TEXT-S&P revises Spanish Broadcasting System outlook to negative
Overview -- U.S. Spanish-language broadcaster Spanish Broadcasting System Inc. had thin EBITDA coverage of cash interest expense (including one quarter of preferred dividends) of 1.1x as of Sept. 30, 2012. -- We are revising our 'B-' rating outlook on the company to negative from stable. -- The negative outlook reflects the potential for a one-notch downgrade if EBITDA trends do not improve in early 2013, causing EBITDA coverage of cash interest expense to drop to 1x in 2013. Rating Action On Nov. 30, 2012, Standard & Poor's Ratings Services revised its rating outlook on Miami, Fla.-based Spanish Broadcasting System Inc. (SBS) to negative from stable. We also affirmed our existing ratings on the company, including the 'B-' corporate credit rating. Rationale The outlook revision to negative is based on the company's thin EBITDA coverage of cash interest expense (including one quarter of preferred dividends) because of the increase in interest expense associated with the February 2012 refinancing. We believe that the EBITDA coverage of cash interest expense, plus one quarter of preferred dividends, could drop to 1x in 2013 because of a potential 200-basis-point increase in interest rates(the company has the option to PIK or cash pay the interest) on the 12.5% secured notes if MegaTV does not hit certain TV segment profitability targets or senior secured leverage does not drop below 4.75x. In addition, the company's 10.75% series B preferred stock becomes putable in October 2013. We believe there is a high likelihood that, without asset sales that allow SBS to reduce leverage, it could prove difficult for the company to redeem the preferred when it is put. Failure to redeem the preferred would not represent an event of default under the new secured debt, but would trigger a voting rights event. It would also prevent the company from incurring additional debt, among other things, based on the indenture. If not remedied, SBS would not be able to refinance its 12.5% senior secured notes when they come due in 2017. Our assessment of the company's management and governance is "fair." Our 'B-' rating reflects tightening liquidity, high debt service costs, and pressure to improve TV segment profitability. Factors supporting our assessment of the company's business risk profile as "vulnerable" (based on our criteria) include the cyclicality of advertising demand, SBS's significant cash flow concentration in a few large U.S. Hispanic markets, competition from much larger rivals, and continued (albeit narrowing) losses at Mega TV. These factors more than offset the company's healthy EBITDA margins and favorable Hispanic demographic trends. Spanish has a "highly leveraged" financial risk profile, in our view, based on its fully adjusted debt (including preferred stock and accrued dividends) to EBITDA ratio of 10.1x as of Sept. 30, 2012. SBS owns and operates 21 radio stations with significant revenue concentration in three markets--New York City, Los Angeles, and Miami--which are highly competitive markets for Hispanic radio and general media. Key competition includes Univision Communications Inc., which has significantly greater scale and resources. In addition, the company owns and operates three TV stations affiliated with its MegaTV network. MegaTV distributes programming through cable and satellite operators. Largely through cost reduction efforts, MegaTV has reduced, but not eliminated, its EBITDA losses. Given SBS's investments in programming and personnel, under our base-case scenario we expect operating losses to continue to narrow at MegaTV, but to remain slightly negative for full-year 2012. Under our base-case scenario, we also believe that revenue could be flat to down at a low-single-digit percent rate for full-year 2012 and again in 2013, based on our operating outlook for radio. As a result, we expect EBITDA to decline at a mid- to high-single-digit percent rate, despite dropping losses in the television segment. We expect the EBITDA margin to be relatively unchanged in 2012 and 2013 as narrowing losses at Mega TV are offset by secular pressure in radio. In the third quarter of 2012 on a consolidated basis, revenue and EBITDA fell by 1% and 13%, respectively, slightly worse than our expectations. Radio revenues were down 2% because of lower local and network sales, while EBITDA declined by 18% because of an increase in operating expenses. Revenue at Mega TV increased 5.6% because of an increase in paid programming, while the segment has modestly positive EBITDA as the company reduced its programming expenses significantly during the quarter. SBS's EBITDA margin was 29% for the 12 months ended Sept. 30, 2012-up from 27% in the prior-year period because of the decreasing loss at Mega TV. Based on restricted payment limitations, we expect SBS to pay preferred dividends in only one quarter of each calendar year totaling about $2.5 million, until total leverage (excluding preferred stock) falls below 4.5x. SBS must pay dividends in at least one quarter annually to avoid triggering a voting rights event. If a voting rights event were to occur we are unsure if future dividends would be paid. Beginning on April 15, 2013, the interest rate on the 12.5% notes could increase by 2% (payable in cash or pay-in-kind interest), unless SBS has recorded positive consolidated station operating income at the TV segment for the last six months of 2012 or secured leverage is below 4.75x. On the next interest payment date, Oct. 15, 2013, the TV segment operating income will be tested on a trailing 12-month basis through June 2013. This rate increase would increase annual interest expense by 2% further pressuring liquidity and bringing pro forma EBITDA coverage of interest expense to less than 1x. We believe that station operating income at Mega TV could be positive in 2013, depending on ad rate demand and the extent of new programming initiatives. SBS converted 59.4% of EBITDA into discretionary cash flow for the 12 months ended Sept 30, 2012. We expect the conversion rate to deteriorate sharply to less than 10% over the next 12 months, as a result of the recent refinancing with high-coupon senior notes. Total lease-adjusted debt (including preferred stock, accrued interest, and accrued dividends) to adjusted EBITDA (including restructuring costs) was high, at 10.1x for the 12 months ended Sept. 30, 2012, but down from peak levels of 23x at year-end 2008. EBITDA coverage of cash interest expense was 3.9x as of Sept. 30, 2012. Pro forma for a full year of interest expense under the 12.5% notes, EBITDA coverage of cash interest expense fell to about 1.2x, while EBITDA coverage of cash interest plus one quarter of preferred dividends was roughly 1.1x as of Sept. 30, 2012. Liquidity SBS has "less than adequate" sources of liquidity to cover its needs over the next 12 to 18 months. We believe financial flexibility will be strained as long as the preferred stock remains outstanding, and based on the risk of a 2% increase in the interest rate on the 12.5% notes. Our characterization of the company's liquidity as less than adequate is based on several qualitative factors as well. Relevant elements of our assessment of SBS's liquidity profile include the following: -- We expect sources of liquidity (including cash balances) to exceed uses by 1.2x or more over the next 12 months. -- We expect net sources to be positive, even if EBITDA drops 15% over the next 12 months. -- SBS does not have financial maintenance covenants under the new notes. -- Because of SBS's narrow EBITDA coverage of cash interest expense, which could thin further in 2013, and only modest discretionary cash flow, we do not believe it could absorb low-probability, high-impact adverse shocks without the need for refinancing. SBS's liquidity sources include cash balances of roughly $30 million as of Sept. 30, 2012, and funds from operations of $16 million over the past 12 months. We expect discretionary cash flow to be modestly positive in 2013. Uses of liquidity over the next 12 months include modest capital expenditures (which we estimate at around $2 million), minimal working capital needs, and preferred stock dividends of $2.5 million. The company has no debt maturities over the next 12 months. SBS's $92 million of 10.75% series B preferred stock, which had $26.8 million of accrued dividends as of Sept. 30, 2012, becomes putable on Oct. 15, 2013. Absent asset sales or a currently unanticipated common equity infusion that significantly reduces secured leverage, we do not believe the company will have the capacity in its capital structure to redeem the preferred stock at that date. The 12.5% notes do not have financial maintenance covenants, but do contain terms that prevent the company from making certain restricted payments until total leverage (excluding preferred stock) falls below 4.5x. As a result, the company will have limited flexibility over the next twelve months to pay down the preferred stock, and dividends will continue to accrue at about 8%, or $7.4 million per year. Outlook The negative rating outlook reflects the company's thin interest coverage and high debt leverage. In addition, we believe the company will generate minimal discretionary cash flow in 2013, which could turn negative if EBITDA trends further deteriorate in early 2013. We could lower the rating if we become convinced that EBITDA coverage of cash interest, plus one quarter of preferred dividends, drops below 1.0x in 2013 based on a potential step-up in interest rates on the 12.5% secured notes. We could revise the outlook to stable if operating trends improve, leading to interest coverage staying in the 1.2x area regardless of the potential step-up in interest rates, and discretionary cash flow generation is positive. We do not believe an upgrade is likely over the intermediate term. An upgrade would entail, at minimum, the company addressing the preferred stock, either through a redemption or amendment of the terms that preclude incremental debt incurrence, following a failure to repay the preferred in a put event. We believe the company would require asset sales, an equity infusion, or outsized revenue and EBITDA gains that meaningfully reduce leverage to facilitate a refinancing of the preferred. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed; Outlook Action To From Spanish Broadcasting System Inc. Corporate Credit Rating B-/Negative/-- B-/Stable/-- Ratings Affirmed Spanish Broadcasting System Inc. Senior Secured B- Recovery Rating 3 Preferred Stock CCC 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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