Fitch Ratings has downgraded Gainwell Acquisition Corp's (Gainwell) Long-Term Issuer Default Rating (IDR) to 'B-' from 'B' and assigned a Stable Rating Outlook.

Fitch has also downgraded the senior secured first-lien term loan rating to 'B+' from 'BB-' and has maintained the recovery rating at 'RR2'. Fitch has additionally assigned a rating of 'B+'/'RR2' to the $250 million incremental term loan that is pari-passu with Gainwell's existing first-lien indebtedness.

The downgrade reflects Fitch's expectation that Gainwell's operational performance could be lower than earlier projected due to higher-than-expected Medicaid Enterprise System (MES) implementation costs. Consequently, FCF margins are anticipated to remain negative in fiscal 2024, with the expectation of breakeven in fiscal 2025. Fitch expects Gainwell's EBITDA leverage to be approximately 9.9x by the end of fiscal 2024, and remain near 7.0x through the rating period.

Fitch could stabilize the rating at 'B' if the company demonstrates successful execution of $200 million of cost-savings measures and reaches a normalized level of MES costs, leading to EBITDA expansion in the subsequent years. Fitch believes that despite short-term pressure on Gainwell's FCF, these strategic investments would strengthen the company's competitive positioning in the Medicaid industry, with the potential for stronger margins once cost savings are realized.

Key Rating Drivers

Strategic Initiatives Stress Near-Term Credit Metrics: Gainwell is undergoing an investment phase to deploy a new cloud-based modular Medicaid platform. This investment phase has resulted in Gainwell reporting lower EBITDA margins because of substantial costs associated with the MES implementation, which have overshadowed the benefits of cost-saving actions previously taken. This, along with a significant interest expense, are anticipated to contribute to a persistent negative FCF for the fiscal year 2024.

Consequently, Gainwell's projected pro forma EBITDA margins, as calculated by Fitch, have been adjusted down to 23% from an earlier forecast of 27%. Fitch predicts that EBITDA margins will climb to the high-20% range over the rating horizon once MES implementation costs normalize and cost saving measures are successfully executed.

Elevated Leverage Profile: Gainwell's financial leverage is high for the rating category. Due to the margin pressures noted above, Fitch is currently forecasting fiscal 2024 leverage of 9.9x. Fitch views Gainwell's leverage as near the upper 6.2x-10.9x range for Fitch-rated covered health care IT issuers in the 'B' rating category. Fitch believes liquidity remains sufficient and leverage is supported by the company's dependable growth prospects over the longer term, strong market position, low capital intensity and low cyclicality, with leverage moderating toward 7.0x over the end of the rating horizon. Beyond the near-term profitability pressure resulting from its strategic initiatives, Fitch expects the company's financial leverage to remain elevated over the rating horizon given its private equity ownership.

Evolving Marketplace: Gainwell faces risks in the evolving MMIS marketplace. Fitch believes Centers for Medicare and Medicaid Services' (CMS) efforts stimulate increased competition and provide opportunities for new entrants seeking to develop niche solutions, which may lead to share erosion over time. However, despite the potential for increased competition, Fitch believes the risk of lost wallet share is moderated by Gainwell's large installed base and undertaken investments, which position it as an entrenched provider of the core underlying platform.

Market Position: Gainwell is the primary MMIS vendor in 36 states/territories, serving 51 in total when including adjacent or modular offerings. The company covers approximately 60 million beneficiaries across its portfolio of offerings, out of the 88 million under Medicaid program. Increased competition from CMS's drive towards modularity and interoperability has increased competitive intensity and moderated Gainwell's growth rate. However, Fitch expects the company's leadership position, long-term contracts and high retention rates to provide support during re-determination of contracts.

Cyclicality: Fitch believes the company will exhibit a correlation with Medicaid spending and enrollment, supported by the non-discretionary nature of health expenditures. Medicaid enrollment exhibits countercyclicality, which experiences elevated growth during economic downturns as job losses increase the pool of eligible beneficiaries, resulting in increased demand for the company's offerings. However, with the increased competition in the industry, Fitch expects Gainwell's revenue growth in mid-single digits driven by new contract wins, new implementations, and new businesses as pharmacy benefits management, partially offset by a few client signature delays on awarded contracts.

