Price whispers on BMC Software’s dual-currency bond offering, which will help finance its USD 8.3bn buyout by KKR, are drifting into the double-digits, according to four buysiders following the transaction. Lead Goldman Sachs has been trying to bring the bond deal to market for some weeks, but pricing pushback and the size of the offering delayed the official launch, two of the buysiders said.

The bond offering follows a tricky loan syndication, which allocated wide of initial talk in June, after investors expressed concern over the possibility of KKR’s ownership leading to follow-up acquisitions, thereby restricting the amount of free cash flow that would go towards debt reduction, as reported by Debtwire.

Alongside KKR’s strategy, the success of the deal also hinges on the company’s ability to offset the cyclicality of the sector—specifically in its mainframe segment—and gradually reduce its aggressive 7x total leverage, three additional buysiders said.

The eight year non-call three USD 1.825bn-equivalent senior unsecured notes offering was launched on Tuesday (31 July), with the roadshow ending 8 August and pricing expected thereafter. The deal will be split between euros and dollars, but tranche sizes have not yet been indicated.

Unofficial price whispers for the CCC+ rated bond have widened to 9.75%-10% range, having started at 9% area when the deal was launched, according to three of the buyside sources and two traders.

The buyout will be funded with proceeds from the bonds, the new term loans and revolving credit facilities, USD 300m in PIK preferred equity and a USD 2.1bn sponsor equity contribution, along with cash on hand. Committed financing for the transaction is being provided by Credit Suisse, Goldman, Jefferies, Macquarie and Mizuho Bank, with the deal expected to close in 3Q18, according to a company press release.

The USD 3.3bn Libor+ 425 (0% floor) TLB due 2025 was last quoted in the 99.956/100.358 context. The EUR 930m Euribor+ 475 (0% floor) TLB due 2025 was last quoted in the 100.124/100.625 context, according to Markit.

BMC is levered 5x through its new term loans and 7x through the proposed notes offering, based on USD 881.2m in pro forma adjusted LTM EBITDA as of 31 March, and USD 6.219bn total debt, according to company documents. The company estimates USD 890.4m in pro forma LTM EBITDA as of 30 June.

Stripping out certain adjustments, investors modelled adjusted EBITDA in the low-to-mid USD 800m range, and bond investors are doing the same, said two of the buysiders.

The company anticipates USD 45m of cost savings for fiscal year 2019, planned independently of the merger, USD 36m of which remain to be realized, according to deal documents. The cost savings include: USD 3m in cost reduction in non-strategic products, USD 9m in performance and compliance, USD 20m in enterprise and sales, USD 1m in reduced headcount in mainframe, USD 4m in professional services and USD 5m in corporate.

The USD 400m revolver due 2023 will be undrawn at deal close, although the company said it could draw up to USD 50m to fund a possible OID and upfront fees and expenses, according to deal documents. Accounting for cash being used to fund the acquisition, the company will have around USD 62m of cash on hand at deal close.

The trough is coming

BMC’s four main segments are mainframe (27% of FY18 revenue), workload automation (21% of FY18 revenue), IT service management (25% of FY18 revenue) and performance and compliance (18% of FY18 revenue), according to deal documents.

The mainframe segment contracts are locked into three-year increments, with IBM driving the mainframe update cycle and in turn the BMC software update cycle, five of the sources said.

During the company’s most recent EBITDA trough in 2016, its IT services segment’s on-premises software product Remedy was losing market share to cloud solution company ServiceNow, forcing BMC to make hefty cost cuts, three of the buysiders said. “ServiceNow came out and ate BMC‘s lunch,” one buysider said.

Although sources agreed with the company’s claim to be better positioned than during the last mainframe downturn, they added that management still has work to do to offset the drop in EBITDA and cash flow that is expected to hit the mainframe business. While the company has moved into cloud services, it faces serious competition, they added.

“More workload moves to the cloud every day, and mainframe is being used less and less,” said one buysider. “Also, all of these legacy languages are used in mainframe that the baby boomer generation is efficient in. But they’re retiring and those languages are becoming less relevant, so there’s a brain drain happening.”

 

Two other buysiders said the cyclicality of the mainframe segment was more subjective than many market participants appreciated.

“Mainframe is not a big concern for me,” said one. “I think people have binary views on this: either you think it’s dying or you are really positive. For me, I don’t think the cycle is going to hit soon. If you look at IBM mainframe sales, the number continues to grow. And mainframe is involved in a lot of important workflow.”

Three buysiders forecast BMC’s free cash flow at USD 160m-USD 237m (2.6%-3.8% of total debt), based on USD 805m to USD 881m of LTM adjusted EBITDA, USD 29.1m of capitalized software and software-as-a-service development costs, USD 28m of capex (PP&E only), USD 60m in taxes, USD 40m for a one-time cash restructuring cost, and USD 487m in interest expense.

Sources forecast a decline in EBITDA adjustment of between USD 50m to USD 150m in the next 12 months due to the cyclicality of the mainframe segment.

Where to from here?

Private equity sponsors Bain and Golden Gate bought BMC for USD 6.9bn in 2013, with USD 5.5bn financed with loans and bonds. The proceeds of a USD 75m 9%/9.75% holdco PIK toggle note offering due 2019 funded a dividend to the sponsors in 2014.

When Bain and Golden Gate bought BMC, mainframe technology was declining in popularity, and struggling public software companies like BMC needed structure from private equity sponsors to keep generating earnings and to remain relevant, two of the buysiders said.

“It was very easy to see what Bain and Golden Gate were doing. They had to take a bloated public company, cut costs, turn operations around and invest in new products,” one of the buysiders said.

BMC’s adjusted EBITDA margin has gone up to 43% at LTM 31 March from 35% at the time of the 2013 acquisition, according to company documents.

Although the company is in better shape than it was during the Bain/Golden Gate buyout, it is unclear what KKR will do with the company, hence the push for double-digit pricing on the bonds, three of the buysiders said. One highlighted the lack of a formal deleveraging target as a point of concern.

“KKR talked about their investment thesis, and said they think there is a lot of organic growth potential,” the buysider said. “They didn’t speak to M&A specifically but that is definitely a concern of investors especially given the leverage profile. There were no questions on dividends, and there was no leverage target given, besides saying they want to get leverage down. It’s always a little better to hear a target.”

With nearly USD 4.4bn-equivalent in secured debt sitting above the unsecured bonds, potential bondholders would like to see KKR decrease leverage before coming back to the market for debt-funded activities like acquisitions or dividends, three of the buysiders said.

“My biggest concern would be the sponsor. Our hope is the company is de-levering soon, but with KKR who knows,” one of the buysiders added.

Sources expect pricing of the proposed notes in line with or a touch tighter than software and hardware company Riverbed Technology because of Riverbed’s exposure to mainframe cyclicality. The CCC+/Caa1 USD 525m 8.875% senior unsecured notes due 2023 last traded on 31 July at 94 to yield 10.56%, according to MarketAxess.

BMC should come much wider than cloud computing company Rackspace Hosting due to Rackspace’s higher rating and business diversification, a source said. Rackspace’s B/B3 USD 1.2bn 8.625% senior unsecured notes due 2024 last traded at 101.25 to yield 8.266%, according to MarketAxess.

BMC’s USD 1.625bn 8.125% opco unsecured notes due 2021 last traded at 102.55 to yield 5.299%, up more than 50 points from trades in the 50s in February 2016, and up two points from trades at par in May before the buyout was announced, according to MarketAxess.

BMC, KKR and Goldman Sachs did not respond to requests for comment.

2018 Debtwire