Fitch Ratings has affirmed
The Rating Outlook has been revised to Negative from Stable. Fitch has also affirmed the senior secured first-lien term loan rating at 'BB-' and has maintained the recovery rating at 'RR2'. Fitch's actions affect approximately
The Negative Outlook reflects the recent operational underperformance against expectations in the current year as Gainwell increased investments in product management and engineering capabilities, along with higher than expected nonrecurring costs related to integration and separation costs. This has resulted in weakened credit protection metrics for the company. Fitch believes that despite short-term pressure on Gainwell's profitability, the investments would strengthen competitive positioning in the Medicaid industry, and margins would become stronger once synergies are achieved.
Key Rating Drivers
Recent Performance: Pro forma revenue growth for the LTM ended
From a profitability perspective, management continues to pursue its margin expansion strategy and has executed on
Evolving Marketplace: Gainwell faces risks in the evolving
Market Position: Gainwell is the primary
Increased competition from CMS's drive toward modularity and interoperability has increased competitive intensity and moderated Gainwell's growth rate. However, Fitch expects the company's leadership position, long-term contracts and high retention rates to provide support during re-determination of contracts.
Cyclicality: Fitch expects Gainwell, which has generated accelerated growth though the pandemic, to continue to exhibit low cyclicality for the foreseeable future. Fitch believes the company will exhibit a correlation with Medicaid spending and enrollment, supported by the non-discretionary nature of health expenditures. In addition, Medicaid enrollment exhibits countercyclicality, which experiences elevated growth during economic downturns as job losses increase the pool of eligible beneficiaries, resulting in increased demand for the company's offerings.
However, with the upcoming end of the PHE in
High Leverage: Gainwell's acquisition of the HMS carve-out in a deal valued at
Beneficial Tailwinds: Fitch expects Gainwell to benefit from strong secular trends propelling growth in Medicaid expenditures. The
In addition, CMS estimates
Derivation Summary
Fitch evaluates Gainwell following its 2021 acquisition of the HMS carve-out that consists of the products that address administration of state Medicaid programs in a transaction backed by private equity sponsor,
Fitch believes the company benefits from favorable tailwinds as the underlying growth of Medicaid, constrained state budgets, constructive regulatory environment and long-standing trends in
The combination with HMS bolstered the company's modular offerings to generate significant cross-selling opportunities in the existing client base. Fitch believes growth is further ensured by the company's leading share, strong client retention rates, high switching costs and continued Medicaid program expansions among states.
Finally, as the country laps the distortions caused by the pandemic and related government policies, Fitch expects Gainwell to demonstrate minimal cyclicality and durable resistance to economic cycles due to the counter cyclical aspects of Medicaid enrollment. While Fitch views the high visibility into long-term revenue growth positively, the company faces risks from an evolving marketplace and the potential for future regulatory changes that may increase competition or reduce growth in Medicaid expenditures and enrollment over time.
The company's profitability metrics, though strong, scores below peers, with Fitch forecasting EBITDA margins in low 30% range over the rating horizon, compared with the 46% average for Fitch-rated healthcare IT peers. However, Gainwell's margins are still above average of Fitch-rated software peers in the B-category. Fitch also expects consistent FCF margins to be constrained in the near term due to increasing interest rates, similar to PE-sponsored peers. Fitch believes FCF will improve gradually as growth and margin expansion returns, and will be sustainable due the low cyclicality and a supportive regulatory environment in the medium term.
Despite these favorable characteristics, Fitch forecast fiscal 2023 leverage of 9.4x is near the upper 6.0x-11.5x range for Fitch-rated health care IT issuers in the 'B' rating category. However, Fitch expects gradual reduction in leverage to 6.5x by fiscal 2026 due to achievement of already actioned cost reduction programs in Gainwell and synergy opportunities from the acquisition of HMS.
While the company clearly benefits from beneficial secular tailwinds, a leading, defensible market position, and low cyclicality, Fitch views sustained elevated leverage as the primary determinant of the 'B' rating. No Country Ceiling, parent/subsidiary or operating environment aspects had an impact on the rating.