Beneficial Tailwinds: Fitch expects Gainwell to benefit from strong secular trends propelling growth in Medicaid expenditures. The CMS forecasts Medicaid expenditure growth of 5.4% per annum due to long-standing trends in medical procedure/drug cost inflation and utilization, program expansions among states, and increased share of the aged and disabled beneficiaries served. In addition, CMS estimates $80 billion of improper payments by Medicaid and $4.3 billion under the Children's Health Insurance Program in 2022 due eligibility and claims processing complexity, lack of sufficient documentation, shifting regulatory requirements, fraud and waste.

States suffering from constrained budgets are strongly incentivized to adopt Gainwell's software and data offerings in order to contain such costs. Fitch believes the secular tailwinds provide for a dependable growth trajectory, benefiting the credit profile in the long-run.

Derivation Summary

Fitch believes Gainwell benefits from favorable tailwinds as the underlying growth of Medicaid, constrained state budgets, constructive regulatory environment and long-standing trends in U.S. health care including, an aging demographic, medical procedure/drug cost inflation and utilization growth are supportive of adoption of the company's software and services.

The combination with HMS bolstered the company's modular offerings to generate significant cross-selling opportunities in the existing client base. Fitch believes growth is further ensured by the company's leading share, strong client retention rates, high switching costs and continued Medicaid program expansions among states.

Fitch expects Gainwell to demonstrate minimal cyclicality and durable resistance to economic cycles due to the counter cyclical aspects of Medicaid enrollment. While Fitch views the high visibility into long-term revenue growth positively, the company faces risks from an evolving marketplace and the potential for future regulatory changes that may increase competition or reduce growth in Medicaid expenditures and enrollment over time.

The company's profitability metrics, though strong, scores below peers, with Fitch forecasting EBITDA margins in high 20% range over the rating horizon, compared with the 38% average for Fitch-rated health care IT peers. However, Gainwell's margins are still above average of Fitch-rated software peers in the B-category. Fitch expects FCF to remain negative in fiscal 2024, and breakeven in fiscal 2025, constrained due to significant interest expenses and MES implementation costs. Fitch believes FCF will improve gradually as growth and margin expansion returns, and will be sustainable due the low cyclicality and a supportive regulatory environment in the long term.

Despite these favorable characteristics, Fitch forecast fiscal 2024 leverage of 9.9x is near the upper 6.2x-10.9x range for Fitch-rated health care IT issuers in the 'B' rating category. However, Fitch expects gradual reduction in leverage to 7.0x by fiscal 2027 due to achievement of already actioned cost reduction programs in Gainwell and stabilization of MES costs.

While the company clearly benefits from beneficial secular tailwinds, a leading, defensible market position, and low cyclicality, Fitch views sustained negative FCF and elevated leverage as the primary determinants of the 'B-' rating. No Country Ceiling, parent/subsidiary or operating environment aspects had an impact on the rating.

Key Assumptions

Normalized revenue growth in the mid-single digits;

EBITDA margins expanding from low 20s in fiscal 2024 to high 20s by fiscal 2027;

Capital intensity 2.5% of revenue;

Debt repayment limited to mandatory amortization;

Interest rate forecasted to be 4.20% in FY25, going down to 3.50% in FY26 and FY27, respectively;

Refinancing of first-lien revolver facility prior to maturity;

Fitch assumes partially cash and debt-funded acquisitions of approximately $250 million through fiscal 2027.

Recovery Analysis

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that Gainwell would be reorganized as a going-concern in bankruptcy rather than liquidated;

A 10% administrative claim.

Going-Concern (GC) Approach

The estimated GC EBITDA reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which Fitch bases the enterprise valuation (EV). Fitch contemplates a scenario where the growing trend of modular MMIS offerings intensifies market competition and leads to loss of market share for Gainwell. This shift is expected to cause a slowdown in revenue growth, with lower profitability stemming from ongoing material MES implementation costs.

