Moody’s Investors Service downgraded ratings for Varsity Brands Holding Co. Inc., including the company’s Corporate Family Rating (CFR) and Probability of Default Rating (PDR), to B3 from B2 and to B3-PD from B2-PD, respectively. The downgrades are largely the result of the company’s planned upsizing of existing debt outstandings, and the associated increase in financial risk in connection with a pending LBO by Bain Capital.

As a result of this rating action, the company’s $1.4 billion principal first lien term loan due 2024 (upsized from $1.125 billion) has been downgraded one notch, to B2 from B1. The ratings outlook remains stable.

Bain Capital is in the process of acquiring a majority stake in Varsity Brands in a sponsor-to-sponsor transaction from Charlesbank Capital Partners, which is expected to maintain a minority stake in the company. Proceeds from the planned $275 million incremental first lien term loan and $120 million incremental second lien term loan, together with $1,620 million of rolled debt from the company’s existing portable capital structure, $879 million of sponsor equity (including both new and rolled equity) and roughly $5 million of balance sheet cash, will be used to fund the acquisition of the company and estimated fees and expenses.

“Varsity Brands’ fundamental ratings downgrade largely stems from its meaningfully elevated financial risk profile, with leverage measured by Moody’s-adjusted debt-to-EBITDA rising from about 6.5 times to approximately 7.8 times pro forma for the planned buyout and notwithstanding potential synergies,” said Moody’s Vice President Brian Silver.

“Although the company’s business profile suggests the ability to quickly deleverage through a combination of earnings growth and debt repayment using associated cash flows, we believe that the employment of relatively aggressive financial policies, particularly under new ownership, with a higher valuation and entry point, will continue, with debt-funded tuck-in acquisitions and/or shareholder distributions likely to delay actual deleveraging and in turn constrain ratings,” added Silver.

The following ratings have been downgraded for Varsity Brands Holding Co., Inc. (with Hercules Achievement, Inc., as a joint and several co-borrower on the term loan):

  • Corporate Family Rating, to B3 from B2
  • Probability of Default Rating, to B3-PD from B2-PD
  • $1.4 billion principal (upsized by $275 million) senior secured first lien term loan due 2024, to B2 (LGD3) from B1 (LGD3)

Outlook Action

The ratings outlook remains stable.

Ratings Rationale

Moody’s said Varsity Brands Holding Co. Inc.’s B3 Corporate Family Rating (CFR) broadly reflects the company’s high financial leverage and relatively aggressive financial policies associated with its private equity ownership. Sales are expected to grow in the low single-digit percent range on an organic basis over the next year, with operating margins remaining moderate in the mid-to-high single-digits, subject to a high degree of seasonality that is evident on a quarterly basis. Topline growth is expected to largely be driven by the BSN and Varsity Spirit segments and partially offset by relatively flat sales in the Herff Jones segment, which continues to face challenges but maintains healthy margins. Debt-funded acquisitions will likely continue to supplement growth over time. Moody’s expects the company’s balance sheet will deleverage somewhat, from roughly 7.8 times on an adjusted debt-to-EBITDA basis for the twelve months ended March 2018 and pro forma for the planned debt upsizing, to approach the seven times range over the next 12-18 months, primarily as earnings grow and, to a lesser extent, as some debt is repaid (all financials are Moody’s adjusted unless otherwise stated). But the risk of a re-leveraging event will remain prominent and may subsequently continue to constrain ratings.

Moody’s said Varsity benefits from its solid position within its niche markets and the operational diversification provided by its three business segments, for which the diversified nature of the product portfolio helps to limit volatility in financial performance. The company also has a track record of deleveraging and is expected to maintain a good liquidity profile, the latter supported by access to a $150 million asset based revolving credit facility (unrated) and positive free cash flow generation (albeit the bulk of which comes in the fourth quarter).

The stable rating outlook reflects Moody’s expectation that sales will grow in the mid-single-digit percent range, with organic gains supplemented by acquisitions and which, together with planned cost saving initiatives, will result in higher EBITDA growth and positive free cash flow generation. The outlook also incorporates Moody’s expectation that Varsity will maintain a good liquidity profile and a disciplined approach to acquisitions, with financial risk tolerance not meaningfully appreciated from current levels.

The ratings could be upgraded if Moody’s-adjusted debt-to-EBITDA improves and is expected to be sustained below seven times. Also, the company would be expected to maintain at least a good liquidity profile and a disciplined approach to acquisitions and broader financial policies. Alternatively, the ratings could be downgraded if Moody’s-adjusted debt-to-EBITDA is sustained above eight times, or if free cash flow generation and/or liquidity materially weaken. Also, increasingly aggressive financial policies, such as a large shareholder dividend, could also prompt consideration for a prospective ratings downgrade.