Moody’s Investors Service (“Moody’s”) has assigned for the first time B2 long-term corporate family rating (CFR) to Interswitch Limited. The rating agency also assigned senior unsecured programme ratings of (P)B2 and Aa3.ng national scale programme ratings to Interswitch Africa One Plc’s, a special purpose vehicle owned by Interswitch, NGN30 billion programme. The issuer outlook is stable.
The assigned (P)B2 senior unsecured programme ratings to Interswitch reflect (i) the assignment of a B2 CFR; and (ii) Moody’s Loss Given Default (LGD) for Speculative-Grade Companies analysis that takes into account Interswitch’s liability structure, which leads to the alignment of the senior unsecured programme ratings with the CFR.
The B2 CFR reflects (i) positive secular industry shifts that will support Interswitch’s business, (ii) the firm’s strong market position and solid profitability, and (iii) its solid liquidity profile, supported by good cash flow generation capacity. These strengths are balanced against (i) rising leverage as the company implements its expansion strategy, (ii) high operational, regulatory and technological risks, and (iii) high geographical, industry and customer concentrations.
In terms of credit strengths, the rating agency expects Interswitch to benefit from the positive industry shifts of increasing usage of electronic and digital payment channels. Although less than 10% of total transactions in Nigeria are digital, ongoing high adoption of cards and alternative channels (electronic payments increased 32% in Nigeria in 2018) will support business generation for Interswitch, mitigating negative impact on financial performance during periods of economic slowdown.
Interswitch’s strong profitability provides good loss absorption capacity, with 2017-2019 average return on average managed assets of 18%. The company has demonstrated strong financial performance, with a 2017-2019 average net revenue growth of 17% and an average EBITDA margin of 40% over the same period. Interswitch’s profitability is supported by its large market share, which enables it to process about 90% of total electronic transactions across various payment channels in Nigeria, and a strong uptake of its card scheme, Verve. Moody’s expects Interswitch’s profitability to soften given that higher interest cost for the upcoming bond issuance will consume a meaningful portion of its earnings.
Interswitch’s solid liquidity is supported by strong cash flow generation. Interswitch generated NGN6.8 billion cash flow from operations from gross revenue of NGN30 billion in the fiscal year end-March 2019. Interswitch had NGN11.6 billion of unrestricted cash and short-term investments at year-end 2019, which covered its current interest-bearing liabilities by about 300%. Moody’s expects the company to generate between NGN14-16 billion EBITDA in 2020 but the ratio of funds from operations to debt, which was 3.7x in 2019 will reduce to around 0.5x, assuming total debt of NGN30 billion.
In terms of credit challenges, Moody’s expects Interswitch’s leverage to rise, and its gross debt/EBITDA ratio to increase to about 2.2x over the next 12-24 months from a 2017-2019 average of lower than 1x. Similarly, Interswitch’s solid tangible common equity to total managed assets ratio of about 20% in 2019 will reduce to 8-10% in the next 12-18 months. However, the company’s high profit generation capacity and a prudent dividend policy will support its capital adequacy, providing a good, although diminished buffer to absorb unexpected losses.
In its assessment, the rating agency has also taken into account Interswitch’s exposure to material operational, regulatory and technological risks. Given that its business relies on sophisticated software and computer systems, it is exposed to risks in case of system errors or defects, or virus attacks. Interswitch requires various licenses across its business units, exposing it to heightened regulatory risks.
It also faces risks related to data breaches and cyber-crime, which exposes it to risks of large fines and reputational damage. In terms of technological risks, Moody’s believes that Interswitch’s business is exposed to rapid changes in the payment service environment. The company faces competition from payment technologies that bypass usage of cards, and risk of disruption by large and well-resourced international payment companies or fintechs are high.
Moody’s views the concentration of Interswitch’s revenue to the banking sector and high client concentration risk as rating challenges. Interswitch’s largest 18 customers are commercial banks and its top 10 clients contribute over 60% of its gross profit. In addition, its business is concentrated in Nigeria, where the rating agency expects the company to generate more than 90% of its revenue and EBITDA in the next 12-18 months. As a result, the CFR of B2 assigned to Interswitch is on par with Nigeria’s sovereign rating (B2 stable), reflecting the interlinkage between the banks that are Interswitch’s main clients and the sovereign, and high concentration of business in Nigeria.
Rationale For Stable Outlook
The stable outlook reflects Moody’s expectation that Interswitch’s business and profitability will benefit from growing electronic transaction volumes, offsetting risks arising from a more leveraged balance sheet.
Factors That Could Lead To An Upgrade/Downgrade
There is little potential for an upgrade given our expectation of rising leverage and the high concentration of Interswitch’s business in Nigeria.
Interswitch’s ratings could be downgraded in the event that (i) leverage rises beyond what is assumed by the CFR and the debt/EBITDA ratio increases substantially, negatively pressuring Interswitch’s capital position, (ii) its profitability, cash flow and liquidity positions weakens, constraining the company’s ability to meet its debt repayments on time.
Interswitch’s ratings could also be downgraded due to adverse changes to its debt capital structure that would lower the recovery rate for senior unsecured debt classes.