Moody's Cuts Sirius' Credit Rating Amid Fears That Proposed Forsythe Buy Will Be Financial Strain

Moody's Investors Service lowered Sirius Computer Solutions' credit rating from B1 to B2 out of concern that the planned purchase of Forsythe Technology will strain its financial flexibility.

The New York-based bond credit rating agency publicly disclosed that Sirius would pay $350 million to buy Forsythe, adding that the acquisition will be funded largely with debt. The ratings downgrade could, therefore, affect Sirius' ability to borrow money, with investors seeing the company as a riskier bet and demanding higher returns.

"Although the rating agency views the acquisition of Forsythe as strategically sound … execution risks and costs of integrating Forsythe will further strain the company's credit metrics over the next couple of years," Moody's wrote Tuesday in a rating action and credit opinion.

[Related: 10 Things You Need to Know About The Colossal Sirius-Forsythe Deal]

Skokie, Ill.-based Forsythe, No. 37 on the 2017 CRN Solution Provider 500, is expected to have $1.2 billion of sales in 2017, meaning that Sirius' purchase price was equivalent to 29 percent of current year revenue. In contrast, Office Depot agreed this week to acquire solution provider CompuCom for $1 billion, or 91 percent of the Charlotte, N.C.-based company's expected $1.1 billion in current year sales.

Sirius' adjusted debt rose to more than five times its EBITDA (earnings before interest, taxation, depreciation, and amortization) after being acquired by private equity giant Kelso & Co. in November 2015.

Moody's expected the debt-to-EBITDA ratio to fall after the Kelso purchase, but Sirius used debt and cash on hand to finance $81 million worth of acquisitions including Continuum Security Solutions, IBM-based infrastructure provider thinkASG, NorthWind Consulting Services, and U.S. government security and networking powerhouse Force 3.

The Forsythe acquisition will only further delay deleveraging plans, with Moody's expecting San Antonio, Texas-based Sirius, No. 26 on the 2017 CRN Solution Provider 500, to use the majority of its free cash flow in 2018 to repay debt.

Sirius has additionally needed to reorganize its procurement systems to accommodate the acquisition of its largest IT distributor partner – Avnet Technology Solutions – by Tech Data. Moody's believes the deal presents an incremental risk to Sirius' sourcing of high-end systems, especially if Tech Data encounters hurdles in its integration of operations.

Moody's expects that Sirius will likely explore options to diversify its supplier base and potentially reduce its large reliance on Tech Data's distribution capabilities. Tech Data declined to comment for this story, while Sirius didn't respond to requests for comment.

The rating agency also identified Sirius's high concentration of IBM products and services at a risk factor, with Moody's saying that Big Blue today accounts for 36 percent of Sirius's $2.2 billion in annual sales. That is down from 52 percent in September 2015, and the figure is expected to further decline to 23 percent – or $746.5 million of a combined $3.26 billion in revenue – once the Forsythe deal closes.

Many of Sirius' products and services remain confined to IBM's offering, however, which Moody's said doesn't include business application software like customer relationship management (CRM) and enterprise resource planning (ERP) systems.

On the other hand, Moody's said IBM's discount pricing model ensures that price increases or declines do not proportionately affect Sirius' profitability. Sirius has additionally made progress in diversifying its vendor base to include products from Cisco, Dell EMC, Hewlett Packard Enterprise and NetApp, according to Moody's.

In fact, the combined Sirius-Forsythe Cisco operation brought in $731.8 million of sales in the year ended June 30, 2017, accounting for 22 percent of overall revenue and coming in just $14.7 million shy of the company's IBM business. Moody's said Sirius must manage the vendor diversification process in a manner that doesn't bring its IBM relationship into jeopardy.

Moody's praised Sirius for growing its recurring revenue business to 35 percent of overall sales, and for maintaining a retention rate of 70 percent. Sirius' operating margins should be stable for the next year thanks to the stickiness of its client base, Moody's said, with high switching costs translating into high renewal rates.

However, Moody's said IT services account for less than 15 percent of Sirius' overall revenue today. IT services constitute 60 percent of global IT spending, according to Moody's, and are growing at a much faster clip than the industry as a whole.