TEXT-S&P raises Dex One rating to 'CCC' from 'SD'
March 30 - Overview -- U.S. directory publisher and marketing servicer Dex One completed a repurchase of term debt after amending its credit agreement, which permits the company flexibility to repurchase term debt at prices below face value. -- Under its recently amended credit agreement, Dex One has the ability to repurchase debt below par until 2013 if certain conditions are met. -- We are raising our corporate credit rating on the company to 'CCC' from 'SD'. -- The negative outlook reflects our expectation of continued revenue declines over the intermediate term, as well as significant pressure to execute further subpar debt restructuring. Rating Action On March 30, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Cary, N.C.-based Dex One Corp. and related entities to 'CCC' from 'SD' (selective default). The rating outlook is negative. At the same time, we affirmed our issue-level rating on Dex Media East Inc.'s $672 million outstanding term loan, Dex Media West Inc.'s $594 million outstanding term loan, and R.H. Donnelley Inc.'s $866 million outstanding term loan due 2014 at 'D'. The recovery rating on these loans remains at '5', indicating our expectation of modest (10% to 30%) recovery for lenders in the event of a payment default. We also raised our rating on Dex One Corp.'s subordinated $300 million notes due 2017 to 'CC' from 'C'. The recovery rating remains at '6', indicating our expectation of negligible recovery (0% to 10%) for noteholders in the event of a payment default. Rationale The upgrade reflects Standard & Poor's assessment of the company's credit profile after the completion of the subpar repurchase transaction in light of upcoming maturities, future subpar repurchases, and our expectation of a continued week operating outlook. The company's March 9, 2012 amendment allows for ongoing subpar repurchases of its term debt until 2013, as long as certain conditions are met. Additionally, on March 22, 2012, the company announced the commencement of a cash tender offer to purchase a portion of its senior subordinated notes due in 2017 below par. The term loan and subordinated notes are trading at a significant discount to their par values, providing the company an economic incentive to pursue a subpar buyback. We believe that these circumstances suggest a high probability of future subpar buybacks, which are tantamount to default under our criteria. The 'CCC' corporate credit rating reflects our view that Dex One's business will remain under pressure given the unfavorable outlook for print directory advertising. We view the company's rising debt leverage, low debt trading levels, weak operating outlook, and steadily declining discretionary cash flow as indications of financial distress. As such, we continue to assess the company's financial risk profile as "highly leveraged," based on our criteria. We regard the company's business risk profile as "vulnerable," based on significant risks of continued structural and cyclical decline in the print directory sector. Structural risks include increased competition from online and other distribution channels as small business advertising expands across a greater number of marketing channels. Under our base-case scenario, we expect Dex One's 2012 revenues and EBITDA to show a mid-teens percentage and high-teens to low-20% rate decline, respectively, reflecting ongoing advertising declines due to a continued shift toward more efficient and lower-cost digital advertising platforms. Despite good growth in online bookings, which amount to about 20% of total bookings, we believe that total bookings will continue to decline at a mid-teens percentage rate over the near term. We do not expect that digital booking growth will offset print booking declines because Dex One has not been able to convert a significant portion of its print customer relationships into digital customers, even though some have been bundled. As a result, we expect the EBITDA margin to deteriorate at an increasing rate, leverage to continue to rise, and discretionary cash flow to decline further. Eliminating the effect of GAAP (generally accepted accounting principles) accounting after restructuring, revenues declined 17.5% and EBITDA fell 10.8% in the quarter ended Dec. 31, 2011 year over year. This was largely because of customer attrition, reduced advertiser renewals, and negative secular trends affecting directories. Though Dex One has reduced costs, the EBITDA margin fell to 42% for the 12 months ended Dec. 31, 2011, from 45%. Pro forma for the subpar repurchase, debt to EBITDA declined to 4.0x, from 4.3x at Dec. 31, 2011. Debt is adjusted for operating leases, postretirement obligations, and accrued interest, together adding $121 million to the reported debt balance. Our base case indicates that the company's leverage could increase in 2012 to the mid-4x area, as we don't think debt repayments and subpar repurchases will offset EBITDA declines. Subpar repurchases are limited to the cash flow in excess of the mandatory cash flow sweep and mandatory amortization payments, which we believe could narrow further in 2012 and 2013 because of steady declines in operating cash flow.. Liquidity In our view, Dex One has "less than adequate" sources of liquidity to support its capital structure. Expectations and assumptions that support our liquidity assessment are as follows: -- We believe the company does not have capacity to absorb high-impact, low-probability events. -- We view the trading price of the company's term loan as an indicator of poor standing in the credit markets. These factors are important considerations in our assessment, even though: -- We expect the company's sources of liquidity (including cash and credit facility availability) to exceed its uses by 1.2x or more over the next 12 to 18 months, and -- We expect net sources to be positive even in the event of a 15% to 20% drop in EBITDA over the next 12 months. After taking into account the subpar repurchase, we estimate that cash balances decreased to $187 million, from $257.9 million at Dec. 31, 2011. Liquidity is provided by cash on hand and positive (though rapidly declining) discretionary cash flow. Standard & Poor's expects Dex One's discretionary cash flow to narrow over the next two to three years as weak operating trends continue to pressure revenues. We estimate that the company will generate $290 million to $320 million of discretionary cash flow in 2012. We expect the company to use most of its discretionary cash flow to repay debt at par, given its high term loan amortization and cash flow sweep. We also expect the company to repurchase debt below par with the remaining portion of its discretionary cash flow, which we estimate will be around $40 million to $50 million in 2013. Given the current cash flow generation and trading levels of the company's debt, we feel that management has a strong incentive to continue to take out debt at prices below par. The term loans mature in October 2014, and the notes mature in 2017. We believe there is significant risk surrounding the company's ability to refinance the full face value of its 2014 maturing debt. Under our operating assumptions, we expect the company to maintain an adequate cushion of compliance against its financial covenants over the near term. At Dec. 31, the company had a satisfactory cushion of compliance with its consolidated leverage ratio and interest coverage ratio covenants at each entity level. Recovery analysis See Standard & Poor's recovery analysis on Dex One, to be published on RatingsDirect as soon as possible following the release of this report. Outlook The negative rating outlook reflects our expectation that Dex One's declining business fundamentals could hinder refinancing of its 2014 debt maturity. We could lower the rating if it appears likely that ad sales declines are not moderating, further hampering the company's ability to refinance its 2014 maturity. We could also lower the rating if we become convinced that the company was going to incur a cash default or file for Chapter 11 bankruptcy protection. Although a remote possibility at this time, a revision of the outlook to stable would likely involve a resumption of top-line revenue growth and the company addressing 2014 maturities. We believe this scenario would entail an substantial increase in digital revenue, as we expect that trends in print advertising will continue to be under significant structural pressure. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- How Standard & Poor's Uses Its 'CCC' Rating, Dec. 12, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded To From Dex One Corp. Dex Media Inc. Dex Media East Inc. Dex Media West Inc. R.H. Donnelley Inc. Corporate Credit Rating CCC/Negative/-- SD/--/-- Ratings Affirmed Dex Media East Inc. Dex Media West Inc. R.H. Donnelley Inc. Senior Secured D Recovery Rating 5 Dex One Corp. Subordinated C Recovery Rating 6 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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