Investing.com -- Viavi Solutions (NASDAQ: VIAV ) Inc. is under credit observation due to its proposed acquisition of Spirent (LON: SPT ) Communications plc’s high-speed ethernet and network security business lines from Keysight Technologies (NYSE: KEYS ) Inc. The decision to place Viavi’s ratings on CreditWatch with negative implications was made by S&P Global Ratings, following the announcement of the acquisition plan.

Viavi intends to finance the acquisition with a new $425 million term loan B. This move is expected to increase the company’s S&P Global Ratings-adjusted debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) to around 6.4x at the close of the transaction, which is anticipated in the fourth quarter of fiscal 2025 (ending June 30, 2025). This is an increase from the current estimated 4.6x pro forma leverage following the acquisition of Inertial Labs.

While the acquisition is expected to expand Viavi’s scale and testing capabilities and modestly increase the company’s earnings, the proposed debt financing will elevate the leverage profile above 4x and reduce the cash cushion expected at the current rating level.

The decision to place all ratings, including the ’BB’ issuer credit rating on Viavi, on CreditWatch reflects the high likelihood of a rating downgrade of up to two notches. The CreditWatch status is expected to be resolved when sufficient information is available to conclude the review, likely upon the close of the transaction in the second quarter of 2025.

The acquisition of Spirent’s high-speed ethernet and network security offerings is viewed as complementary to Viavi’s base business. The acquisition is expected to add $180 million in annual revenue in the first 12 months post-close. However, the earnings generated from the acquired assets are anticipated to be insufficient to offset the incremental leverage impact from the acquisition.

The proposed debt financing will further reduce Viavi’s cash cushion to absorb potential business volatility. The company has historically held substantial cash balances well above annual free operating cash flow (FOCF) generation.

Viavi has been acquisitive in the past 24 months, but it is unlikely to pursue larger, transformative acquisitions. Future mergers and acquisitions (M&A) activity is expected to be tuck-in in nature and completed to expand its capabilities and scale offerings in adjacent markets.

The negative CreditWatch placement reflects the likelihood of up to a two-notch downgrade on all of Viavi’s ratings over the next few months. This considers the expectation that the company’s S&P Global Ratings-adjusted debt to EBITDA will increase to 6.4x initially following its acquisition of Spirent’s network and security assets and remain above 4x two years post-close.

The higher debt balance will weigh on Viavi’s credit metrics and deteriorate the cash cushion previously forecasted at the current rating. The combined company’s strategy and ultimate capital structure will be reviewed following the close of the transaction. If the acquisition does not close, the stand-alone company’s credit profile will be reassessed.

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