TEXT-S&P revises outlook on Gala to stable;affirms 'B' rating

Wed Dec 5, 2012 7:12am EST

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Dec 05 -

Overview

-- U.K.-based gaming operator Gala Coral Group Ltd. (Gala) has in the last 12 months managed to stabilize and slightly improve its operating performance. Over the next 12 months, we forecast that Gala's operating performance will remain resilient.

-- We are therefore revising our outlook on Gala to stable from negative.

-- At the same time, we are affirming our 'B' long-term corporate credit rating on Gala.

-- The stable outlook reflects our expectation that the company will post a Standard & Poor's-adjusted interest-coverage ratio of more than 1x in 2012-2013, while maintaining adequate liquidity over the next 12 months.

Rating Action

On Dec. 5, 2012, Standard & Poor's Ratings Services revised its outlook on U.K.-based gaming operator Gala Coral Ltd. (Gala) to stable from negative. At the same time, we affirmed our 'B' long-term corporate credit rating on Gala.

We also affirmed our 'B+' rating on Gala Coral Group Finance PLC's GBP350 million secured notes, and our 'CCC+' rating on Gala Electric Casino PLC's GBP275 million unsecured notes. Recovery ratings on these instruments are unchanged at '2' and '6', respectively, highlighting our expectations of substantial (70%-90%) and negligible (0-10%) recovery in the case of payment default.

Rationale

The rating action follows what we see as a stabilization, and some early signs of improvement, in Gala's operating performance. In the financial year to Sept. 29, 2012, we forecast revenues of about GBP1.19 billion and reported EBITDA (before exceptional cash costs) of about GBP280 million, in line with management's budget and ahead of the GBP261 million reported in 2011. Over the next 12 months, we forecast that Gala's operating performance will remain resilient. The rating action also reflects our expectations that Gala's credit metrics will remain in line with our guidance for the current rating (interest coverage of more than 1.0x; 1.5x when considering cash interest) and that liquidity will remain adequate over the next 12 months.

We continue to assess Gala's financial risk profile as "highly leveraged" under our criteria. This is based on our view of the group's aggressive capital structure, high leverage, weak debt-service coverage measures, and tightening financial covenants. Including the casino business, we estimate that Gala's Standard & Poor's-adjusted debt-to-EBITDA ratio will be about 9.5x by year-end 2012 (ending Sept. 29, 2012) and 2013. Our estimate for financial 2012 includes financial debt of approximately GBP2.14 billion (including operating lease adjustments of about GBP370 million and approximately GBP340 million of debt at Gala Property Company ) and approximately GBP620 million in the form of preferred equity certificates (PECs). We treat these PECs as debt-like and include them in our adjustments. That said, we believe that the PECs benefit the company's financial flexibility, thanks to their noncash payment features.

Mitigating these weaknesses is our view of Gala's "adequate" liquidity after a refinancing in mid-2011. Liquidity is supported by available cash and committed credit facilities, a lack of material short-term debt amortization requirements, and our projection of adequate (at least about 15%) headroom under its financial covenants for financial 2013.

We continue to assess Gala's business profile as "fair," thanks to the company's diversified portfolio of cash-generative gaming businesses. These businesses include Coral, the third-largest U.K. bookmaker; Gala Bingo, the market leader in U.K. bingo; and a growing Italian retail betting business. Gala has recently announced the disposal of its third-ranked U.K. casinos business to The Rank Group PLC (not rated). The disposal is still subject to approval by The Competition Commission.

Our business risk profile assessment reflects Gala's bookmaking business, which we rate on a stand-alone basis in the low investment-grade category, and its somewhat weaker casino and bingo segments. In our view, the benefits of high barriers to entry and strong brand recognition are tempered by the industry's mature and competitive nature and its potential exposure to adverse tax and regulatory changes. The ratings also reflect Gala's exposure to unexpected sporting results, its underperforming online businesses, and pressure on consumer discretionary spending from the weak state of the economy in the U.K.

In the coming quarters, we anticipate that Gala will maintain resilient key performing indicators (KPI) and operating performance. Despite recent investments, we conservatively project that the contribution from the online business will remain limited, as Gala continues to lag materially behind its main peers in this sector. In the financial year to Sept. 30, 2013, we forecast that reported EBITDA (before exceptional cash costs) will remain at about GBP280 million. This is despite the lack of the positive contribution from international football tournaments in the summer and the extra week's worth of consolidated numbers--as per U.K. Generally Accepted Accounting Principles--that Gala enjoyed in 2012. In view of the step up in covenants, we believe that over the next 12-18 months a material improvement in profitability of the online division will be key to maintaining adequate (that is, at least 15%) headroom on covenants in financial years 2014 and 2015.

Liquidity

We consider Gala's liquidity to be "adequate" under our criteria, after a refinancing in May 2011. The group has good operating cash flow and access to debt facilities to fund its operating needs and capital investments over the medium term.

