The Long and Short
Balance sheet improvement at Broadcom
Meredith Contente | April 1, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Broadcom management is taking advantage of relatively low rates and investor demand to improve its capital structure. The company recently issued new longer-term debt in order to redeem shorter term notes, combined with a pending exchange announcement that will extend its weighted average maturity profile and reduce the weighted average coupon. The new senior notes issued in both the deal and exchange will rank pari passu with the company’s existing senior unsecured debt. The company’s strong margin and cash flow generation should strengthen credit metrics, which could lead to ratings improvement over the next 12 to 24 months.
Exhibit 1. AVGO Debt Maturity Profile
Broadcom Inc. (AVGO, Baa3 (p)/BBB-/BBB-) tapped the market for $1.95 billion in an effort to further improve its balance sheet, with proceeds earmarked for the redemption of its 4.7% 2025 notes, with $1.0 billion outstanding, and its 4.25% 2026 notes, with $944 million outstanding. Both notes contain make-whole calls that will be enacted to fully redeem the notional outstanding. Additionally, the company will be launching an exchange for five series of notes maturing between 2027 and 2032 for new notes maturing in 2037, a year in which they have no debt currently maturing. While the exchange has not yet been formally announced, it is expected to expire on or around April 27, 2022.
Exhibit 2. AVGO EBITDA and FCF Performance
Subscription-Based Software Model Supports Profit Growth
AVGO has witnessed impressive EBITDA margin and free cash flow/sales growth over the past five years (Exhibit 2). In fact, AVGO’s profit margins are some of the industry’s highest given the company’s leading positions across infrastructure markets as well as its software assets. AVGO completed the CA acquisition in 2018 and one year later completed the Symantec acquisition. AVGO’s software acquisitions have improved its revenue and profit visibility given the subscription-based model associated with those assets, coupled with maintenance and support revenues associated with the subscriptions. According to management AVGO’s percentage of subscription-based software revenues increased 10% over the past three quarters, to 53%. Management believes it can achieve a 90% or above rate of software subscriptions over time as it moves to exclusively sell subscription licenses.
Furthermore, the EBITDA margin is forecasted to exceed 60% this year given the higher margins associated with its software offerings. Management noted at its last investor day that Broadcom software is now in a position to produce organic top line growth of at least 5% annually. Additionally, the level of R&D spending associated with the assets has declined which improves profitability considerably. Prior to the CA and Symantec Enterprise acquisitions, the model supported an operating margin of roughly 39%, excluding G&A, and now produces an operating margin nearly twice that of roughly 70%. AVGO’s software business generates over $5.2 billion in annual recurring revenues and serves roughly 80% of Fortune 500 companies.
Acquisitions Still a Source of Growth
AVGO has used both large and small acquisitions in the past to support growth, but also maintains a good track record of reducing debt post acquisition. Total leverage currently stands at 2.5x and net leverage at 1.8x, which are both solid for the ratings. Management remains committed to investment grade ratings and is expected to maintain a conservative financial policy, which includes leverage below 3.0x. While leverage can temporarily increase above the 3.0x metric when pursuing acquisitions, strong free cash flow generation supports the use of more cash when pursuing acquisitions as well as reducing leverage in a short time frame below the 3.0x level. With no acquisitions on the horizon, management announced a $10 billion share buyback program for calendar year 2022, in which the company has utilized $2.7 billion of the authorization. A similar pace of buybacks is expected to continue for the remainder of the year assuming no acquisitions come to fruition. Cash on hand has grown to over $10 billion, and strong EBITDA growth helps to reduce overall leverage. This provides AVGO with some flexibility in the ratings when pursuing acquisitions. The company could also suspend buybacks if it were to pursue a larger acquisition, providing further flexibility.
Agencies Affirm Ratings
Post the new issue and redemption/exchange announcements, all three ratings agencies affirmed AVGO’s ratings and outlooks. Moody’s has a positive outlook on the Baa3 rating which reflects their expectation for continued revenue growth despite economic uncertainties associated with supply chain issues and the ongoing Russia/Ukraine conflict. Moody’s believes that AVGO will limit the use of debt to fund any large acquisition and will work quickly to bring leverage below the 3.0x threshold should it pursue a larger acquisition. S&P noted that its BBB- rating and stable outlook reflect its expectation that the company will continue to be supported by consistent EBITDA and cash flow generation given its increased proportion of subscription-based enterprise software sales. S&P maintains its leverage threshold at 3.5x and noted that ratings could be upgraded if the company were to maintain leverage below 2.5x. Fitch believes that AVGO’s strong operating profile offsets its track record of debt funded acquisitions. The company’s higher profitability coupled with low capital intensity supports free cash flow growth and helps to strengthen the company’s financial profile. Fitch is looking for leverage to be maintained below 2.5x for an upgrade to occur. Fitch currently calculates AVGO’s leverage at 2.4x.
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