TEXT - S&P rates Media Holdco
Overview -- Media Holdco L.P., majority owner of U.S. television broadcaster ION Media Networks, is issuing a $255 million term loan to fund the buyout of two of its existing investors. -- ION Media Networks is putting in place a $50 million revolving credit facility for general corporate purposes. -- We are assigning the company our 'B+' preliminary corporate credit rating. We are assigning the revolving credit facility our 'BB' preliminary issue-level rating with a '1' preliminary recovery rating. We are assigning the term loan B our 'BB-' preliminary issue-level rating with a '2' preliminary recovery rating. -- The stable outlook reflects our expectation that leverage will remain in the 2x-3x range over the next couple years and liquidity will remain adequate. Rating Action On Dec. 6, 2012, Standard & Poor's Ratings Services assigned Media Holdco L.P., the majority owner of ION Media Networks Inc., its 'B+' preliminary corporate credit rating. We rate the two entities on a consolidated basis. The outlook is stable. In addition, we assigned the $50 million five-year revolving credit facility issued by ION Media Networks our 'BB' preliminary issue-level rating, with a '1' preliminary recovery rating (two notches higher than the 'B+' corporate credit rating), indicating our expectation for very high (90% to 100%) recovery for lenders in the event of a payment default. The revolving credit facility will be used for general corporate purposes and is expected to be undrawn at the time of closing. We also assigned Media Holdco's $255 million 5.5-year term loan B our 'BB-' preliminary issue-level rating, with a '2' preliminary recovery rating (one notch higher than the 'B+' corporate credit rating), indicating our expectation for substantial (70% to 90%) recovery in the event of a payment default. The proceeds from the term loan will be used to buy out two of the three owners of Media Holdco L.P. Following the transaction, Black Diamond Capital Management will be the sole owner of Media Holdco, which currently owns 87% of ION Media Networks. Rationale The 'B+' preliminary rating on Media Holdco reflects our view of ION Television's modest ratings, minimal original programming, and above-average use of infomercials. These factors underpin our view of the business profile as "weak." We regard the company's financial risk profile as "aggressive" due to its private-equity ownership and modest leverage. Pro forma for the transaction, lease-adjusted debt to EBITDA is 2.7x (2.1x on an unadjusted basis) and lease-adjusted EBITDA coverage of interest is 5.6x (we do not add back to EBITDA stock compensation that is only payable in cash). Pro forma EBITDA coverage of cash interest is 8.6x. We view the company's management and governance as "fair." ION Media owns and operates 60 TV broadcast stations, including stations in all of the top 20 markets in the U.S. The company's flagship network, ION Television, has extensive reach, covering 100 million homes. ION Television must be carried by cable and satellite providers in markets where ION has a TV station, and carriers have often chosen to carry it in markets where it does not have a station. In the past, the company generated the majority of its revenue from infomercials. Over the last couple years, the company has increased the amount of programming it airs, and now programs around 16 hours per day. Programming consists mainly of off-network and off-cable shows, often in their second run, and original programming is limited. The company has been successful in raising advertising rates but we believe it will be difficult to continue do so. ION Television is also vulnerable to ongoing ratings erosion affecting broadcasting and cable networks. We view the lack of original programming as an obstacle to generating subscription fees and growing advertising rates. As the company has shifted away from infomercials, it has made increasingly large programming commitments that span three-to-four years. The company has attempted to maintain flexibility by limiting the number of episodes it buys up front and including options to buy additional episodes or seasons at a later date. Nevertheless, we view the increase in programming commitments as risk since a drop in viewership levels and ad rates would significantly impact margins. Under our base case for 2013, we expect revenue to grow at a low- to mid-single-digit percent rate as the company adds additional hours of programming. We expect EBITDA to fall 8% to 10% due to higher programming expenses. Any softening of ad demand could weaken both the revenue and EBITDA outlook. We expect that lease-adjusted leverage will increase slightly in 2013, due to lower EBITDA. Interest coverage should remain in the mid-5x area. In the third quarter of 2012, revenue grew 4.9% and EBITDA increased 13.3% as growth in advertising revenue offset a decline in infomercial revenue. The improvement in EBITDA was due to higher revenue and lower station operating expenses. For the 12 months ended Sept. 30, 2012, the EBITDA margin was 35.9%, down from 38% for the full-year 2011 due to higher programming expenses as the company shifts its business model more toward entertainment programming versus infomercials. As the company shifts away from infomercials, the funding of programming uses cash and thus, working capital usage. During the 12 months ended Sept. 30, 2012, ION spent roughly 18% of EBITDA on capital expenditures. During the same period, the company converted 70% of EBITDA to discretionary cash flow (discretionary cash flow is negative when including a special dividend payment in the third quarter of 2012). In 2013, we expect conversion of EBITDA to discretionary cash flow to fall to 30% to 40% due to increased interest expense. Liquidity We believe ION Media has "adequate" liquidity (per our criteria) to cover needs over the next 12 to 18 months. Our assessment of its liquidity profile incorporates the following expectations and assumptions: -- We expect the company's sources to be sufficient to cover uses for the next 12 to 18 months by 1.2x or more. -- We expect net sources to be positive even with a 15% to 20% drop in EBITDA over the next 12 months. -- The company has the capacity to absorb high-impact, low-probability events over the next 12 months. -- We expect that the company would be able to maintain compliance with its new credit facility covenants, even with a 15% to 20% decrease in EBITDA. ION derives liquidity from pro forma cash balances of around $50 million, full availability under its $50 million undrawn revolving credit facility, and expected $30 million to $50 million in discretionary cash flow. Uses of liquidity include capital expenditures of $20 million to $25 million per year. As the company transitions away from infomercials, working capital is a use of cash since the company typically receives payment for infomercials upfront, and pays for entertainment programming in advance of airing it. The company must also pay dividends to minority owners concurrent with dividends distributed to Media Holdco to fund interest and principal payments. Currently, the minority owners own 13% of ION Media Networks. There are warrants that could be exercised to reduce Media Holdco's ownership to 78% (on a fully diluted basis) from 87%. Debt maturities are modest as the term loan amortizes at 1% annually. We expect there will be an interest coverage covenant and a total leverage covenant. We have assumed that the interest coverage covenant will be set at 3x for the life of the term loan. The total leverage covenant is expected to start at 3x, then step down to 2.75x in 2015, 2.5x in 2016, and 2.25x in 2017. We expect the total leverage covenant will be the tighter of the two, and that headroom will be over 35%. Recovery analysis For the complete recovery analysis, please see our recovery report on Media Holdco, to be published on RatingsDirect following this release. Outlook The stable outlook is based on our expectation that the company will continue to generate positive discretionary cash flow, keep leverage between 2x and 3x, and maintain adequate liquidity and sufficient headroom with covenants. We could lower the rating if operating performance weakens and EBITDA declines significantly, potentially resulting from weak ratings and ad demand, and higher-than-expected content costs. We could also lower the rating if leverage rises to the mid-3x area, which could be the result of poor performance or debt-financed acquisitions. We could raise the rating if the company is able to successfully continue its transition toward more programming hours, improve ratings, maintain EBITDA margins, and grow revenues. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 Ratings List New Rating Media Holdco, LP Corporate Credit Rating B+ (prelim)/Stable/-- Senior Secured $255M term loan B BB- (prelim) Recovery Rating 2 (prelim) ION Media Networks Inc. Senior Secured $50M revolver BB (prelim) Recovery Rating 1 (prelim)
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