In our view, short-term liquidity is supported by:

-- Our projection that the group's sources of liquidity, including cash and the available RCF, will exceed its uses by 1.2x or more over the next 12 months.

-- Our forecast that net sources of cash will remain positive, even if EBITDA declines by 15% in the coming year.

-- The fact that there are no debt maturities or material debt amortization requirements before 2014, when the Gala Propco debt matures (according to financial statements and debt documentation this is ring-fenced from the operating companies), and 2017-2018.

-- Generally cash flow-generative business, with limited seasonal working capital needs and fairly low maintenance capital expenditure (capex).

-- Adequate (at least about 15%) headroom under the financial covenants of the senior loan agreement. However, we note that the covenants tighten over time and the maintenance of adequate headroom requires EBITDA growth over the next few years. We anticipate covenant headroom of at least about 15% for financial year 2013 (ending Sept. 30, 2013).

Our assessment of Gala's liquidity sources in the 12 months to September 2013, under the scenario outlined above, includes:

-- Access to cash balances of about GBP115 million as of Sept. 30, 2012 (including approximately GBP10 million estimated at Propco);

-- Ample availability (approximately GBP80 million as of September 2012) within its GBP100 million RCF maturing in 2017; and

-- Good operating cash flow generation. We project more than GBP120 million of reported funds from operations in the 2013 financial year.

In our opinion, liquidity and cash flow generation is sufficient to fund capex of up to about GBP75 million estimated in 2013.

Assuming the planned disposal of the casino business is finalized, it could have a slightly positive effect on Gala's liquidity in terms of covenant compliance, if Gala uses the proceeds to reduce leverage. Under such a scenario, we would continue to assess Gala's liquidity as "adequate" under our criteria.

Recovery analysis

The issue rating on Gala Coral Group Finance PLC's GBP350 million secured notes is 'B+', one notch above the corporate credit rating. The recovery rating on these instruments is '2', indicating our expectation of substantial (70%-90%) recovery in the event of a payment default.

The issue rating on Gala Electric Casino PLC's GBP275 million unsecured notes is 'CCC+'. The recovery rating on this debt is '6', indicating our expectation of negligible (0%-10%) recovery in the event of a payment default.

In order to determine recoveries, we simulate a default scenario. On the path to default, we assume that Gala will be restructured (triggered by a breach of its financial covenants) before payment default occurs. As a gaming company, Gala operates in a highly regulated sector. Therefore, our hypothetical default scenario assumes some decline in revenues and margins, primarily stemming from the potential introduction of regulatory and tax reforms in the U.K. and Italy. It also assumes deterioration in the current general economic environment, with rising unemployment reducing consumers' discretionary spending and retail earnings. Under our scenario, EBITDA declines to about GBP180 million (including the casino business) by the time of our hypothetical point of default in 2015.

At our simulated default, we value the business on a going-concern basis, based on the company's strong market share, leading brands, cash-generative businesses, and barriers to entry (regulation and licenses). On this basis, we estimate recovery prospects for senior secured lenders at the low end of the 70%-90% range, leaving negligible (0%-10%) coverage for the unsecured notes.

If the planned disposal of the casino business is finalized, use of proceeds will be the key rating driver for recovery purposes. Assuming that the bulk of proceeds will be used to repay senior debt, we expect coverage to remain in the current range.

For our detailed recovery analysis, see "Gala Coral Group Ltd. Recovery Rating Profile," published June 15, 2012.

Outlook

The stable outlook reflects our view that Gala will continue to demonstrate a resilient operating performance over the next 12 months, with some further improvements in KPI, and maintain credit metrics consistent with our guidance for a 'B' rating. Under our base-case scenario, we estimate that EBITDA (before exceptional cash costs) will remain at about GBP280 million in 2013, enabling the group to maintain an adjusted EBITDA interest coverage of more than 1.0x (corresponding to a reported EBITDA to cash interest coverage of more than 1.5x). The stable outlook also reflects our opinion that Gala will maintain what we consider to be "adequate" liquidity, despite tightening covenants.

We could lower the ratings if Gala's liquidity becomes "less than adequate," for example, if headroom on its weakest-performing covenant test falls to meaningfully less than 15%. We could also lower the ratings if adjusted EBITDA interest coverage falls to materially less than 1.0x (equivalent to reported EBITDA cash interest coverage of less than 1.5x).

Rating upside, in our opinion, is limited at this stage, given Gala's highly-leveraged capital structure.

Related Criteria And Research

All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.

-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

-- Understanding Standard & Poor's Rating Definitions, June 3, 2009

-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Ratings Affirmed; CreditWatch/Outlook Action

To From

Gala Coral Group Ltd.

Corporate Credit Rating B/Stable/-- B/Negative/--

Ratings Affirmed

Gala Electric Casinos PLC

Senior Unsecured*

Local Currency CCC+ CCC+

Recovery Rating 6 6

Gala Group Finance PLC

Senior Secured*

Local Currency B+ B+

Recovery Rating 2 2

*Guaranteed by Gala Coral Group Ltd.

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