Primary: Citrix Returns to HY Market to Refi 2L Bridge Loan; Initial Whispers at 14% YTM; Deal Presents Limited Pro Forma FCF Information, Numerous EBITDA Addbacks

Relevant Document:
Preliminary OM

Citrix has returned to the high-yield market to offer $3.838 billion of Caa2/B- second lien notes with a coupon of 9%, after the issuance of $4 billion senior secured notes last September at a yield of 10%. The offering is the largest since the high-yield market reopened last week, following the banking crisis spurred by the failure of Silicon Valley Bank.

The enterprise software company was acquired in the fourth quarter of 2022 by Vista Equity Partners and Elliott affiliate Evergreen Coast Capital. It was then combined with Vista portfolio company Tibco in a deal valuing the combined entity at $23.9 billion, and rebranded as Cloud Software Group Inc. As reported, bookrunners for Citrix’s $3.95 billion second lien bridge loan began talking to a select group of funds late last year about a potential takeout of the group’s bridge loan with new paper yielding about 14%. Initial price thoughts for the new second lien notes are for an OID of 78, confirming the aforementioned yield.

Proceeds from the new issue, together with $76.8 million of cash on hand, will be used to prepay all borrowings outstanding under the second lien bridge facility. After the announcement of the deal on Monday, pricing is expected today, Tuesday, April 4.

Although last September’s issuance was marketed on net leverage of 7x, the group now claims pro forma net leverage of 6x; management attributes the improvement to better margins.

However, investors evaluating the deal are relying on an incomplete set of pro forma financials: There is no consolidated cash flow statement while, as seen in the EBITDA addback chart below, financials for the pre-merger Citrix entity reflect only 10 months of trading. Further, as also seen below, numerous addbacks - excluding cost-savings - take pro forma EBITDA to $1.822 billion from $768 million, raising concerns about the actual profit potential of the business.
 
The group’s pro forma capital structure is below, with the new notes subordinated to more than $11 billion of first lien debt:
 
The sponsors expect to sell Wrike, which is outside of the restricted group. Proceeds from the sale of the entity, which was purchased by Citrix for $2.25 billion in early 2021, are expected to be used to redeem the preferred equity, as reaffirmed by management on the investor call.

Pro forma combined further adjusted cash EBITDA of $2.406 billion, explored further below, is contingent on $485 million of cost savings, of which $432 million has already been implemented. The remainder is expected to be realized in 2023. This figure is up from $371 million of savings articulated during the previous bond issue.

At the time, management said it would need to draw on the group’s RCF over the coming quarters to finance $200 million of cash restructuring costs. However, during the presentation, while management upsized both the savings, as mentioned above, and the costs to incur them to $250 million, it acknowledged that it never drew on the RCF and feels comfortable getting through the year without doing so. Management added that it expects to generate positive free cash flow this year.

The group’s structure chart is below:
 
Guarantees

The notes will be unconditionally guaranteed on a senior secured basis by the issuer’s existing and future wholly owned domestic subsidiaries that are borrowers, or that guarantee the issuer’s obligations, under the senior secured credit facilities. As of the 12 months ended Nov. 30, 2022, and on a pro forma basis, the company’s nonguarantor subsidiaries generated approximately 44% of the group’s total revenue. As of Nov. 30, the nonguarantor subsidiaries held approximately 10% of the group’s consolidated assets.

Security

The notes and related guarantees will be secured by second-priority liens on substantially all of the assets that secure the issuer’s and the guarantors’ obligations under the senior secured credit facilities, subject to certain exceptions.
 
Compared with other SaaS companies that generate revenue through sales of subscriptions and services, the pro forma entity has a notably high proportion of recurring revenue, accounting for 92% of its top line.

As a result of the acquisition and restructuring costs associated with the merger with Tibco in 2022, the company's gross and EBITDA margins currently lie toward the lower end of the spectrum. However, as mentioned, it plans to improve margins by implementing cost-cutting measures amounting to $485 million.

Compared with its peers, Citrix has a high leverage level, rendering it susceptible to rising rates.
 
From a relative value perspective, Citrix stands out with its higher yield to maturity and lower net total leverage level compared with the following securities within the same rating category. However, considering that the credit is at the long end of the forward curve, assessing potential downside risks in the longer term is imperative based on business fundamentals. Further, as mentioned, the marketed leverage may be based on ambitious assumptions that may not be realized.
         
Citrix benefits from a sticky revenue stream, particularly as it continues its transition to a subscription model. Further, the group’s products are embedded with its customers and switching costs are high. Its combined net retention rate for fiscal year 2022 was 105%, with 92% of revenue attributed to recurring streams.

The group’s focus on converting legacy perpetual software license users and maintenance-paying customers into subscriptions is credit positive, and management said the “vast majority” of customers should be on subscription contracts by 2024. These have historically been two-year contracts, but the group is moving most to three years. The company said it is benefiting from inflation, having no problem passing on 5% to 8% price increases for customers whose contracts are linked to the consumer price index.

Adjusted EBITDA is being marketed as $2.406 billion on a pro forma adjusted basis, which is derived as follows:
 
Key cost savings items are shown below:
 
As seen above, most of the group’s $485 million of cost savings will come from headcount reductions. The group says it is able to lay off sales and marketing staff because its strategy is now about expanding within its existing install base as opposed to acquiring new logos. Management said on the call that it has “acquired the customers we want for this business.”

From a cash flow perspective, capital expenditures and working capital outflows are expected to be relatively low, particularly as the group’s subscription-based model benefits its working capital flows. Capex was 2% of pro forma revenue in 2021 and 2022, and management said it expects during 2023 to spend at a level similar to the $67 million incurred in 2022.

The group presents the following unlevered FCF information in the offering memorandum:
 
Of concern, however, is that the company has not produced a pro forma set of cash flow statements, making it difficult to accurately gauge future liquidity. Analysts and investors are therefore left to assume that the company will be able to at least break even on a cash flow basis given cash EBITDA figures and minimal working capital- and capex-related outflows. Cash interest costs will be at least $1 billion annually, and 47% of the group’s pro forma debt will be subject to variable rates, a high number that leaves it vulnerable if yields continue to climb.

Further, the group’s pro forma leverage is high. Management is marketing the new deal off of net leverage of 6x based on a pro forma EBITDA figure of $2.406 billion that assumes the successful realization of $485 million of cost savings and other adjustments. Net leverage based on LTM EBITDA before pro forma adjustments is 7.5x, and this could go higher if management draws on the RCF.

Given potential macroeconomic headwinds, management may not be able to realize its EBITDA growth target, which would hinder the group’s deleveraging. Additionally, in a downturn, given the position of the second lien holders in the group’s capital structure, a large enough impairment in the group’s enterprise value would compromise second lien noteholder recoveries.