Fitch Ratings has assigned a first-time 'BB+' Long-Term Issuer Default Rating (IDR) to MKS Instruments, Inc.
The Rating Outlook is Stable. In addition, Fitch has assigned a 'BBB-'/'RR1' senior secured term loan issue rating to the company's planned issuance.
MKS is seeking to issue a $500 million senior secured revolving credit facility, to be undrawn at close, a $4.3 billion senior secured term loan, and a $1 billion USD equivalent Euro senior secured term loan with proceeds, along with a $1.6 billion equity issuance and cash on the balance sheet, used to fund the $6.5 billion acquisition of Atotech Limited. Fitch's actions affect approximately $5.8 billion of debt, pro forma for the issuance.
Key Rating Drivers
Cyclicality: Fitch believes the acquisition of Atotech accelerates efforts to reduce the high levels of cyclicality experienced by MKS historically, as exposure to semiconductor capital equipment demand will decline to 39% of pro forma revenue from 59%. Semicap equipment demand, measured by aggregate semiconductor industry capex, has experienced periods of excessive volatility with two-year declines of approximately 50% in both 2001-2002 and 2008-2009, while more moderate cycles have witnessed mid-teens rates of decline.
The addition of Atotech introduces direct exposure to semiconductor manufacturing volumes, which have experienced significantly less volatility with a median decline of 6.6% in down years with the deepest trough producing a decline of 22% during the financial crisis. Fitch estimates that 10%-15% of revenue will be derived from markets closely correlated with semiconductor volumes, contributing to the reduced cyclicality.
Diversification: The addition of Atotech reduces customer concentration and increases exposure to non-correlated end-markets. Management has pursued a long-term strategy to expand into new markets through the 2016 and 2019 acquisitions of Newport and ESI that laid the foundations for the company's Advanced Markets segment and provided exposure to sources of demand spread across life sciences, advanced electronics manufacturing, industrial technology, advanced research, quantum computing and defense. Atotech also contributes increased exposure to automotive production with its leadership position in general metal finishing. Finally, the combination reduces customer concentration with the company's two largest customers representing 16% of pro forma revenue, down from 25% previously.
Financial Policies: The company has demonstrated a willingness to utilize elevated financial leverage in pursuit of strategic M&A, but management has historically prioritized debt repayment to quickly reduce debt levels thereafter. Fitch expects that management will maintain the policy post the Atotech acquisition and forecasts debt repayments of $550 million-$650 million per annum, resulting in a decline in opening pro forma leverage of 4.4x to 2.8x over the rating horizon. Fitch believes the 'BB' rating category is indicative of the flexibility needed to fulfill the company's acquisitive strategy.
Previously, the 2016 acquisition of Newport was financed with the issuance of a $730 million term loan, which was followed by $185 million of prepayments in the 12 months after close with an additional $235 million in prepayments in the two years thereafter. Similarly, the 2019 ESI acquisition was financed with a $650 million incremental term loan, which was followed by $165 million of repayments in the subsequent 12 months.
FCF: MKSI generated FCF margins averaging 14% over the most recent four years and has demonstrated strong cash flow resiliency during adverse environments with a 2019 margin of 7% in a period that saw semiconductor production volumes and aggregate industry capex declines of 3% and 8.5%, respectively. Fitch expects the current strong demand conditions to contribute to FCF margin expansion to 17% in fiscal 2023 as the additional scale from Atotech hastens the path towards $1 billion in annual FCF over the longer term. Finally, Fitch's stress case models demonstrate that the increased diversification and scale will moderate impacts from future down cycles, forecasting FCF margin compression to 12% in a hypothetical scenario similar to 2019.
Secular Tailwinds: MKSI benefits from strong secular tailwinds as increasing technological intensity and complexity across sectors generates demand for precision manufacturing and process control. The company's heritage in semiconductor capital equipment subsystems positions it well to benefit from the increasing cost and complexity of sustaining Moore's law that is expected to drive a 45% increase in wafer fab equipment spending by 2025.
In addition, demand growth for the company's Advanced Markets segment is supported by trends towards miniaturization, higher densities, expanded use cases and new materials across a variety of applications including printed circuit boards, digital displays, electronics packaging, solar panels, fiber optics, materials processing,, quantum computing and medical technologies.
Fitch expects the secular dynamics to lead to mid-cycle organic growth of 4%-6% per annum. In addition, Fitch believes the trends will extend MKSI's competitive advantages as technological capability, breadth of product portfolio, and deep partnerships with customers serve as increasing points of differentiation.
Strategic Fit: Fitch believes the industrial logic for the Atotech acquisition is sound as increasing miniaturization and complexity of electronics generates needs for optimization at the interconnect between chips and devices. Atotech's capabilities in electronics chemicals is synergistic with MKSI's heritage in laser drilling as it simplifies customers' design process and accelerates their product roadmaps and time to market. Fitch believes the combination improves the credit profile through deeper collaboration with customers, cross selling opportunities and increased product differentiation.