Key Assumptions
Fitch's Key Assumptions Within the Rating Case for the Issuer:
Organic revenue growth in the mid-to-high single digits in fiscal 2023 and mid-single digits thereafter, due to decreased Medicaid enrolments and reduced COVID-related volumes, consistent with Medicaid enrolment forecasts;
EBITDA margins depressed in fiscal 2023, then expand to early 30% over the rating horizon, reflecting actioned margin improvement initiatives at Gainwell and achievement of synergies at HMS;
Capital intensity of 3%, due to cloud migration efforts, decreasing to 2.5% by fiscal 2025 and thereafter;
Bolt-on acquisitions of total
KEY RECOVERY RATING ASSUMPTIONS
The recovery analysis assumes that Gainwell would be reorganized as a going-concern in bankruptcy rather than liquidated;
A 10% administrative claim.
Going-Concern (GC) Approach
The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which Fitch bases the enterprise valuation (EV). Fitch contemplates a scenario in which the increasing modularization of
As a result, Fitch expects Gainwell would likely be reorganized with a similar product strategy and higher than planned levels of operating expenses as the company reinvests to develop competing products, ensure customer retention and defend against competition.
Under this scenario, Fitch believes EBITDA margins would decline such that the resulting GC EBITDA is approximately 4% below fiscal 2022 EBITDA. Fitch believes GC EBITDA will be above future results as much of the company's recent margin pressures are viewed as transitory.
An EV multiple of 7.0x EBITDA is applied to the GC EBITDA to calculate a post-reorganization enterprise value.
The choice of this multiple considered the following factors:
Comparable Reorganizations: The historical bankruptcy case study exit multiples for technology companies ranged from 2.6x to 10.8x. Of these companies, only three were in the software sector:
M&A Multiples: A study of 273 precedent transactions in the healthcare IT industry during 2015-2020 established median EV/EBITDA transaction multiples ranging 9x to 18x, depending on the specific product area. In addition, HMS was acquired at a 15.5x multiple, excluding synergies.
Fitch evaluated a number of qualitative and quantitative factors that are likely to influence the GC valuation:
Secular trends and regulatory environment are highly supportive with Medicaid enrollment and expenditure growth resulting from program expansions, looser eligibility standards leading to a higher share of the aged and disabled beneficiaries served, and increased claims processing complexity. In addition, constrained state budgets encourage adoption of the company's products that reduce improper Medicaid spend;
Barriers to entry are high relative to software issuers, as deep domain and regulatory expertise are required to develop necessary solutions;
Gainwell is the leading commercial provider of
Revenue and cash flow outlooks are favorable as long-standing secular trends are supportive of revenue growth, while moderate margin expansion and low capital intensity promote FCF margins in the low teens;
Revenue certainty is high as a result of the 92% recurring revenue profile, typical contract duration of 6 to 10 years, 100% client retention and the countercyclicality of Medicaid;
Operating leverage is durable given a highly variable cost structure typical of software developers.
Fitch believes these factors reflect a particularly attractive business model that is likely to generate significant interest, resulting in a recovery multiple at the high-end of Fitch's range.
The recovery model implies a 'BB-' and 'RR2' Recovery Rating for the company's first-lien senior secured facilities, reflecting Fitch's belief that lenders should expect to recover 82% or greater in a restructuring scenario.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--(Cash flow from operations-capex)/total debt sustaining above 6.5%;
EBITDA leverage sustaining below 5.5x;
Organic growth sustaining above high-single digits.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
EBITDA Interest Coverage sustained below 1.5x;
EBITDA leverage sustaining above 7.5x;
--(Cash flow from operations-capex)/total debt sustaining below 3%;
Erosion of the company's competitive advantage or market position.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
Liquidity and Debt Structure
Declining Liquidity: As of 2Q23, total cash has declined to
Issuer Profile
Gainwell is a software and solutions provider that supports the administration and operation of government Medicaid programs and other Health & Human Services initiatives through a Medicaid Management Information System.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of Environmental, Social and Corporate Governance (ESG) Credit Relevance is a Score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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