TEXT - Fitch affirms Cogeco Cable Inc rating at 'BBB-'
Dec 3 - Fitch Ratings has affirmed all ratings for Cogeco Cable Inc. (Cogeco) at 'BBB-'. Fitch has also removed Cogeco from Rating Watch Negative. The Rating Outlook is Stable. Cogeco --Issuer Default Rating at 'BBB-'. --Senior secured notes at 'BBB-'. The rating affirmation is the result of Cogeco closing its $1.36 billion acquisition for Atlantic Broadband Group, LLC (ABB). Financing for the transaction includes $660 million committed first lien term loan at ABB that is non-recourse debt to Cogeco. Leverage pro forma for the acquisition would increase to approximately 2.7x at Cogeco Cable (3.1x on a consolidated basis) which is outside of Fitch's expectations for its leverage range. Longer-term expectations for Cogeco ratings include leverage of approximately 2.5x or less. Fitch expects Cogeco will reduce leverage back to this range within the next 12 - 15 months. The 'BBB-' ratings reflect Cogeco Cable's stable operating profile and the strength of the Canadian operations that generate the majority of the company's revenue and cash flow. Fitch believes that the Canadian operations are well supported by Cogeco Cable's competitive position anchored by its high speed internet and triple play offering. The cable systems are also clustered in less concentrated and generally less competitive suburban regions. Nevertheless, the competitive intensity in Canada is expected to increase with additional IPTV footprint expansion through fiber-to-the-home overbuilds in a substantial portion of Cogeco's regions. This will likely increase the pressure on primary service unit additions which have been decreasing due to category maturity, competitive offerings and tightening of credit controls. Fitch believes Cogeco also needs to upgrade technology supporting its video offering to better match capabilities with the telco's IPTV video service. The increased financial risk due to higher debt levels reduces the tolerance for potential operational shortfalls associated with greater than expected competitive impacts. Operating trends that fall below expectations, thus pressuring cash flows and slowing the deleveraging process could warrant changes in Outlook and/or ratings. Cogeco should be able to mitigate pressure through rate increases and SMB primary service unit additions which will become an increasingly important offset. In addition, the enterprise services segment provides a growing diversified revenue stream with good margins. Cogeco's capital spending intensity has been elevated relative to its peers due to success-based spending within this segment. Cogeco will use a material portion of its good liquidity position to close the ABB acquisition. Cogeco's main sources of liquidity are through its credit facilities, cash position, and free cash flow (FCF). As of Aug. 31, 2012, Cogeco Cable had no outstandings on its CAD750 million credit facility due 2017 and CAD215 million of cash. Cogeco Cable will use proceeds from the $660 million first lien term loans at ABB, a substantial drawdown on its revolver and fund the remaining portion of the acquisition with cash on hand. Going forward, Fitch expects Cogeco will restore at least a portion of its liquidity position on the revolver. Free cash flow (FCF) for the fiscal year 2012 was CAD42 million after dividend payment. Cogeco's current guidance excludes ABB, and after dividend payment the company is expected to generate approximately CAD54 million of FCF in FY 2013. Cogeco's conservative financial policies also support its current ratings. The company does not have an active share program. Additionally the most recent dividend increase of 4% is much lower than in the past reflecting in part the increased leverage resulting from the acquisition and Cogeco's desire to use discretionary cash flow to delever the balance sheet. Importantly, Fitch believes the new ABB subsidiary should be in a self-funding position. This is supported by ABB's current cash generation, a substantial tax shield related to net operating losses, a competitive environment with limited triple play competition and the expected growth from increasing underpenetrated services. ABB will increase success-based capital spending which should improve its competitive position relative to satellite operators which is the primary competitor in approximately three quarters of its markets. The corporate structure used by Cogeco for the ABB acquisition also enables material tax related benefits. Consequently, Cogeco's increased interest costs are essentially covered through a tax-free interest payment from the intercompany subordinated debt at ABB and tax interest deductibility associated with the ABB term loan. WHAT COULD TRIGGER A RATING ACTION Negative: Future developments that may, individually or collectively, lead to negative rating include: --Cogeco does not make progress on deleveraging Cogeco Cable below the mid 2.5x range in next 12 - 15 months; --An additional material leveraging transaction; --Greater than expected IPTV competition in Cogeco Cable territory that adversely affects operating trends; --Negative operating trends in the Atlantic Broadband operations that requires Cogeco Cable to infuse additional funding; --Reduced free cash flow prospects. Positive: Fitch believes that the current leverage, smaller operational scale of operations relative to its peers and increased competitive factors constrain upward movement in the ratings. As a result, Fitch's sensitivities do not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade.