Fitch Ratings has assigned a first-time Long-Term Issuer Default (IDR) of 'B+' to Quartz AcquireCo, LLC (dba Qualtrics).
The Rating Outlook is Stable. Fitch has also assigned a 'BB+'/'RR1' rating to Qualtrics $200 million secured revolving credit facility (RCF) and $1.0 billion first-lien secured term loan. The proceeds, along with cash on balance sheet and equity, will be used for the acquisition of Qualtrics by Silver Lake Partners and Canada Pension Plan Investment Board. The acquisition was announced on March 13, 2023.
The ratings are supported by Qualtrics' industry-leading software solutions for enterprise experience management that incorporates data acquisition and analytics to provide enterprise customers with actionable outcomes. The net revenue retention rates of approximately 120% are reflective of highly recurring revenue base and supported by the quantifiable value provided to its customers that translate to improvements in lifetime value of the end customers.
The ratings are limited by material execution risk as a result of significant reorientation of the company to shift focus from high growth to greater emphasis on profitability. The private equity ownership is likely to prioritize ROE through reinvestments in growth or shareholder return limiting deleveraging to EBITDA growth.
Key Rating Drivers
Industry Tailwind Supports Growth: Qualtrics is positioned in the space of utilizing multi-channel customer engagement data, analyzing the data, and providing actionable insight for companies to increase lifetime value of end-customers. The increasing amount of customer data and analytics capabilities available to companies are providing the potential for greater insight into the end-customers. These insights offer quantifiable value to companies as they could improve customer satisfaction and translate to greater revenue opportunities. Fitch expects data analytics utilization to continue to grow as companies seek to use such insight as competitive advantages.
High Revenue Retention: Nearly 85% of Qualtrics' revenue is subscription-based with gross retention rates of over 90% and net retention rate of 120%. The high net retention is reflective of Qualtrics' land-and-expand product strategy where cross-sell and up-sell have been successful in driving increased customer adoption. Qualtrics products provide measurable benefits to its customers, and Fitch believes retention rates would remain high as customers build their customer experience management workflow around Qualtrics products.
Significant Customer Diversification: Qualtrics has a highly diversified customer base of approximately 19,000 that spans industry verticals including technology, retail, financial services, healthcare, education, and government. The diverse customer base effectively minimizes idiosyncratic risks that are associated with individual industry verticals and should reduce revenue volatility for Qualtrics.
Moderate Execution Risk: Along with the plan to be privatized by Silver Lake and CPP, Qualtrics will undergo the transition from a high-growth company to a moderate-growth company with greater focus around profitability. The plan involves significant changes in cost structure with greater emphasis around operational efficiency. While Fitch believes the plan is realistic, execution risk exists and deviation from plan could impact Fitch's rating case for the company.
Technology Disruption Risk: While Qualtrics' product portfolio encompasses the entire end-customer experience management, the increasing maturity of general-purpose generative artificial intelligence (AI) could pose risk to the company's product offerings. However, Qualtrics' products are integrated within customers' operating workflows, and replacing its products with general-purpose generative AI may involve significant switching costs. In Fitch's view, AI risk is low for Qualtrics for the foreseeable future.
Near-Term Depressed FCF: Despite expanding EBITDA margins through Fitch's forecast period, Qualtrics' FCF is forecasted to be negative through 2024 as the company has significant near-term liabilities from deferred cash settled awards related to the acquisition and long-term incentive payments. As part of the acquisition funding, Fitch estimates the company has sufficient cash and cash generation to satisfy its obligations through 2024. Fitch estimates Qualtrics' Fitch-defined FCF would turn positive in 2025.
Moderate Financial Leverage: Fitch estimates gross leverage to be near 5x in 2023 and delever to approximately 3x with successful execution of its operational optimization plans. However, in addition to the execution risk involved, the private equity ownership is likely to prioritize growth and ROE, Fitch believes accelerated debt repayment is unlikely. Fitch expects Qualtrics to maximize ROE through investments for growth or to optimize capital structure with financial leverage remaining at moderate levels.
Derivation Summary
Qualtrics is a leader in the niche market of software solutions that provide enterprises with experience management based on data analytics. Its customers benefit from improved customer satisfaction, customer support cost, and monetization opportunities. Overall, customers of Qualtrics products increase lifetime value of their end-customers. As product implementation typically involves deep integration within the customers' workflows, this integration results in a highly sticky customer base due to the high switching cost.
Qualtrics' recurring revenue represents approximately 85% with professional services primarily contributing to the remainder. Gross retention rates have been over 90%, and net retention has been consistently near 120%. Qualtrics serves approximately 19,000 customers with no meaningful customer concentration.
The Analytics Data Management & Integration Platforms market is projected to grow in the high-single-digits CAGR. Fitch anticipates Experience Management segment being a sub-segment within the broader analytics space to growth at a higher rate. Qualtrics' strong position within the niche market extends to include data integration, analytics, and automation, which should enable the company to maintain growth consistent with the industry.
Fitch believes moderate execution risk exists as Qualtrics transitions from a high-growth, low-profit operation to a moderate-growth, normalized-profit operation.
Balancing the favorable operating profile, moderate execution risk, and moderate financial structure, Fitch believes Qualtrics' operating and credit profiles are consistent with other 'B+' rated enterprise software companies.
Key Assumptions
Fitch's Key Assumptions Within the Rating Case for the Issuer
Normalized revenue growth rate in the mid-teens;
EBITDA margins expanding from low-teens in 2023 to high-20's in 2026;
Capex intensity 3% of revenue;
Debt repayment limited to mandatory amortization;
No acquisitions assumed through 2026;
Optimization of ROE through investments for growth or capital structure optimization upon successful implementation of operational optimization.
KEY RECOVERY RATING ASSUMPTIONS
The recovery analysis assumes that Qualtrics would be recognized as a going concern in bankruptcy rather than liquidated;
Fitch has assumed a 10% administrative claim.
Going-Concern (GC) Approach
A bankruptcy scenario could occur if Qualtrics fails to execute on its operational optimization as planned in conjunction with technology changes that significantly disrupts demand for its products;
In the event of a bankruptcy reorganization, technology disruption to demand would materially impact its revenue trajectory that also results in EBITDA margin compression due to operating leverage. In this scenario, Fitch assumes that Qualtrics would continue to execute on its cost reduction plan as part of the reorganization plan. Qualtrics' GC EBITDA is assumed to be at a level above the $83 million EBITDA achieved in 2022 and below estimated EBITDA in 2024;
The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level that should be approaching the industry norm while incorporating the risks associated with necessary operational improvements, upon which Fitch bases the enterprise valuation;
Fitch assumes an adjusted distress enterprise valuation of $1.75 billion;
Fitch assumes that Qualtrics will receive a GC recovery multiple of 7.0x. The estimate considers several factors, including the highly recurring nature of the revenue, the high customer retention, the secular growth drivers for the sector, the company's strong normalized FCF generation and the competitive dynamics. The EV multiple is supported by:
The historical bankruptcy case study exit multiples for technology peer companies ranged from 2.6x to 10.8x;
Of these companies, only three were in the Software sector: Allen Systems Group, Inc., Avaya, Inc. and Aspect Software Parent, Inc., which received recovery multiples of 8.4x,8.1x and 5.5x, respectively;
The highly recurring nature of Qualtrics' revenue and mission critical nature of the product support the high-end of the range.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Fitch's expectation of EBITDA leverage sustaining below 4.0x;
--(CFO - capex)/debt with equity credit ratio sustaining near 10%;
Sufficient financial flexibility for company to pursue strategic actions without significant deviation in credit metrics;
Organic revenue growth sustaining above the high single digits.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Fitch's expectation of EBITDA leverage sustaining above 5.5x as a result of weakness in market position or failure to execute on operational optimization;
--(CFO - capex)/debt with equity credit ratio sustaining below 7%;
Erosion in revenue retention rates resulting in organic revenue growth sustaining near or below 0%.
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 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: At closing of the transaction, Qualtrics will have $500 million on its balance sheet. Fitch forecasts the liquidity to be adequate to address near-term cash requirements to address Deferred Cash Settled Awards, Long-Term Incentive Plan payments, and restructuring expenses through 2024. Fitch forecasts the company would begin generating positive free cash flow beginning 2025 as cash obligations decline. In addition to cash on balance sheet and operational cash generation, Qualtrics also has an undrawn $200 million RCF to support liquidity.
Debt Structure: The $1,000 million term loan will mature in 2030. Given the recurring nature of the business and strong normalized FCF generation capacity, Fitch believes Qualtrics will be able to make its required debt payments.
Issuer Profile
Qualtrics is an Experience Management company with products that collect data from multiple sources, analyze the data, recommend actions, and automate select workflows. Qualtrics' analytics platform reduces service resolution time and cost, improves customer satisfaction and increases lifetime value of customers.
Date of Relevant Committee
05 April 2023
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 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 our ESG Relevance Scores, visit www.fitchratings.com/esg.
QUALTRICS INTERNATIONAL INC. 
