TEXT - S&P cuts Affinion Group Holdings to 'B-'
Overview -- U.S.-based integrated marketer Affinion Group Holdings Inc.'s already high debt leverage likely will rise further. Operating performance is under pressure stemming from financial institution reregulation. -- We are lowering our corporate credit rating to 'B-' from 'B' and removing all ratings from CreditWatch, where they were placed with negative implications on Aug. 20, 2012. -- The stable outlook reflects our expectation that liquidity will be adequate over the near term. Rating Action On Dec. 7, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on U.S.-based integrated marketer Affinion Group Holdings Inc. to 'B-' from 'B' and removed all ratings from CreditWatch, where they were placed with negative implications on Aug. 20, 2012. At the same time, we lowered all issue-level ratings on the company's debt by one notch, in conjunction with the downgrade. The recovery ratings on these debt issues remain unchanged. Rationale The downgrade reflects the company's weak near-term operating outlook, increasing debt leverage, and only near-term covenant relief provided by the recent amendment to the credit facility. Also, operating company Affinion Group Inc. is not in compliance with its restricted payments test of 5x. This covenant permits it to pay dividends to the parent, Affinion Group Holdings Inc., so that the holding company can pay cash semiannual interest payments of $18.9 million in May and November on its 11.625% senior notes due 2015. We believe that Affinion Group Holdings has the resources to make its next three semiannual interest payments, with its current cash resources of slightly more than $19 million and the $40 million operating company restricted payment provision. The rating reflects our assessment of the company's business risk profile as "weak," because of continued membership attrition in many of its services, some affinity partner concentration (especially in the financial services industry), and competitive pressures in the membership marketing business. Relatively high leverage, a record of acquisitions and special dividends, and minimal discretionary cash flow underpin our view of Affinion's financial risk profile as "highly leveraged." We assess management and governance as "fair," as we believe there are significant risks relating to its private equity ownership. Affinion is a direct marketer of membership, insurance, and credit card ancillary services, primarily sold under the names of affinity partner institutions, such as financial institutions and retailers. We consider its industry mature and heavily dependent on ongoing spending to acquire new members. The company has some customer concentration as the top 10 domestic financial institutions contributed 28% of the company's membership business. Revenue from its existing customer base has historically generated a significant percentage of sales, but organic revenue has been recently declining, reflecting weak conditions in the financial services industry. Direct mail, which we view as facing declining fundamentals, remains a significant marketing channel for the company to acquire new members. We expect the company to continue to expand its online marketing efforts, though response rates could decline because many players are pursuing a similar strategy. Under our base-case scenario for the fourth quarter of 2012, we expect that revenues will decline at a mid- to high-single-digit percent rate as regulatory pressures likely will result in lower new campaign launches by large financial institution marketing partners. We expect that EBITDA will fall roughly 20% due to continued need to spend on marketing. In 2013, we expect revenue to decrease at a mid-single-digit percentage rate and EBITDA to decline at a mid- to high-single-digit percentage rate. We expect the EBITDA margin will fall to about 20% in 2013. Revenues declined 6.1% in the third quarter of 2012, while EBITDA increased 5.2% due to lower marketing expenses. The EBITDA margin rose to 21% in the 12 months ended Sept. 20, 2012, from 19% over the prior 12 months due to reduced restructuring charges and legal expenses. Our base case suggests lease-adjusted gross leverage will increase to high-7x area for 2013, based on our outlook for weak performance as a result of declining membership. Leverage is well in excess of the more than 5x adjusted debt-to-EBITDA indicative threshold that we associate with a "highly leveraged" financial risk profile. Lease-adjusted EBITDA coverage of interest expense was thin at 1.6x for the 12 months ended Sept. 30, 2012. Our base-case scenario indicates that interest coverage will decline to 1.4x in 2013 due to weaker operating performance and higher interest expense. The lease-adjusted debt-to-EBITDA ratio was high at 6.9x for the 12 months ended Sept. 30, 2012, as $259 million in special dividends in 2011 offset the contribution from underperforming Webloyalty acquisition. Discretionary cash flow was negligible for the 12 months ended Sept. 30, 2012, because of weak profitability and increasing working capital related to recent acquisitions and higher capital spending. We expect discretionary cash flow to be slightly negative in 2012 due to weaker operating performance and higher interest expense. Liquidity We believe Affinion has "adequate" liquidity to cover its needs over the next 12 months, although we believe it will have a narrowing margin of compliance with financial covenants by 2014. We will likely revise our assessment of the liquidity profile to "less than adequate" in the near term, unless we become convinced that the company will be able to maintain an adequate margin of compliance. Our view of the company's liquidity profile incorporates the following expectations and assumptions: -- We expect that the company's sources will be sufficient to cover uses for the next 12-18 months by 1.2x or more. -- We expect that net sources would be positive, even with a 15%-20% drop in EBITDA over the next 12 months. -- Compliance with the net senior debt leverage covenant would survive a 15% drop in EBITDA over the coming 12-18 months. -- We believe the company currently has good relationships with its banks and has a satisfactory standing in the credit markets. As of Sept. 30, 2012, liquid resources included $40 million in unrestricted operating company cash an undrawn $165 million revolving credit facility due 2015. Credit facility financial covenants apply to the Affinion Group Inc. operating company and exclude public debt at the Affinion Group Holdings parent. The amendment replaces its operating company, Affinion Group Inc., net leverage covenant with a net secured leverage test. The new net-secured-leverage test is set initially at 4.25x, which steps down to 4.0x at March 31, 2014, 3.75x at Sept. 30, 2014, and 3.0x at March 31, 2015. We estimated that the company will initially have a margin of compliance of slightly over 25% at year-end 2012, though the margin of compliance will decline to the mid-to-high teen range in 2013 due to weaker operating performance. We believe the margin of compliance will decline to under 10% in the second half of 2014 due to stepdowns. Term loan debt maturities are minimal, as the loan amortizes at a 1% rate, or $11 million per year, until the $1.1 billion maturity in 2016, which we expect will be refinanced. Intermediate-term debt maturities consist of $680 million of notes due 2015 and the unused $165 million revolving credit facility due 2015. Recovery analysis For the complete recovery analysis, see the recovery report on Affinion, to be published on RatingsDirect following the release of this article. Outlook The stable rating outlook reflects our expectation that the company will be able to maintain an adequate margin of compliance with financial covenants over the near term. We could lower our rating to 'CCC+' if operating performance continues to deteriorate, and we conclude that negative discretionary cash flow will exceed $20 million in 2013, and the margin of compliance with covenants will narrow to under 10%. More specifically, we could lower the rating if we become convinced that EBITDA will decline 15% for the full year 2013. Factors that could contribute to such a scenario include accelerating membership declines and an inability to increase average revenue per member caused by financial institution spending cutbacks and a resurgence of economic pressures on consumer spending. Although a remote likelihood, we could raise the rating to 'B' if Affinion improves operating performance and we become convinced that the company will generate moderately positive discretionary cash flow and establish a sufficient margin of compliance with financial covenants to withstand step-downs at March 31, 2013 and Sept. 30, 2014. Related Criteria And Research -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- 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 Downgraded; CreditWatch Removal To From Affinion Group Holdings Inc. Corporate Credit Rating B-/Stable/-- B/Watch Neg/-- Senior Unsecured CCC CCC+/Watch Neg Recovery Rating 6 6 Affinion Group Inc. Senior Secured B B+/Watch Neg Recovery Rating 2 2 Senior Unsecured CCC CCC+/Watch Neg Recovery Rating 6 6 Subordinated CCC CCC+/Watch Neg Recovery Rating 6 6