Consequently, Fitch expects Gainwell would likely be reorganized with a similar product strategy and higher than planned levels of operating expenses as the company reinvests to develop competing products, ensure customer retention and defend against competition.

Under this scenario, Fitch believes EBITDA margins would decline such that the resulting GC EBITDA is approximately 15% below FY25 expected EBITDA level. Fitch believes GC EBITDA will be above future results as much of the company's recent margin pressures are viewed as transitory.

An EV multiple of 7.0x EBITDA is applied to the GC EBITDA to calculate a post-reorganization enterprise value.

The choice of this multiple considered the following factors:

Comparable Reorganizations: The historical bankruptcy case study exit multiples for technology companies ranged from 2.6x-10.8x. Of these companies, only three were in the software sector: Allen Systems Group, Inc; Avaya, Inc.; and Aspect Software Parent, Inc., which received recovery multiples of 8.4x, 8.1x, and 5.5x, respectively. Long-term contracts ranging from 6 years-10 years, average client relationship of 10 years-20 years, with low customer concentration, and mission critical nature of Gainwell's solutions support the high-end of the range;

M&A Multiples: A study of 273 precedent transactions in the health care IT industry during 2015-2020 established median EV/EBITDA transaction multiples ranging 9x to 18x, depending on the specific product area. In addition, HMS was acquired at a 15.5x multiple, excluding synergies.

Fitch evaluated a number of qualitative and quantitative factors that are likely to influence the GC valuation:

Secular trends and regulatory environment are highly supportive with Medicaid enrollment and expenditure growth resulting from program expansions, looser eligibility standards leading to a higher share of the aged and disabled beneficiaries served, and increased claims processing complexity. In addition, constrained state budgets encourage adoption of the company's products that reduce improper Medicaid spend;

Barriers to entry are high relative to software issuers, as deep domain and regulatory expertise are required to develop necessary solutions;

Revenue and cash flow outlook are favorable as long-standing secular trends are supportive of revenue growth, while moderate margin expansion and low capital intensity promote higher FCF margins;

Revenue certainty is high as a result of the 92% recurring revenue profile, typical contract duration of 6 years to 10 years, 100% client retention and the countercyclicality of Medicaid;

Fitch believes these factors reflect a particularly attractive business model that is likely to generate significant interest, resulting in a recovery multiple at the high-end of Fitch's range.

The recovery model implies a 'B+' and 'RR2' Recovery Rating for the company's first-lien senior secured facilities.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

--(CFO-capex)/ debt sustaining above 3%;

EBITDA leverage sustaining below 7.5x;

EBITDA Interest Coverage sustained above 1.5x;

Organic growth sustaining above high single digits.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

EBITDA Interest Coverage sustained below 1.0x;

--(CFO-capex)/debt sustaining below 0%;

Erosion of the company's competitive advantage or market position.

Liquidity and Debt Structure

Adequate Liquidity: Gainwell appears to have sufficient liquidity. As of pro forma 3Q24, the company had approximately $200 million of cash on the balance sheet. EBITDA margin compression, non-recurring integration and MES implementation costs, and rising interest rates have pressured FCF and credit protection metrics, with coverage ratios now near 1.0x.

However, Gainwell has full availability of $400 million revolver which is fully undrawn, post the recent incremental term loan of $250 million. Fitch forecasts steady growth in liquidity as FCF builds up after the costs related to the MES implementation settle down and cost efficiencies take effect. It is also expected that the RCF will remain undrawn. While liquidity has come under some pressure, Fitch believes it remains more than sufficient to fund operating costs.

Debt Structure: Gainwell has first lien senior secured facilities including an undrawn $400 million revolver, and an outstanding amount of $4,355 million term loan which amortizes at 1% per annum. Gainwell also has a second lien senior secured term loan of $1,459 million. The revolver matures in 2025, the first lien term loan in 2027, and the second lien term loan in 2028, providing the company ample headroom. Fitch further expects the company to refinance the revolver credit facility prior to maturity.

Issuer Profile

Gainwell is a software and solutions provider that supports the administration and operation of government Medicaid programs and other Health & Human Services initiatives through a Medicaid Management Information System.

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 www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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