Fitch evaluates MKSI pending its acquisition of Atotech and compares the combined company against Amkor Technology, Inc. (BB/Stable), TTM Technologies, Inc. (BB/Stable), II-VI Incorporated (BB/RWN) and KLA Corporation (BBB+/Stable) given similar product segments, operating profile characteristics or underlying secular trends.
Fitch believes MKSI's technological leadership in process control and precision manufacturing has led to strong market shares with the company achieving leadership positions across 15 product categories. Despite leading share and technological capability, the company has historically been challenged by elevated cyclicality and constrained profitability, similar to TTM and II-VI, as both companies have endured highly volatile end-market demand and weaker bargaining positions relative to customers. However, similar to the noted peers, Fitch believes MKSI benefits from secular trends including, expanding use cases into new end-markets and growing technological complexity, that enable scaled companies to extend technology leadership, increase product differentiation and deepen partnerships with customers, which will benefit the credit profiles over time.
MKS scores well across operating metrics as Fitch expects a continuation of the constructive demand environment to result in consistent EBITDA margins of 29%-30% over the rating horizon, which compares well to the to the 22% peer median. In addition, low capital intensity and a small dividend, contribute to a favorable FCF profile with Fitch forecasting FCF margins to range 12%-17%, well above the 6% peer median. Fitch notes that recent and forecast EBITDA and FCF margins are consistent with the 'A' rating category. However, Fitch believes that the overall credit profile is weighed down by volatility of profitability, as seen recently in 2019 where an 8% decline in revenue contributed to 700 bps of EBITDA margin compression while FCF margins were reduced by roughly half to 7%. Relative to peers, Fitch believes the company's strategy to increase diversification and scale will moderate impacts from future down cycles as our stress case models demonstrate FCF margin compression to 12% in a hypothetical scenario similar to 2019, suggestive of a stronger credit profile than the similarly rated peers.
MKSI has demonstrated a willingness to utilize elevated financial leverage in pursuit of strategic M&A opportunities, but management has historically prioritized debt repayment to quickly reduce debt levels thereafter. Fitch expects that management will maintain the policy post the Atotech acquisition and forecasts debt repayments of $550 million-$650 million per annum, resulting in a decline in opening pro forma leverage of 4.4x to 2.8x over the rating horizon, in line with the 2.7x median for peers in the 'BB' category. While the company's forecast leverage is consistent with the 'BBB' rating category, Fitch believes the 'BB' rating category is indicative of the flexibility needed to fulfill the company's acquisitive strategy.
Fitch believes the rating is supported by the leverage profile in line with similarly rated peers, declining cyclicality, strong FCF and growing competitive advantages, while historical volatility of profitability and a debt-funded acquisitive strategy act as the leading constraints of the rating in comparison to peers. No country-ceiling, parent/subsidiary or operating environment aspects impacted the rating.
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Acquisition of Atotech closes in 2021, funded by readily available cash, as well as the issuance of a new $500 million undrawn RCF, a $4.28 billion Term Loan B, a $1 billion Euro equivalent term loan B and $1.6 billion of equity to Atotech shareholders;
MKSI standalone growth of 24% in fiscal 2021, contribution of Atotech acquisition in fiscal 2022 and organic growth of 4%-6% thereafter;
EBITDA margin of 29% in fiscal 2021 with expansion of 50 bps per annum due to gradual realization of $50 million cost synergies and improving bargaining position relative to customers;
Capital intensity of 3% per annum, consistent with historical average;
Dividends of $47 million in fiscal 2021, stepping up to $58 million in fiscal 2022 due to equity issuance in connection with Atotech acquisition, growing 3% per annum thereafter;
Debt repayments of $550 million-$650 million in per annum.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Reduced volatility of profitability;
Increased customer and end-market diversification;
Mid-cycle leverage or a publicly announced explicit leverage defined as total debt with equity credit/operating EBITDA at or below 2.75x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Mid-cycle leverage defined as total debt with equity credit/operating EBITDA at or above 3.5x;
Cash Flow from operations - Capex/total debt with equity credit sustained below 15%;
Sustained revenue declines or margin compression due to decreased bargaining power relative to customers or decreased competitive advantage.
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
Ample Liquidity: Fitch expects abundant liquidity for MKSI over the rating horizon. Pro forma for the transaction, liquidity will be comprised of $800 million of readily available cash and an undrawn $500 million senior secured RCF. Liquidity is further supported by Fitch's expectation for $1.4 billion of aggregate FCF over the rating horizon following the transaction.
MKS provides process control and precision manufacturing solutions. Primary served markets include semiconductor, industrial technologies, life and health sciences, research and defense.
Summary of Financial Adjustments
Fitch made standard financial adjustments as described in the applicable ratings criteria.
Date of Relevant Committee
30 September 2021
Sources of Information
The principal sources of information used in the analysis are described in the applicable criteria.
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.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
RATING ACTIONSENTITY/DEBT RATING RECOVERY
MKS Instruments, Inc. LT IDR BB+ New Rating
LT BBB- New Rating RR1
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