Rating Action Overview

• Australia-based accounting software provider MYOB Group Co. Pty Ltd.'s earnings should recover in fiscal 2023, as R&D investment and integrated acquisitions undertaken during the pandemic gain further traction and contribute to the group.
• We expect MYOB's business to exhibit resilience through current macroeconomic conditions. This reflects the relevance and sticky nature of MYOB's products to its customers.
• In our view, the company will continue to effectively generate new software sales, manage customer churn levels, and pass on price increases to its client base.
• On May 31, 2023, S&P Global Ratings revised its outlook on MYOB to stable from negative. At the same time, we affirmed our 'B-' issuer credit rating and the related issue rating on the company's A$961 million term loan B and A$50 million revolving credit facility (RCF). The recovery ratings on these facilities are '3', reflecting meaningful (50%-70%; rounded estimate: 65%) recovery prospects in a payment default.
• The stable outlook reflects our view that MYOB will balance its approach between growth and profitability. We expect the company will refocus on integrating and supporting its existing systems, product suite, and infrastructure in lieu of further expansion. This should underpin margin and earnings growth over the forecast period.

Rating Action Rationale

The revised outlook reflects our view that MYOB's acquisitions and research and development (R&D) investments should drive a recovery in financial performance from fiscal 2023. We expect increased pricing and improved volumes will underpin this recovery, particularly for MYOB's Enterprise and Financial Services segments. In recent years, MYOB has undertaken an accelerated R&D capital expenditure (capex) program to augment and diversify its product suite. This included capex to integrate bolt-on acquired software onto MYOB's single software platform. MYOB's elevated R&D investment has constrained its S&P adjusted EBITDA given we reclassify capitalized R&D as an operating expense.

In fiscal 2023 (ending Dec. 31, 2023), we anticipate fewer acquisitions by MYOB as it shifts its focus from shaping product suite functionality to improving operating leverage and efficiencies. This should support margin improvement. Reduced acquisitions, combined with continued progress for MYOB's migration of desktop users to cloud-based products, will moderate R&D capex. Our base case assumes revenue and EBITDA uplift in fiscal 2023 from product augmentation and higher cloud-based sales.

We forecast free operating cash flow (FOCF) will turn positive in fiscal 2024, strengthening the company's balance sheet and capital structure. This is attributed to an improved earnings base, reduced acquisition activity, and normalizing R&D capex. We expect FOCF to improve as MYOB leverages operational efficiencies from its cloud products. This should support balance sheet deleveraging and a sustainable capital structure, which we view as currently elevated and a constraint for the rating.

MYOB's ability to deleverage will depend on earnings improvement, the company's acquisition pipeline, and R&D capex requirements. In addition, further increases to borrowing costs will drag on cash flow, although the payment-in-kind nature of MYOB's shareholder loan should provide partial offset. We forecast S&P adjusted EBITDA cash interest coverage of about 1.0x in fiscal 2023 and 1.5x in fiscal 2024.

MYOB's small and midsize enterprise (SME) customer base remains exposed to downside risks associated with a macroeconomic slowdown. However, we expect the company as a group will demonstrate resilience through economic cycles. Accounting and business software is deemed essential especially during periods of economic stress as businesses look to manage operating costs to mitigate financial strain. As such, we expect MYOB's SME customers will continue to utilize the company's software while they explore other cost efficiencies.

MYOB's customer churn rates have improved through the COVID-19 pandemic. We believe this reflects the sticky nature of MYOB's product offering. We expect customer churn rates to remain reasonably stable over the next few years despite uncertain macroeconomic conditions. In addition, MYOB should benefit from the continued migration of existing desktop users to the cloud, which underpins the company's recurring revenue base.

We expect MYOB will maintain adequate sources of liquidity. A cash balance of about A$83 million as of Dec. 31, 2022, supports the company's liquidity position. MYOB benefits from a capital-light operating model and a drawn debt profile that mostly matures after May 2026. MYOB's financial sponsor provided capital to support the company through its heightened period of R&D investment and acquisitions. We anticipate this support to continue.

Outlook

The stable outlook reflects our expectation of MYOB's 2023 earnings recovery, as the benefits of product augmentation, higher cloud-focused sales, and incremental earnings from successful integration of multiple acquisitions start to accrue.

Despite volatile macroeconomic conditions over the next 12 months, the company's competitive advantage in certain market segments should position it to maintain market share and increase earnings. This should underpin positive and improved free cash flow over forecast periods.

Downside scenario

We could lower the rating if we believe the company is unable to maintain adequate liquidity amid material customer churn and loss related to its SME customer base. We could also lower the ratings if we view MYOB's capital structure as unsustainable.

This could occur if there is:

• Weaker revenues than we expect, without a commensurate reduction in software development investment;
• A material acceleration in customer churn or reduction in new sales that further impairs free cash flow; or
• The company returns capital to either common or noncommon equity holders.

Upside scenario

We could consider an upgrade if MYOB continues to navigate macroeconomic challenges such that it maintains adjusted debt to EBITDA (excluding the shareholder loan) below 7.5x. In addition, an upgrade would depend on the company's ability to execute its software development requirements, while maintaining at least adequate liquidity and sustaining positive free cash flow.

Company Description

Established in 1991, MYOB develops and publishes software in Australia and New Zealand. The company provides tax, accounting, and other business services software to SMEs and a network of accountants, bookkeepers, and consultants.

