Oct 25 -
Summary analysis -- Interxion Holding N.V. ------------------------ 25-Oct-2012
CREDIT RATING: B+/Stable/-- Country: Netherlands
Primary SIC: Communications
Credit Rating History:
Local currency Foreign currency
16-Feb-2010 B+/-- B+/--
02-Feb-2010 B-/-- B-/--
The rating on Dutch data center operator Interxion Holding N.V. (Interxion) reflects Standard & Poor's Ratings Services' view of the group's "highly leveraged" financial risk profile and its "fair" business risk profile.
The highly leveraged financial risk profile primarily factors in our view that the large capital investments associated with Interxion's expansion plans will keep the group's free operating cash flow (FOCF) generation negative over the medium term (next two to three years) and potentially require additional debt financing. However, the group benefits from strong and predictable underlying funds from operations (FFO) through its significant recurring revenues and strong profit margins.
The fair business risk profile reflects our opinion that the competitive environment in which Interxion operates could lead to meaningful shifts in the supply-demand dynamics of the data center and co-location market over the medium term. These potential variations could increase pressure on the group's operating margins, owing to its inherently high operating leverage, and on cash flow generation. However, this is offset in part by Interxion's status as one of the few carrier-neutral data center providers with a presence in most European communications hubs; moderate barriers to entry in the industry; and currently favorable supply-demand dynamics. The latter are driven by the limited amount of space available in key Internet hub locations; growth in Internet traffic and communications volumes in general; and limited penetration, so far, of outsourced data centers in Europe.
S&P base-case operating scenario
We continue to anticipate that Interxion's percentage revenue growth for full-year 2012 will be in the low teens on the back of strong reported year-on-year revenue growth of 13% in the second quarter of 2012. The chief growth drivers are the group's strong investment in additional capacity and its resilient capacity utilization levels due to supportive demand dynamics. The group's reported EBITDA margin of 40% on June 30, 2012 (on a 12-month rolling basis), is consistent with our forecast of about 40% for 2012. We see potential further improvement in reported EBITDA margins to around 41% in 2013.
S&P base-case cash flow and capital-structure scenario
We believe that Interxion's expansion plans will continue to require significant capital spending, resulting in negative FOCF over the medium term. In 2011, the group's tangible and intangible capital expenditures (capex) of EUR162 million exceeded operating cash flow by almost EUR100 million, by our calculations. We anticipate that FOCF will potentially turn positive in 2015; however, if Interxion's capital spending is higher than we forecast over the coming years, FOCF could stay negative for longer.
We forecast that Interxion's Standard & Poor's-adjusted debt to EBITDA will remain around 4x at year-end 2012 and 2013, compared with 4.2x on Dec. 31, 2011, due to continued EBITDA growth contributed by the group's recently opened data centers. This is despite a continued rise in operating lease commitments following capacity expansion. We capitalize these commitments and include them in Interxion's reported debt according to our methodology. We calculate adjusted leverage on a gross debt basis.
We assess Interxion's liquidity as "adequate" under our criteria. Thisreflects our view that the group's sources of liquidity will cover its uses by at least 1.2x for the next 12 months.
As of June 30, 2012, we estimate Interxion's liquidity sources over the next 12 months to be about EUR231 million. These include:
-- Cash and cash equivalents of about EUR85 million;
-- Forecast FFO of about EUR85 million; and
-- A EUR60 million undrawn committed revolving credit facility (RCF) maturing in May 2016. The credit facility includes financial covenants, under which we project Interxion will maintain adequate headroom.
We estimate Interxion's liquidity needs over the same period to be about EUR190 million, primarily comprising capex, which the group forecasts at about EUR170 million-EUR190 million. We understand that Interxion has favorable working capital dynamics due to its upfront billing and collections, and that the group only faces EUR0.75 million of debt maturities in the next 12 months.
We note that much of the group's capex is tied to data center expansion. This provides some cushion for the group to delay or scale down expansionary capex if industry conditions deteriorate and reduce demand for co-location space, albeit with a likely time lag, in our opinion. Nevertheless, the "adequate" liquidity profile will depend on the group bolstering its balance sheet with additional financing given its anticipated negative consolidated free cash flow generation in the medium term.
The issue rating on Interxion's EUR60 million RCF is 'BB'. The recovery rating on this instrument is '1', reflecting our expectation of very high (90%-100%) recovery in the event of a payment default.
The issue rating on the EUR260 million senior secured notes (including the recent tap issuance) is 'BB-'. The recovery rating on these notes is '2', reflecting our expectation of substantial (70%-90%) recovery in the event of a payment default.
The issue and recovery ratings reflect our valuation of Interxion as a going concern, given its leading market position in Europe's key Internet hubs, valuable long-term relationships and contracts with a fragmented and established customer base, and specific industry characteristics such as moderate barriers to entry and the cash-generative nature of the business. Based on our valuation, we estimate Interxion's stressed enterprise value at about EUR380 million. We have pushed back the year of default in our hypothetical default scenario to 2016 from 2015, assuming that the group's expansion plans do not yield the forecast returns, resulting in continued negative cash flows beyond our current estimates.
While cover for the notes nominally exceeds 90%, we maintain a recovery rating of '2' to reflect the risks inherent in Interxion's expansion strategy, which, under our default scenario, might require additional debt financing beyond the existing facilities. This in turn could lower recoveries for noteholders, depending on the extent of additional financing required.
The stable outlook reflects our view that Interxion will continue to benefitfrom increased demand for data center capacity, resulting in sustained capacity utilization rates and strong growth in revenues and EBITDA. This should enable the group to maintain adjusted debt to EBITDA of less than 5x over the next 12 months, in our opinion. The stable outlook also factors in Interxion's maintenance of adequate liquidity despite high planned expansionary capex.
We could lower the ratings if Interxion's liquidity weakens in the absence of proactive financing or if pricing pressures erode EBITDA such that the group's adjusted leverage ratio increased to more than 5x, while reducing its FFO in absolute terms. Pricing pressures could arise due to falling capacity utilization rates or shifts in the supply-demand dynamics for data centers in the group's key markets.
The potential for an upgrade of Interxion is limited, in our view, given that we anticipate significant negative FOCF generation through 2014 at least, but this remains highly dependent on the level and timing of expansionary capex. Over time, however, we could consider a positive rating action if Interxion were to approach sustainable positive free cash flow while adjusted leverage remained in the range of 3.5x-4.0x on a sustainable basis. Additionally, an upgrade would hinge on liquidity remaining adequate.
Related Criteria And Research
-- Research Update: Interxion Holding N.V. Outlook Revised To Stable From Negative On Successful IPO; 'B+' Rating Affirmed, March 10, 2011
-- Methodology And Assumptions: Standard & Poor's Standardizes Liquidity Descriptors For Global Corporate Issuers, July 2, 2010
-- Interxion Holding N.V., Feb. 16, 2010
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008