OREANDA-NEWS. November 17, 2015. Fitch Ratings has placed Oberthur Technologies Group S.A.S.'s (Oberthur) Issuer Default Rating (IDR) of 'B' on Rating Watch Positive, (RWP) following the registration of the company's initial public offering planned for early 2016. Fitch estimates a successful IPO and deleveraging in line will management's guidelines could lead to the IDR being upgraded by up to two notches.

The outstanding instrument ratings of the group's debt are also placed on RWP although we expect that some external debt will be repaid with proceeds from the IPO and the balance refinanced with new bank financing. In these circumstances the ratings of the existing debt are likely to be withdrawn following the closing of the relevant transactions and assuming the new debt structure is put in place simultaneously.

Resolution of the RWP is expected to accompany closing of the IPO and an associated debt refinancing broadly in line with the parameters outlined in the registration document. A full list of rating actions is available at the end of this commentary. Whether the IDR is upgraded by one or two notches will depend on the continued strength of operating results and the improving visibility of future cash flow generation. Expectations around key cash flow items - in particular negative working capital and non-recurring / restructuring items will be important in updating our forecasts and understanding where FFO adjusted net leverage is likely to stabilise.

KEY RATING DRIVERS

IPO and Deleveraging
The IPO registration document outlines Oberthur's intended near- to medium-term financing structure. Proceeds from the IPO will in part be used to refinance / repay existing debt with the intention being to retire the senior unsecured bonds and replace the existing secured bank debt with an unsecured debt package consisting of a EUR200m term loan A and EUR270m term loan B. In addition, the company's core debt of approximately EUR690m will be reduced by EUR220m.

Management guidelines in the registration document indicate it expects net debt-to-EBITDA to reduce to 2.5x at end-2015, pro-forma for the IPO, from 4.2x. Subject to the company's current operating and financial trends being sustained, a similar quantum of deleveraging would be expected to accompany the IPO assuming it goes ahead in the New Year. This quantum of deleveraging is expected to lead to an IDR upgrade of up to two notches.

Resilient Business Model
Oberthur benefits from a solid market number-two position (behind Gemalto) in secure card and SIM-based solutions to the financial services, mobile network operator, connected devices and identity sectors. Pricing pressure in the commoditised SIM market results in margin pressure, the need to maintain operating efficiencies and develop new technological solutions. Revenue growth in the mobile network operator division and margin expansion at the group level indicate these pressures are being managed. Long-established relationships and the lead time to certify or validate products with a new customer provide barriers to entry within the financial services division.

Leverage and Cash Flow
With its current capital structure the legacy of an LBO, Oberthur remains highly leveraged. Free cash flow (FCF) has remained weak as a result of high interest costs, working capital pressures and exceptional costs. Operationally the business is performing well - EBITDA for 9M15 is up 31% and EBITDA margin continues to improve - 15.9% for 9M15 (from 14.8% in 9M14).

Working capital trends continue to be negative and remain a constraint on the ratings. A successful IPO would tangibly improve leverage and FCF (given medium-term savings on interest costs) and financial flexibility.

An IPO that raises proceeds broadly in line with the guidance in the registration document is forecast to reduce funds from operations (FFO) lease adjusted net leverage to below 3.5x, a level Fitch considers to be in line with a rating in the 'B+' to 'BB-' range, given the company's other rating factors.

Diversified but Volatile Revenues
Under the new reporting structure 9M15 revenues are 61% derived from financial service institutions (secure payment cards), 24% mobile network operators (SIM cards and related technologies), and 15% connected devices & identity (mobile solutions, e-passports, e-ID cards, e-driving licenses). The mix provides some diversification and counters cyclicality, although volatility within the divisions can be pronounced.

We view the company's position in financial services as a strength given the company's solid customer relationships and growth in this segment. Financial services revenues, for instance, (9M15 growth of 43%) are currently being driven by the adoption of the EMV (Europay, Mastercard, Visa) standard in the US. We also consider both financial services and mobile network customers to offer potential demand for shifting technologies and growth in the use of secure digital personal data.

Technology Risk
Mobile money/wallet offers sound growth potential to service operators, social media and technology providers. Determining who benefits most in a complex and evolving business though is less clear. Oberthur's main competitor, Gemalto, is better positioned in NFC SIM while Oberthur is stronger in embedded secure element (eSE). Concerns have been raised about the impact that embedded SIMs could have on volumes in the telecom segment. Technology risk along with financial leverage, are important risk drivers.

Non-Recurring Charges
Oberthur incurred a further EUR19.2m of non-recurring charges in 1H15, following non-recurring cash-flow charges in 2014 of EUR34.8m, mainly associated with the European manufacturing site consolidation currently underway. Non-recurring charges are, in our view, better characterised as non-operational but recurring, although they should, subject to no further major announced management plans, decline from 2016. This, along with the ability to deliver improved working capital trends, will be an important driver of a stronger cash flow profile. The expected deleveraging accompanying the IPO is nonetheless an overriding near- term ratings driver in terms of an expected upgrade from the current 'B' level.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Oberthur include:-

-Revenue growth of 15 % in 2015 vs. 22.5% in 9M15, and mid-single digit growth thereafter
-EBITDA margin of 15.5% in 2015 and broadly stable thereafter
-Capex of EUR65m in 2015 and 5% of sales for 2016- 2018
-Non recurring cash flow of (EUR40m) in 2015, comprising EUR22m payment of restructuring costs related to the 2014 reorganisation of the group's European manufacturing and EUR18m costs of IPO and refinancing
-Non-recurring cash flow charges in the region of EUR5m after 2015
-Negative working capital of EUR13m in 2015. This is assumed to improve in future years but remain negative

RATING SENSITIVITIES
Negative: The ratings could be negatively affected by FFO net adjusted leverage above 6.5x and FFO fixed charge cover below 2x on a permanent basis and any material loss in market share in the payment or telecom divisions.

Positive: The ratings could be positively affected by FFO net adjusted leverage below 4.5x and FFO fixed charge cover above 2.5x on a permanent basis along with an expectation of consistent positive FCF generation.

LIQUIDITY
The company had balance sheet cash of EUR57m and an available EUR53m under a bank revolving credit facility of (after EUR35m was drawn) as at end-September 2015.

FULL LIST OF RATING ACTIONS

Oberthur Technologies Group SAS:
Issuer Default Rating: 'B' placed on RWP

Oberthur Technologies SA
Senior secured term loan B1 due 2019: 'BB-'/'RR2' placed on RWP

Oberthur Technologies of America Corp
Senior secured term loan B2 due 2019: 'BB-'/'RR2'; placed on RWP

Oberthur Technologies Finance SAS, Oberthur Technologies of America Corp,
and Oberthur Technologies SA
RCF due 2018: 'BB-'/'RR2'; placed on RWP

Oberthur Technologies Group SAS
Unsecured notes due 2020: 'CCC+'/'RR6'; placed on RWP