TEXT-S&P raises Crown Media rating to 'B+' from 'B'
Overview -- U.S. cable network company Crown Media Holdings improved the audience ratings and distribution of its cable networks in recent quarters, resulting in higher EBITDA and lower leverage than we expected. -- We are raising our corporate credit rating on the company to 'B+' from 'B'. -- The stable rating outlook reflects our view that neither upward nor downward rating actions appear likely in the intermediate term, and any further upgrades likely would require increased clarity regarding the future investment strategy of Crown Media's majority owner, Hallmark Cards Inc., as it relates to Crown Media. Rating Action On May 24, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Studio City, Calif.-based cable network company Crown Media Holdings Inc. to 'B+' from 'B'. The rating outlook is stable. At the same time, we raised the issue-level ratings on the company's senior secured debt to 'BB' (two notches higher than the corporate credit rating) from 'BB-', with no change in our recovery rating of '1', which indicates our expectation that lenders would receive very high (90%-100%) recovery for lenders in the event of a payment default. We also raised the issue-level rating on the senior unsecured notes to 'B' (one notch lower than the corporate credit rating) from 'B-', and kept our recovery rating on this debt at '5', indicating our expectation of modest (10%-30%) recovery for noteholders in the event of a payment default. (For the complete recovery analysis, see our recovery report on Crown Media, to be published immediately following this report on RatingsDirect.) Rationale The upgrade reflects Crown Media's recent operating performance, which achieved higher EBITDA and lower leverage than our expectations. The stable rating outlook reflects our view neither upward nor downward rating actions appear likely in the intermediate term, and any further upgrades likely would require increased clarity regarding the future investment strategy of Crown Media's majority (90.1%) owner, Hallmark Cards Inc. (unrated), as it relates to Crown Media. Our rating on Crown Media reflects our view that the company has a "weak" business risk profile and an "aggressive" financial risk profile, based on our criteria. Its narrow business focus on two cable channels with relatively low audience ratings, underdeveloped distribution, a very low proportion of affiliate fees to total revenue, and a relatively low EBITDA margin compared with other cable network companies support our assessment of the business risk profile as weak. We regard Crown Media's financial risk profile as aggressive because of its still-high debt leverage, modest cash flow generating ability, and aggressive financial policy, although leverage has recently declined because of EBITDA growth. Crown Media owns and operates two cable-TV channels in the U.S., the Hallmark Channel and Hallmark Movie Channel. Although it has been operating for a decade, neither channel is fully distributed. The Hallmark Channel reaches about 87 million subscribers and the Hallmark Movie Channel reaches about 47 million, compared with about 105 million domestic pay-TV households. Some cable operators do not put the company's channels on their basic tier, particularly the movie channel, which leads to lower penetration and lower subscription and ad revenue. Crown Media's subscription revenue is less than 25% of total revenue, compared with 40%-50% for other cable network companies. Advertising revenue accounts for the remainder of revenue, and growth in ad revenue is subject to both economic conditions and audience ratings. Apart from special programming aired during the holiday season, the networks' audience ratings are low. The company has been introducing new daytime content on the Hallmark Channel in an attempt to attract higher audience ratings and younger viewers, but initial programming did not catch on with viewers. As a result, the company is now preparing to launch new replacement programming. Over the longer term, we expect Crown Media and other cable network companies to face growing competition from the Internet and other forms of digital media, which could begin to gain audience share from cable networks and lessen their attractiveness as an advertising medium. We expect Crown Media to benefit from generally favorable ad demand in 2012. Achievement of faster ad and subscription revenue growth will depend on its ability to attract more viewers with appealing new programming, which is likely to take several years and additional investment. Our base-case scenario for 2012 assumes total revenue growth at a high-single-digit percentage rate, consisting of about 10% growth in ad revenue and mid-single-digit growth in subscription revenue. We further assume that expense growth will lag revenue growth only slightly as the company increases its programming expense. This will result in EBITDA growth at a low-teen percentage rate and about a 1% improvement in the EBITDA margin. In the first quarter of 2012, Crown Media's