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