Veritas' Cohesity Deal Promises 62.5% Debt Paydown but Risks Leaving Behind Weakest Businesses in Overlevered Structure; Lenders Fear Cohesity Stake Dropdown

Global enterprise software provider Veritas Technologies’ term loans jumped on the news that the group intends to sell its data protection business to Cohesity for $2.5 billion of cash and a 20.9% stake in the combined entity, which should result in an up to 62.5% paydown of Veritas’ debt. But the term loans have started to give up some of their gains as lenders digested the deal. While Veritas has disclosed few details, lenders are concerned that the remaining debt will likely be over 10x levered and backed by the group’s weakest assets, and that sponsor The Carlyle Group could shift the stake in the Newco out of Veritas’ restricted group via a dropdown transaction to try recoup some of its original investment, sources said.

Veritas’ data protection segment, which is the group’s best asset, accounts for 70% of group revenue. According to management, it has slightly lower margins than the remaining parts, given that it includes the hardware business, which is inherently lower margin than software, which means the data business likely generated around 65% of group EBITDA, sources estimated. That implies that out of Veritas’ $410 million LTM September 2023 adjusted EBITDA, the data protection business likely generated in the region of $267 million EBITDA and the remaining business around $144 million. Assuming Veritas applies the $2.5 billion cash proceeds to repaying debt, it would be left with $1.5 billion of debt, which would mean it would still be over 10x levered, excluding the minority stake in the Newco. And leverage will likely rise, given that all of the remaining assets are in long-term decline, sources noted.

Post transaction, Veritas will comprise Software Defined Storage, Data Compliance and BackUpExec (SME solution), which are all the underperforming parts of the group and in long-term decline, sources noted.

Software Defined Storage sales were down 20.2% in 2019, down 12.4% in 2020, grew 9.3% in 2021, were flat in 2022, down 13.2% in 2023 and fell 10.1% in the year-to-date period to the third-quarter 2024. Veritas was the last player in the software defined storage market to follow the customer transition to Linux and lost a lot of market share as a result, with the sector now dominated by Dell and NetApp, one source said.

Data Compliance sales were down 11.7% in 2019, down 2.3% in 2020, down 7.5% in 2021, down 7.6% in 2022, down 3.8% in 2023 and fell 4.8% in the year-to-date period to Q3’24. The data compliance market has stopped growing and is highly competitive.

BackUpExec (SME solution) sales were down 15.5% in 2019, down 9.2% in 2020, down 25.6% in 2021, down 16.7% in 2022, down 22.5% in 2023 and fell 19% in the year-to-date period to Q3’24. The sector is highly commoditized and under heavy pricing pressure from newcomers like Veeam and Commvault, the same source added.

The Newco will have sales of around $1.6 billion, of which 70% will come from Veritas’ data protection business. Cohesity has lower margins than Veritas, which means the new entity will likely have 25% margins at best, implying around $400 million EBITDA, sources estimated. Assuming a 12x EV/EBITDA multiple, the Newco could be worth $4.8 billion and assuming it raises $2 billion of debt to fund the acquisition leaves around $2.8 billion of equity, so the 21% stake could be worth close to $600 million.

The terms of the deal include a liquidation preference of $1.5 billion, which is effectively a call option by Cohesity’s shareholders in case they want to buy back the 21% stake, one source noted.

But it's unclear whether this minority stake will be part of the Veritas restricted group, sources cautioned. Under the term loan documentation, Veritas could shift the stake into a new entity outside of the restricted group via a dropdown transaction, the sources added. Carlyle will likely want to make some recoveries on its original $2.65 billion equity check it stumped up to buy Veritas back in 2016, and it will unlikely make any recoveries from the remaining assets, they noted.

Some lenders also questioned whether the deal will ultimately go through. Cohesity seems to be aiming to buy Veritas’ data protection business to gain scale rather than out of any conviction in the product, given that it has publicly highlighted some of Veritas’ NetBackup offering’s shortcomings, sources noted.

Veritas reported weak Q3’24 results, pushing net leverage up to 9.8x. Group sales fell 5% year over year to $398 million, adjusted EBITDA slumped 28% to $88 million while margins declined to 22% from 29% the same period last year. Management noted that part of the underperformance was driven by timing issues. The group’s full-year guidance of $1.642 billion sales and $435 million EBITDA implies 4% sales and 16% EBITDA growth during the fourth quarter. However, Veritas has already revised adjusted EBITDA guidance down twice from $525 million initially and then $480 million. The group also remains free cash flow negative and now expects to burn $260 million during its fiscal 2024 after having revised its previous cash burn forecasts of $160 million initially and then $230 million. That means liquidity is getting tight with $211 million of cash as of December 2023, which is expected to fall to around $185 million by March 2024, sources said. However, Veritas’ $183 million RCF remains undrawn.

The group’s euro term loans dropped to 89/91 after having climbed to 94/95 from 84/85 following the news of the Cohesity deal, one source noted. The dollar term loan B slipped to 92.5 after having jumped to 93.21-mid from 87.31-mid, according to TRACE.

Veritas’ capital structure as of Dec. 31, 2023, is below:

According to Reorg’s CLO database, Veritas’ loans are held by the following managers. Click HERE to see the full list of holders in the database.

To see the covenant analysis or to talk to one of our legal analysts, click HERE.

Carlyle and Veritas did not respond to requests for comment.