TEXT - S&P cuts Nelson Education Ltd to 'CCC+'

Fri Nov 30, 2012 4:07pm EST

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Overview
     -- We are lowering our long-term corporate credit rating on Nelson 
Education Ltd. to 'CCC+' from 'B-'. 
     -- We are also lowering our issue-level rating on the company's senior 
secured first-lien debt one notch to 'B-' from 'B'. The '2' recovery rating on 
the debt is unchanged. 
     -- In addition, we are lowering our issue-level rating on Nelson's senior 
secured second-lien term loan to 'CCC-' from 'CCC'. The recovery rating on the 
debt is unchanged at '6'.
     -- We base our downgrade on Nelson's weakened operating performance, 
including declining revenue and EBITDA, which we expect to continue in 2013 
because of secular industry changes and the lackluster economy. The ongoing 
decline in the company's EBITDA has led to very high debt leverage, which 
could make it challenging to refinance Nelson's debt facilities, which start 
to mature in July 2013.
     -- The negative outlook reflects our expectation that we could lower the 
ratings on Nelson in the next year if the company fails to address its 
refinancing risk. 

Rating Action
On Nov. 30, 2012, Standard & Poor's Ratings Services lowered its long-term 
corporate credit rating on Toronto-based Nelson Education Ltd. to 'CCC+' from 
'B-'. The outlook is negative.

At the same time, Standard & Poor's lowered its issue-level rating on the 
company's senior secured first-lien debt one notch to 'B-' from 'B'. The '2' 
recovery rating on the debt is unchanged. 

In addition, we  lowered our issue-level rating on Nelson's senior secured 
second-lien term loan to 'CCC-' from 'CCC'. The recovery rating on the debt is 
unchanged at '6'. 

The downgrade reflects what we view as Nelson's weak operating performance, 
including ongoing lower revenue and EBITDA, which we expect will continue in 
2013. The decline in the company's EBITDA has led to very high adjusted debt 
leverage of 12x for the 12 months ended Sept. 30, 2012, up from about 10.5x 
the year before. Furthermore, Nelson faces refinancing risk with its revolving 
credit facility maturing in July 2013, as well as its senior secured 
first-lien term loan maturing in July 2014 and senior secured second-lien term 
loan maturing in July 2015. 

Rationale
The ratings on Nelson reflect Standard & Poor's view of the company's 
"vulnerable" business risk profile and "highly leveraged" financial risk 
profile. We base our business risk assessment on the company's weak operating 
performance, lack of geographic diversity given the high proportion of its 
sales in Ontario, and participation in the challenging educational publishing 
industry, which is mature and characterized by reduced revenues given lower 
government funding and increased product alternatives. These factors are 
partially offset by what we consider the company's solid market position in 
the Canadian educational publishing industry. We base our financial risk 
assessment on a very aggressive financial policy, highly leveraged capital 
structure, and limited financial flexibility. In addition, the company could 
face refinancing risk given that its debt facilities start maturing in July 
2013. 

Nelson was formed in 2007 to enable OMERS Private Equity and Apax Partners to 
purchase the Canadian division of educational publisher Thomson Learning Inc. 
(previously unrated) from Thomson Reuters Corp. (A-/Negative/--). The purchase 
price was financed with bank debt and equity. The sponsors' contribution was 
in the form of common equity and a deeply subordinated shareholder loan. The 
shareholder loan is junior to the bank facilities, with terms that are 
favorable to the first- and second-lien lenders; hence, it is treated as 
equity for ratio calculations. 

The company is one of the largest academic publishers in Canada, with the No. 
1 market position in the school segment (Kindergarten-Grade 12) and the No. 2 
position in higher education. Nelson has a relationship with Cengage Learning 
Holdings II L.P. (the former U.S. Thomson Learning business; CCC/Negative/--) 
through an operating agreement that doesn't expire until January 2018, and is 
renewable for one-year extensions thereafter. The agreement outlines 
participation in a procurement program by both companies and terms relating to 
the distribution of the U.S. company's products in Canada.

Under our base-case scenario, we expect revenues to decline at a 
mid-single-digit percent rate in fiscal 2013, while we believe EBITDA will 
continue to be pressured due to lower volume and pricing. We do not anticipate 
significant debt repayment this fiscal year. Nelson's performance will likely 
remain weak in 2013 due to challenging industry and economic conditions, 
resulting in the likelihood that government spending on educational books in 
the school segment will remain soft, combined with increased used book sales 
in the higher education segment. 

Revenue was down 5.3% in the first fiscal quarter ended Sept. 30, 2012, 
compared with the same quarter in 2011, due to declines in both the higher 
education and school segments. This followed a 7.5% decline in revenue in the 
fiscal year ended June 30, 2012, compared to fiscal 2011. After a significant 
18.1% drop in segment operating profit (before amortization and unusual items) 
in fiscal 2012, segment profit declined only 2.0% in the first quarter ended 
Sept. 30, 2012. 

Credit protection measures (adjusted for operating leases and the deduction of 
amortized pre-publication costs from EBITDA) are weak for the ratings. 
Adjusted debt to EBITDA is very high, in our opinion, at about 12x for the 12 
months ended Sept. 30, 2012. We believe debt leverage will remain elevated 
this year because of lower EBITDA and nominal declines in the debt balance.

Liquidity
We believe Nelson has less-than-adequate liquidity based on refinancing risk. 
Relevant expectations and assumptions in our assessment of Nelson's liquidity 
profile are as follows:
     -- Its sources of liquidity are free cash flow, cash, and a C$50 million 
revolving credit facility due July 2013. Revenue and cash flow have 
considerable seasonality, with peak working-capital needs occurring in the 
third calendar quarter. During these times, Nelson's liquidity position 
weakens and we believe could become further exacerbated should the company's 
financial performance deteriorate.
     -- The first-lien facility has an adjusted senior leverage covenant of 
7x, which was met for the quarter ended Sept. 30, 2012. 
     -- The company is required to make annual principal sweep payments on the 
first-lien term loan based on the previous year's excess cash flow, which can 
be used as future mandatory principal payments. Because free cash flow is 
constrained by what we consider significant interest expense, we don't expect 
annual payments to be large. 

Recovery analysis
For the complete recovery analysis, see the recovery report on Nelson to be 
published on RatingsDirect on the Global Credit Portal following this report.

Outlook
The negative outlook reflects our expectation that we could lower the ratings 
on Nelson in the next year if the company fails to address its refinancing 
risk. We could also consider lowering our ratings on Nelson if the company's 
operating performance weakens more than we expect or if there is less than a 
10% EBITDA cushion within the financial covenant. We could revise the outlook 
to stable after completion of a debt refinancing and if the company 
demonstrates sustainable improvement in its operating performance, including 
revenue and margin stability, which we expect would result in adequate 
covenant cushion with continued debt repayment.

Nelson is a private company and does not release financial information 
publicly.

Related Criteria And Research

     -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 
1, 2012
     -- Methodology and Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Criteria Guidelines For Recovery Ratings On Global Industrials 
Issuers' Speculative-Grade Debt, Aug. 10, 2009
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 
May 27, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List
Nelson Education Ltd.
Ratings Lowered/Recovery Ratings Unchanged
                          To                 From
Corporate credit rating   CCC+/Negative/--   B-/Stable/--
First-lien bank fac.      B-                 B
  Recovery rating         2                  2 
Second-lien bank fac.     CCC-               CCC
  Recovery rating         6                  6
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