MYOB's segments are:

• SME--this segment includes the sale of online accounting software targeting single member teams of accountants, bookkeepers, and small businesses. The key software sold via this segment is MYOB Business, a customizable cloud-based accounting software that can also assist businesses with tax, cash flow, and payroll solutions.
• Enterprise Solutions-–MYOB sells enterprise resource planning (ERP) software to assist businesses with integrating and streamlining their main activities. The key software sold in this segment is MYOB Advanced Business, a customizable cloud ERP system that is designed to provide financial management, customer management, inventory management, and project accounting solutions. Additionally, the company sells ERP software targeting partners and accounting practices. This includes the sale of GreatSoft practice management software, which is developed for mid-tier accounting firms that need a scalable and cloud-based solution.
• Financial Services--online invoice processing for SMEs is a core product in this segment. MYOB also recently acquired a workplace financial services platform, Flare, to expand its capabilities in providing workplace financial service solutions.
• Other--this segment includes revenue received from R&D grants.

Our Base-Case Scenario

• Australia real GDP growth of 1.6% in 2023 and 1.7% in 2024;
• New Zealand real GDP growth of 0.8% in 2023 and 1.7% in 2024;
• 2023 low double-digit revenue growth underpinned by: About mid-single digit SME revenue growth supported by new sales and subscriber volume and yield improvement; Low double digit Enterprise revenue growth supported by increased services and desktop products uptake driving higher sales volumes and yields; Material FS revenue growth from the Flare business and continued growth of online invoice payments.
• 2023 S&P adjusted EBITDA margin between 14.3% and 15.3%. This largely reflects easing labor inflationary pressures, partially offset by increased marketing expenditure to drive SME sales.
• Heightened but moderating R&D capex (inclusive of capitalized R&D) as MYOB continues to focus on product and infrastructure development in 2023. Capex to normalize in 2024.
• No major material debt-funded acquisitions, divestments, or discretionary dividends to shareholders; and
• Given MYOB's financial sponsor ownership, we do not deduct any surplus cash from our forecast debt balances.

Key Metrics

• We forecast MYOB's debt-to-EBITDA ratio (excluding shareholder loan) will be between 12.3x to 13.3x in fiscal 2023.
• We forecast MYOB's EBITDA interest coverage (excluding shareholder loan coupons) will be about 1x in fiscal 2023.

Liquidity

We consider MYOB to have adequate liquidity. We expect sources of liquidity, including cash, to exceed uses by more than 1.2x over the next 12 months. In our view, net sources should remain positive even if EBITDA declines by 15%.

MYOB's cash balance was A$83 million as of Dec. 31, 2022. The company also has an increasing proportion of recurring revenue and a capital-light operating model, which support its liquidity position. However, we do not deduct any surplus cash from our forecasts for debt balances.

MYOB had the following liquidity profile as of Dec. 31, 2022:

Principal liquidity sources:

• Cash and cash equivalents of about A$83 million; and
• Cash funds from operations (FFO) of about A$75.2 million over the next 12 months.

Principal liquidity uses:

• No debt maturities within the next 12 months;
• Minimum debt amortization of about A$10 million a year;
• Capex (inclusive of capitalized development costs) of about A$88.9 million; and
• No dividend distributions over the next 12 months.

Covenants

We anticipate MYOB will maintain adequate covenant headroom under its revolving credit facility. The first-lien revolving credit facility is governed by a 7.35x first-lien net leverage ratio that springs when the company draws at least 35% of the facility's commitment in cash. Under this facility, the company may capitalize software development expenses.

Environmental, Social, And Governance

ESG credit indicators: E-2, S-2, G-3

Governance is a moderately negative consideration in our credit rating analysis of MYOB. The company has a highly leveraged financial risk profile. This reflects corporate decision-making that prioritizes the interest of its controlling owners, in line with our view of the majority of rated entities owned by private equity sponsors. Our assessment also reflects their generally finite holding periods and a focus on maximizing shareholder returns.

Issue Ratings - Recovery Analysis

Key analytical factors

Our recovery analysis for MYOB contemplates a hypothetical simulated default in the first half of 2025. The recovery rating of '3' and issue rating of 'B-' on the senior secured first-lien term loan facility and revolving credit facility reflects our expectation of a meaningful recovery of 65% in the event of a default.

At the time of the hypothetical default, we expect weaker macroeconomic sentiment across Australia and New Zealand as well as a weaker competitive position for the group. The latter is due to the relentless growth of a competitor that erodes the group's customer base. This results in lower renewal rates and forces the group to materially reduce prices and margins to retain customers, placing pressure on EBITDA. At the same time, the group limits its capex to the maintenance portion and has limited options to sell nonviable or challenging business segments.

We value MYOB as a going concern because we believe that following a payment default, the company is likely to be reorganized and consolidated. This is due to the longer-term value of its niche services and brand. We applied a 6.5x valuation multiple to our estimated distressed emergence EBITDA of about A$110 million to arrive at a gross enterprise value of about A$717 million. The net enterprise value after administrative costs is A$681 million.

Simulated default assumptions

• Simulated year of default: 2025
• Jurisdiction: Australia
• EBITDA at emergence: A$110 million
• EBITDA multiple of 6.5x
• Gross enterprise value at emergence: A$717 million

Simplified waterfall

• Net enterprise value at emergence (after 5% administrative costs): A$681 million
• Estimated secured first-lien claims: about A$973 million
• Recovery expectations: 50%-70% (rounded estimate: 65%)
• Recovery rating: 3

Ratings Score Snapshot

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings , Oct. 10, 2021
• General Criteria: Group Rating Methodology , July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments , April 1, 2019
• Criteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers , Dec. 7, 2016
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers , Dec. 16, 2014
• Criteria | Corporates | General: The Treatment Of Non-Common Equity Financing In Nonfinancial Corporate Entities , April 29, 2014
• General Criteria: Methodology: Industry Risk , Nov. 19, 2013
• Criteria | Corporates | General: Corporate Methodology , Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions , Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities , Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings , Feb. 16, 2011

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