strengthen its capabilities around hybrid cloud and data analytics/AI.
M&A Central to Company's Growth Strategy: Fitch expects Rocket will remain acquisitive in the infrastructure software space, given still considerable industry fragmentation and in its effort to expand technology platform. The company has made a number of acquisitions in the past, including
Secular Tailwind Supporting Growth: Digital transformation and hybrid cloud continue to be growth catalysts within the technology industry, as businesses continue to digitalize workflow to increase efficiency. The future of IT is steering towards a hybrid IT management framework, with mainframes anticipated to play a crucial function in this evolving landscape. Mainframe workload continues to grow mid- to high single digits per year.
Although Fitch anticipates a gradual reduction in the reliance on mainframe systems as newer workloads migrate to cloud environments, these systems continue to be a bedrock of critical infrastructure. They are responsible for processing billions of daily transactions across vital sectors such as banking, retail, insurance, healthcare, transportation, and government. Fitch maintains that essential mainframe workloads, integral to legacy operations, are likely to remain on these systems well into the future.
Significant Customer Diversification: Rocket has a diversified customer base of over 12,500 customer accounts, with approximately 50% exposure to banking, insurance and services industries. The company is geographically well-diversified and no single customer contributed more than 10% of revenues, and top 10 customers contributed 14% to the 2023 revenues (excluding
Derivation Summary
Rocket's consolidated hybrid cloud solutions, including AMC's portfolio are considered mission-critical as they encompass the entire mainframe lifecycle for enterprise customers. Rocket's large, diverse base of customers spans over various countries and a broad range of industries and businesses, with particular strengths in banking, insurance, and governmental agencies. The company enables customers to modernize proven applications on legacy environments without losing valuable business logic or decades of investment. Rocket benefits from high top-line visibility with a majority of revenues comprised of subscriptions and fixed duration maintenance contracts.
The acquisition of AMC business provides Rocket with broad product coverage and limited customer overlaps. This provides the company with opportunities for cross-selling of products as a driver for revenue growth and will further strengthen its stickiness. With the completion of integration between AMC and Rocket, Rocket is poised to benefit from operating leverage and AMC'S higher margin profile. Fitch expects revenue growth to remain in the low to mid-single digit through the medium term with EBITDA margins expanding to mid-50%.
Fitch believes Rocket is solid for the 'B' rating with its strong operating profile offset by a track record for debt-funded acquisitions weighing on credit metrics. The company's robust profit margins, end-market and customer diversification and market share positioning is supporting its operating profile strength. Meanwhile, higher profitability and low capital intensity are driving FCF growth and strengthening the financial profile, even as upcoming AMC deal is primarily debt-funded.
Within the infrastructure software market, Rocket primarily competes with BMC, and Broadcom (BBB-/Stable). Broadcom is substantially larger than Rocket with EBITDA leverage of approximately 3.0x and much more diversified. Rocket has a very similar operating and credit profile as BMC. Like BMC, Rocket's EBITDA margins are above industry-average, translating to strong free cash flows, and have a moderate leverage profile. In Fitch's view, while the three companies have product overlaps in some areas, Rocket has a more hybrid cloud-centric product, supporting customers with exposure to mainframe industry.
Fitch also compares Rocket to other software peers in the 'B' to 'B+' rating categories. Rocket's revenue scale compares favorably to peers. Rocket's leverage and FCF generation are consistent with peers in the 'B' to 'B+' rating categories. With additional debt to fund AMC's acquisition, Fitch expects Rocket's pro forma leverage to reduce in the range of 6.0x with successful acquisition integration over the next two years. Fitch believes the private equity ownership is likely to prioritize ROE optimization over accelerated deleveraging, resulting in leverage remaining elevated.
Key Assumptions
Organic revenue growth in the low to mid-single digit;
EBITDA margins gradually expands by 500 bps through fiscal 2027 from fiscal 2023 level;
Capital intensity 1% of revenue;
Debt repayment limited to mandatory amortization;
Floating interest rate forecasted to be 5.0% in FY24, going down to 3.5% and 3.2% in FY25 and FY26, respectively;
Aggregate acquisitions of
No dividend payments through 2027.
Recovery Analysis
The recovery analysis assumes that Rocket would be recognized as a going concern in bankruptcy rather than liquidated;
Fitch has assumed a 10% administrative claim.
Going-Concern (GC) Approach
Fitch assumed a distress scenario where a combination of operational under-performance and capital misallocation result in unsustainable capital structure. This could be a result of elevated customer churn, inability to maintain strong EBITDA margins, and debt-financed dividends or M&As;
In such event, Fitch expects Rocket's revenue base to decline resulting in EBITDA margin contraction on lower revenue scale. Fitch assumes that due to competitive pressure, revenue to suffer a 10% reduction along with margin contraction resulting in GC EBITDA of
Fitch assumes that Rocket will receive going-concern recovery multiple of 7.0x. The estimate considers several factors, including the highly sticky and resilient business model, recurring nature of the revenue, high customer retention, company's strong FCF generation and the competitive dynamics. The enterprise value (EV) multiple is supported by:
The historical bankruptcy case study exit multiples for technology peer companies ranged from 2.6x to 10.8x, with 5.9x median;
Of these companies, only three were in the Software sector:
The highly recurring nature of Rocket's revenue and mission critical nature of the product support the high-end of the range.
Fitch arrived at an EV of
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Fitch's expectation of EBITDA leverage sustaining below 5.5x;
--(CFO-Capex)/Debt sustaining above 6.5%;
Organic revenue growth sustaining above the mid-single digit.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Fitch's expectation of EBITDA leverage sustaining above 7.5x;
--(CFO-Capex)/Debt sustaining below 3.5%;
Organic revenue growth sustaining near or below 0%.
Liquidity and Debt Structure
Adequate Liquidity: The company's liquidity is projected to be ample, supported by its strong FCF generation, an undrawn
Debt Structure: Pro forma for the transaction, Rocket's debt will consist of
Issuer Profile
Date of Relevant Committee
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.
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