Fitch Ratings has affirmed the Long-Term Issuer Default Rating of
Fitch has also affirmed VIAVI's senior unsecured notes at 'BB'/'RR4'. The Rating Outlook is Stable.
The Rating and Outlook reflect VIAVI's leadership position in wireless and wireline test and measurement sub-sectors that benefit from secular trends. In addition, relative to peers, the company's anti-counterfeiting pigments business reduces cyclicality. Under Fitch's base case, VIAVI's credit protection metrics may test Fitch's positive rating sensitivities. However, Fitch believes rating upside is not warranted as the continued commitment to a gross leverage target of below 3.5x is suggestive of potential for future leveraging transactions.
Key Rating Drivers
Strong Market Position: VIAVI is a top five provider in the test and measurement space and enjoys leading market positions in wireline cable, access, metro and transport, fiber, wireless RAN-to-core, as well as land-mobile and military radio, navigation, communication and transponders. Additionally, VIAVI is a leader in anti-counterfeiting pigment materials as well as 3D sensing optical filters and diffusers used in mobile phones.
Industry Trends Spur Demand: VIAVI benefits from exposure to both development and field deployment of wireless and wireline communication technologies. Increased fiber deployment in homes, data centers and wireless backhaul increases demand for VIAVI's test and measurement offerings applicable to client manufacturing operations and its network management solutions, while development of 800 Gbit/s and 1.6 Tbit/s ethernet speeds support demand for module prototype and lab-test solutions.
Similarly, transition to 5G wireless has benefited VIAVI through relationships with service providers that provide demand growth as their networks are built out, while 6G development supports deeper engagement with key wireless equipment providers.
Finally, the company's 3D sensing offering for mobile phone applications has grown in the iOS ecosystem and the potential for eventual adoption within android-based phones may significantly expand market potential. Growth from ADAS automotive applications should also support demand for VIAVI's optical filters and diffusers.
Diversification Outweighs Customer Concentration: VIAVI's revenue composition includes about 70% from the network and service enablement segment (NSE), inclusive of core test and measurement and network optimization, and approximately 30% attributed to the highly entrenched optical security and performance products (OSP) segment, which primarily provides the anti-counterfeiting pigments needed for physical currency.
This secondary source of revenue helped to offset demand declines in the NSE segment during the pandemic. For FY21 NSE segment revenue declined by 1.4%, while the OSP segment increased by 25.8%, resulting in overall VIAVI revenue rising by 5.5%. The counter cyclicality of the anti-counterfeiting business is driven by fiscal and monetary stimulus support programs that drive bank note growth during times of macroeconomic stress.
While the government's large stimulus response to the pandemic cannot be assumed for typical economic downturns, the fundamental countercyclical nature of the anti-counterfeiting business can be relied upon to provide some offset to any economic driven demand fall off in wireless and wireline end-markets. Fitch views this diversification benefit as partially offsetting the customer concentration associated with the anti-counterfeiting business.
Improved Operating Leverage: Since VIAVI (formerly
Additionally, increased scale (FY16 revenue of
Conservative Financial Policy: VIAVI maintains an explicit gross leverage target of below 3.5x. Since the time of Fitch's initial ratings in 2021, VIAVI's gross leverage has remained modestly above 2.0x, well below the company's stated upper threshold and testing Fitch's positive sensitivity of 2.0x. The current leverage posture provides meaningful headroom to accommodate investment, end market cyclicality, and acquisitions, of which VIAVI has completed
Absent leveraging transactions and under conservative growth and margin assumptions, Fitch sees VIAVI's credit metrics remaining above positive rating sensitivities over the medium term. Positive rating momentum could be warranted as the company completes its capital structure transition from convertible notes to traditional high-yield unsecured debt and commits to a firmer leverage target. However, Fitch believes the company's maintenance of its current financial policy at its recent analyst day in September of 2022 is indicative of the desire to maintain the flexibility provided by the current rating to execute on growth, profitability and balance sheet strategies over the longer term.
Derivation Summary
VIAVI's ratings reflect its market leadership as a test and measurement provider in certain segments of the communications end market, as well as complimentary positions in anti-counterfeiting pigment materials and 3D sensing optical filters. The company is a competitor of peer
Additionally, post the note offering executed at the time of Fitch's initial ratings, VIAVI has maintained a fairly conservative capitalization, as evidenced by 2.2x total debt with equity credit to operating EBITDA leverage for FY22, compared with peer Keysight, where leverage for the FY22 is expected to close at 1.1x. VIAVI targets gross leverage not to exceed 3.5x, while Keysight targets 2.0x on average.
Peer
Fitch believes a 'BB' IDR is warranted as the company's market leadership position, strong secular gross drivers, diversification and operating improvements are weighed against financial policies, potential for leveraging transactions elevated leverage and operating metrics relative to peers.
No country-ceiling, parent/subsidiary or operating environment aspects affect the rating.
Key Assumptions
Fitch's Key Assumptions Within the Rating Case for the Issuer
Revenue growth of 1% in FY23 due to reduced service provider spend partially offset by countercyclicality of OSP segment, and mid-single digit growth per annum thereafter due to demand from 5G infrastructure buildout, fiber upgrade cycle, as well as testing and development of 6G wireless and 800 gigabit/1.6 terabit ethernet;
Maintenance of a 25% margin, with modest improvement over the next two to three years, reflecting fairly stable NSE gross margins, modestly declining OSP margins and improved operating leverage with growth;
Capex normalizing to 4%-5% of revenue due to completion of new
Repurchase of remaining 2023 convertible notes and refinancing of 2024 convertible notes with upsized issuance;
Opportunistic share repurchases in fulfillment of
M&A incremental to the rating case and any corresponding leverage to be considered within the context of a financial policy that gross leverage shall not exceed 3.5x and will be brought back to 3.5x or below within 12-18 months of a leveraging transaction.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Total debt with equity credit to operating EBITDA sustained below 2.5x;
Sustained organic growth approaching mid-single digits;
Adoption of a more conservative leverage target.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Total debt with equity credit to operating EBITDA sustained above 3.5x;
FCF margin approaching neutral;
Organic growth approaching breakeven;
Shift to a more aggressive financial policy.
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 '
Liquidity and Debt Structure
VIAVI had
Issuer Profile
VIAVI is a provider of network test, monitoring and assurance solutions as well as optical solutions for hard currency anti-counterfeiting pigments and 3D sensing.
Summary of Financial Adjustments
Fitch made standard financial adjustments as described in the applicable ratings criteria.
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.
ESG Considerations
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.
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