revenue and EBITDA increased 14% and 41%, respectively, year over year. Ad revenue rose 15% and subscriber fees 12%. At the same time, expenses grew more slowly because of a 6% increase in programming costs and the absence of one-time banking fees incurred during 2011. The EBITDA margin for the 12 months ended March 31, 2012 was 36%, up from 32% a year ago, but relatively low compared with margins of more than 40% for most of its cable network peers. Debt to EBITDA was 4.3x at March 31, 2012, down from 5.6x as of the July 2011 refinancing, because of EBITDA growth and lower debt balances. We expect that the company could reduce its leverage to about 4.0x by the end of 2012 as a result of EBITDA growth. Conversion of EBITDA into discretionary cash flow was about 18% in the 12 months ended March 31, 2012, and we expect the company to be able to maintain broadly similar conversion over the intermediate term. Our base case does not take into account the possibility that the company could renegotiate its credit agreement and use its leverage capacity to either pay a special dividend to Hallmark Cards and public shareholders, or initiate a special dividend. We have assumed that Hallmark Cards has greater financial resources than Crown Media, and it is not providing any explicit credit support to the proposed debt issues. Our rating analysis is therefore based on the company's performance as a stand-alone entity. Liquidity In our view, Crown Media has "adequate" sources of liquidity to meet uses over the next 12-18 months. Relevant factors and assumptions supporting our liquidity assessment include: -- We expect sources of liquidity over the next 12-18 months to exceed uses by 1.2x or more. The company has minimal debt maturities over the intermediate term. -- We expect net sources to remain positive, even if EBITDA declines by 20%. -- Compliance with financial covenants could survive a 15% drop in EBITDA, in our view. -- Crown Media has a sound relationship with its banks, in our opinion. -- We believe the company would be able to absorb low-probability, high-impact shocks because of its moderate EBITDA conversion to discretionary cash flow. Crown Media derives its liquidity from small cash balances, an undrawn $30 million revolving credit facility due 2016, and our expectation of about $35 million of discretionary cash flow in 2012 and $45 million in 2013. Uses of liquidity include modest capital spending of a few million dollars per year. Debt maturities are minimal, consisting of 1% annual amortization on the term loan until its maturity. Credit facility covenants consist of a total leverage covenant (its tighter covenant) and a secured leverage covenant. The leverage covenant, currently at 7.0x, tightens to 6.5x in the third quarter of 2012, to 5.75x in the third quarter of 2013, and finally to 5.25x in the third quarter of 2014. The secured leverage ratio, currently at 3.5x, tightens to 3.25x in the second quarter of 2012, to 3.0x in the first quarter of 2013, and finally to 2.75x in the first quarter of 2014. At March 31, 2012, the company had a 42% EBITDA cushion of compliance with the leverage covenant. We regard this as adequate. Outlook The stable rating outlook reflects our view that neither an upgrade nor a downgrade appears likely in the intermediate term, and any further upgrades likely would require increased clarity regarding the future investment strategy of Crown Media's majority owner Hallmark Cards Inc. as it relates to Crown Media. For example, further de-leveraging could lay the groundwork for the company to pay a large dividend to its parent, thereby re-leveraging the balance sheet. Longer term, we could raise the rating if we obtain more clarity on Hallmark's investment and ownership strategy, and if Crown Media further strengthens the business position of its cable networks, including subscriber penetration, audience ratings (particularly outside of the holiday season), and affiliate fees. We would also focus on continued EBITDA growth and debt repayment, provided that a recapitalization is not contemplated. On the other hand, we could lower the rating if revenue and EBITDA growth flatten or if the company increases its debt burden by, for example, buying out the remaining public shareholders, or undergoing a comprehensive refinancing that allows for a special dividend and permits ongoing distributions from cash flow, or a combination of the two, such that leverage rises above 5.5x with no prospect of declining permanently. Related Criteria And Research -- Liquidity Descriptors for Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines for Recovery Ratings, Aug. 10, 2009 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded; Outlook Action To From Crown Media Holdings Inc. Corporate Credit Rating B+/Stable/-- B/Positive/-- Upgraded; Recovery Ratings Unchanged To From Crown Media Holdings Inc. Senior Secured BB BB- Recovery Rating 1 1 Senior Unsecured B B- Recovery Rating 5 5 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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