Credit rating agency Moody's Investors Service recently designated Baa1 ratings to many tranches of senior unsecured notes issued by Marsh & McLennan Companies, Inc. MMC. The company plans to use a portion of the fund for buying the equity of UK-based insurance broker Jardine Lloyd Thompson Group plc (JLT).
Marsh & McLennan will also use the proceeds to pay related fees and expenses, repay a fraction of JLT indebtedness as well as spend on general corporate purposes. Both companies expect to close the buyout, subject to closing conditions, in the spring of 2019.
The rating outlook is negative.
Rationale Behind the Rating Affirmation
The ratings reflect the acquirer’s global market presence, client diversification, varied products and regions, skill in providing complex risk and human resource solutions to global, national and middle market accounts plus a long record of profitable growth. However, the strengths are offset by its high financial leverage, execution risk, vulnerability to variable pension compulsions and penalties from errors and omissions in dispensing professional duties.
The credit rating giant considers the company’s acquisition of JLT to be strategically sound but credit negative because of its pending rise in financial leverage and execution risk. The transaction is expected to enhance the acquirer’s top line by 13%. Moreover, this purchase will boost Marsh & McLennan’s portfolio in special industries like energy, mining, construction, marine, healthcare, aerospace etc. and also drive the group’s presence in reinsurance brokerage.
To fund this acquisition, the company will take the aid of significant debts. Moody’s projects that its debt-to-EBITDA ratio will increase above 4x after the deal’s closure, way higher than the historical leverage of 2.6x-2.8. Notably, (EBITDA - capex) interest coverage would reduce toward mid-single digits from the high-single ones. The credit rating agency also stated that JLT has weaker profit margins than MMC. These hazards influence the negative rating outlook.
However, Moody’s expects Marsh & McLennan to lower its financial leverage via debt repayment and EBITDA growth over a span of 12-18 months post the buyout. The company informed that it will slow down its share buybacks and other consolidations to support the deleveraging process.
Factors Behind Potential Change in Ratings
There can be an upgrade in the company’s ratings if there is a seamless integration of JLT into Marsh & McLennan with consistent profitable growth, decrease of debt-to-EBITDA ratio lying below 3.2x after the acquisition, (EBITDA - capex) coverage of interest remaining in mid-single digits or more and net profit margins coming in at high-single digits or more.
There can also be a downgrade if debt-to-EBITDA ratio scales above 3.2x on a sustained basis, EBITDA - capex coverage of interest falls below 5x or net profit margin is lower than 8%.
Shares of this Zacks Rank #3 (Hold) company have dipped nearly 1.4% in the past year versus the ’s growth of 3.6%.
Stocks to Consider
Investors interested in the same space might consider a few better-ranked stocks like On Deck Capital, Inc. ONDK, FedNat Holding Company FNHC and Virtu Financial, Inc. VIRT, each carrying a Zacks Rank #2 (Buy).
On Deck Capital operates as an online platform for small business lending in the United States, Canada and Australia. It managed to deliver positive results in three of the last four reported quarters, the average earnings surprise being 109.47%. The company currently carries a Zacks Rank of 2. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
FedNat and subsidiaries engage in insurance underwriting, distribution and claims processing business in the United States. The company is a Zacks #2 Ranked player and pulled off average trailing four-quarter positive surprise of 44.87%.
Virtu Financial provides market making and liquidity services to the financial markets worldwide. The company came up with average four-quarter beat of 17.56%. It is a #2 Ranked stock.
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