TEXT-S&P cuts Reader's Digest to 'CCC-'
Overview -- U.S. publisher and direct marketer Reader's Digest announced it could violate its total leverage credit facility financial covenant. -- The company's discretionary cash flow deficit has been greater than we had expected, and deficits are not narrowing. -- We are lowering our corporate credit rating two notches to 'CCC-' from 'CCC+' and lowering the issue-level ratings on the company's debt. -- We would lower our corporate credit rating further if the company can't address its potential financial covenant breach and its debt obligations accelerated. Rating Action On Sept. 4, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on New York City-based Reader's Digest Assn. Inc. two notches to 'CCC-' from 'CCC+'. At the same time, we removed the ratings from CreditWatch with negative implications, where they were placed on July 31, 2012. The outlook is negative. We also lowered our issue-level rating on its senior secured notes due 2017 to 'CC' from 'CCC'. The recovery rating on its senior secured loan remains at '5', indicating our expectation of 10% to 30% recovery of principal in the event of payment default. Rationale The downgrade reflects the deterioration in the company's liquidity profile and profitability, as well as its recent announcement of a potential covenant breach. We project that the company could violate its total leverage and cash interest coverage covenants in the reporting period ending Sept. 30, 2012. It is our understanding that the company is in discussions with its lenders to obtain covenant relief. Reader's Digest's direct-mail and publishing businesses are subject to significant medium-term structural risks. We view a meaningful decline in liquidity or a covenant violation as a key short-term catalyst that would contribute to a payment default. In our opinion, there are significant uncertainties and limited visibility surrounding Reader's Digest's revenues and earnings prospects given its declining businesses and ongoing restructuring requirements. In our 2012 and 2013 base-case scenario, we believe that revenues could continue to decline at a double-digit rate because of the impact of divestitures, a weak economy, anemic consumer demand in Europe and the U.S., and secular pressures on the business. We believe that EBITDA could continue to decline at a greater rate because of the company's burdensome cost structure and our expectation of high restructuring costs. Sales compared to the same period last year, pro forma for the sale of "Everyday with Rachael Ray" magazine, fell 18.7% in the three months ended June 30, 2012. Covenant EBITDA decreased to $34.3 million from $57.1 million stemming from an inability to reduce costs at the same pace as revenue declines. Cash balances are the primary source of liquidity as the company does not have a revolving credit facility. Liquid cash balances were only about $42 million as of June 30, 2012, after subtracting about $62 million of cash held by foreign subsidiaries, while negative discretionary cash flow was about $92.9 million for the 12 months ended June 30, 2012. On Aug. 23, 2012, the company announced it had reached a settlement with the Federal Trade Commission (FTC) to pay up to $23.8 million to settle disputes regarding its marketing campaign for Ab Circle Pro. The settlement requires an initial payment of $5 million, $5 million within 180 days, and $3.8 million within 270 days of the entry of the consent order. In addition, the company could make an additional payment of up to $10 million within a year based on consumer refund claims. In our opinion, a potential covenant violation, continuing cash flow deficits, required FTC payments, and our expectations for weak consumer spending in Europe (where the company generates a significant proportion of sales) will place significant pressure on Reader' Digest's "weak" liquidity profile and has escalated the possibility of a payment default in the near term. Outlook We will lower the rating if the company can't address its potential financial covenant breach and therefore its debt obligations are accelerated. Much less likely, and depending on the success of the company's international business transformation to a partnership and royalty model, we could revise the outlook to stable or raise the ratings if the company improves its liquidity. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; CreditWatch/Outlook Action To From Reader's Digest Assn. Inc. RDA Holding Co. Corporate Credit Rating CCC-/Negative/-- CCC+/Watch Neg/-- Reader's Digest Assn. Inc. Senior Secured CC CCC/Watch Neg Downgraded; CreditWatch/Outlook Action To From Reader's Digest Assn. Inc. Senior Secured Local Currency CC CCC /Watch Neg Recovery Rating 5 5
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