Moody’s Investors Service and S&P Global Ratings placed Crocs, Inc.’s debt ratings on review for downgrade to reflect the impact of its planned acquisition of Heydude.

The $2.5 billion deal is subject to customary closing conditions and is expected to close in the first quarter of 2022.

At Moody’s, Crocs’ the ratings affected include its Ba3 corporate family rating, Ba3-PD probability of default rating and B1 senior unsecured notes rating. The speculative grade liquidity rating of SGL-2 is unchanged. The outlook was revised to ratings under review from stable.

Moody’s said its possible downgrade reflects the expectation that Crocs will use debt to fund over 80 percent of the transaction cost.  The company plans to fund the transaction with $2.05 billion of debt and $450 million of its equity, which it will distribute to Heydude’s founder.

Moody’s said, “Moody’s review will focus on review of the target company’s financial statements, Crocs’ integration plans and ability to enhance Heydude’s long term brand strength and growth potential. Moody’s review will consider Crocs’ pro forma credit metrics and future capital structure. Moody’s review will also focus on any amendments to Crocs’ revolving credit facility which may be needed in order to allow for the transaction including potential financial covenant relief associated with the acquisition as well as Crocs’ future governance considerations, including its ability and willingness to accelerate de-leveraging given the current global supply chain challenges and uncertainty presented by new coronavirus variants.”

S&P said it placed all of its ratings on Crocs, including its ‘BB-‘ issuer credit rating, on CreditWatch with negative implications.

S&P said in a statement, “The acquisition could cause us to downgrade Crocs if we believe its leverage will be sustained above 3x for over 12 months. This could occur due to integration difficulties or operational missteps or additional aggressive financial policy decisions that result in leverage sustained above 3x.

“Crocs exceeded our expectations in 2021 by increasing its S&P Global Ratings-adjusted EBITDA for the 12 months ended September 30, 2021, by over 200 percent relative to its 2020 levels, largely due to its continued strong demand amid the pandemic and ability to sell at higher price points. However, the company has also undertaken several large debt-funded share repurchases, since we assigned our initial rating in early 2021, totaling approximately $1 billion, which eliminated a significant amount of its leverage cushion to take on a large debt-funded acquisition at this rating level while maintaining leverage of 2x. If Crocs and Heydude continue to perform, even at decelerated growth levels, we believe the company’s leverage will likely improve below 3x in 2022. However, given Crocs’ elevated leverage levels, there is little room for an underperformance, either due to unexpected volatility in the macroeconomy stemming from the spread of new coronavirus variants, further supply chain disruptions, or operational missteps.

“Heydude is a fast-growing, mid-price casual footwear brand with limited brand recognition. Similar to Crocs, Heydude has benefited from the casualization of apparel trends accelerated by the pandemic. Specifically, it increased its revenue and EBITDA exponentially in 2020 and more than doubled both figures this year. We view positively Crocs’ planned investment in branding and marketing to increase Heydude’s consumer reach and brand equity. Rapidly expanding companies typically experience growing pains as they try to scale beyond their initial loyal customer base. However, Crocs has a proven track record of expanding its own signature shoe and it will leverage its experience to scale Heydude by expanding its distribution and deepening its brand reach. The addition of Heydude will also diversify the company’s product portfolio away from its signature clog product (currently accounting for approximately 75 percent of its sales). Nonetheless, Crocs’ execution risk remains high, especially given HEYDUDE’s participation in the highly competitive and fragmented casual shoe segment, where the levels of competition and fashion risk are higher than in the clog category. Given these risks, we do not believe the acquisition will improve our assessment of Croc’s business risk in the near term.

“We will seek to resolve the CreditWatch placement following our receipt of more information regarding Heyedude’s financial performance and Crocs’ financial outlook and policies. At that time, we will assess the acquisition’s effect on our view of the company’s overall operations, credit metrics, and financial policies, including its communicated target to prioritize debt repayment.

“Upon the completion of our review, we could affirm our ratings on Crocs if we expect it to maintain leverage of less than 3x over the next 12 months because it will continue to expand its EBITDA and repay debt to reduce its leverage.

“Alternatively, we could lower our ratings on the company if we forecast it will sustain leverage of over 3x due to continued aggressive financial policies.”

Photo courtesy Crocs