TEXT-S&P revises AutoTrader.com outlook to stable from negative
Overview -- U.S. online automotive advertising company AutoTrader Group Inc. has performed well over the last two quarters and its cushion of compliance with financial covenants has increased. -- We expect that the company will maintain at least a 20% cushion of compliance with its financial covenants, including scheduled step-downs in the next 12 months, and continue to reduce leverage with discretionary cash flow. -- We are revising our 'BB+' rating outlook on the company to stable from negative. -- The stable outlook reflects our view that AutoTrader.com will continue to exhibit strong operating fundamentals, reduced leverage, and an adequate cushion of compliance with financial covenants. Rating Action On Dec. 12, 2012, Standard & Poor's Ratings Services revised the rating outlook on Atlanta, Ga.-based AutoTrader.com Inc. to stable from negative. At the same time, we affirmed all ratings, including our 'BB+' corporate credit rating, on the company. Rationale The outlook revision reflects AutoTrader Inc.'s solid operating performance, which has restored covenant headroom to more than 20%. The company has filed an SEC Form S-1 for an initial public offering (IPO), and intends to use the proceeds to repay debt and fund general corporate purposes. We have not factored any IPO proceeds in our 2013 assumptions. AutoTrader.com's leading market share, strong brand, and high conversion of EBITDA into discretionary cash flow support our view that the company's business risk profile is "fair," (based on our criteria). We assess AutoTrader.com's financial profile as "aggressive" because of its acquisitive growth strategy and recent debt-financed dividend. We view the company's management and governance as "fair." We continue to factor into the rating implied support from Cox Enterprises Inc., which maintains operating control. We would rate AutoTrader.com in the 'BB' category on a stand-alone basis. While we do not view the AutoTrader.com debt as a Cox obligation, given the significant value of Cox's ownership position, we believe it has incentives to provide some degree of credit support to AutoTrader.com. AutoTrader.com is the world's largest automotive classifieds marketplace and consumer information Web site and is a leading provider of marketing and software solutions for automotive dealers in the U.S Its business is subject to intense competition in the online automotive classifieds market from other online sites, and also from traditional print and newspaper classified advertising. AutoTrader.com's concentration of earnings from this market and some cyclicality in the business are also key risks. Although the company has benefited from the shift in advertising toward online platforms and away from print, traditional media still captures the majority of automotive advertising. AutoTrader.com generates almost 65% of its revenues from auto dealers, largely from relatively stable monthly subscriptions. The next largest source of AutoTrader.com's revenue is Kelley Blue Book (accounting for about 13% of revenues), which provides vehicle pricing information and operates KBB.com. The company has a diverse revenue stream, with no client accounting for more than 2% of revenues, and a strong EBITDA margin that we expect will remain steady, if not expand. For 2013, we expect revenue and EBITDA to grow at a high-single-digit to low-double-digit percent rate, reflecting growth across all segments. We estimate high-single-digit percentage growth in the Digital Media segment as a result of 2%-3% growth in dealer penetration and an increase in revenue per dealer from the sale of additional services. We expect Software Solutions' revenue to increase at a double-digit percent rate as the number of subscribers grows. We believe the EBITDA margin will remain in the low-30% area, but that it could potentially expand slightly because of the company's operating leverage. For the quarter ended Sept. 30, 2012, revenue and EBITDA (before stock compensation expense) increased 15% and 25%, respectively, year over year. Revenue from the Digital Media segment grew 13% due to an increase in the average monthly subscription rate paid by dealers and growth in advertising from original equipment manufacturers while revenue from the Software Solutions segment jumped 36% with an increased number of subscriptions and an increase in subscription fees per dealer. For the 12 months ended Sept. 30, 2012, the EBITDA margin increased to 31.5%, up slightly from 29.7% for the same period in 2011, due to benefits of cost containment measures. Lease-adjusted leverage was 3.4x as of Sept. 30, 2012, down from 4x in March 2012, pro forma for the debt-financed divdidend, as a result of debt repayment and EBITDA growth. We believe that debt leverage will decline to 3x or less over the next 12 to 18 months from EBITDA growth and a decline in debt balances. Pro forma for the recent debt-financed dividend, EBITDA coverage of interest expense was around 9x. We expect interest coverage to increase to the 10x area in 2013. Conversion of EBITDA to discretionary cash flow has been high, at around 50% (but negative when including the special dividend in the second quarter of 2012), and we expect the conversion rate to remain in this area. Liquidity AutoTrader.com has "adequate" liquidity to cover its needs in the near-to-intermediate term, even in the event of moderate unforeseen EBITDA declines. Our assessment of the company's liquidity profile incorporates the following expectations and assumptions: -- We expect sources to cover uses for the upcoming 12 to 24 months by at least 1.2x. -- We also expect net sources to be positive, even if EBITDA drops 15%-20% over the next 12 months. -- Headroom under the company's financial covenants could withstand a 15% drop in EBITDA. -- Because of AutoTrader.com's high conversion of EBITDA to discretionary cash flow, we believe it could absorb low-probability, high-impact shocks. -- In our opinion, the company has a generally satisfactory standing in the credit markets. Sources of liquidity include our expectation of roughly $240 million in funds from operations in 2012 and $270 million in 2013. An additional source of liquidity as of Sept. 30, 2012, is its borrowing availability of $185 million under the revolving credit facility due 2015. We believe AutoTrader.com will generate good discretionary cash flow of around $150 million in 2012 and $190 million in 2013, despite an increase in interest expense. As of Sept. 30, 2012, the company had 28% headroom with its debt-to-EBITDA covenant, its tightest covenant. Based on our 2013 EBITDA assumptions and modest debt repayment, we expect the company to maintain an adequate cushion of compliance of over 20% with this covenant over the next 12 to 18 months, including the covenant step-down to 4x in the fourth quarter, and the final step-down to 3.5x on Dec. 31, 2013. We believe debt maturities are manageable, based on our discretionary cash flow expectations over the next few years. Annual amortization of debt is between $45 million and $61 million, until the term loan A matures in 2015. Recovery analysis For the recovery analysis, see Standard & Poor's recovery report on AutoTrader.com, published April 17, 2012, RatingsDirect. Outlook The rating outlook is stable, reflecting our expectation that AutoTrader.com will continue to reduce debt leverage with discretionary cash flow, maintain an adequate margin of compliance above 20% while meeting covenant step-downs, and demonstrate satisfactory liquidity over the intermediate term. We could lower the rating if, notwithstanding the IPO, the margin of covenant compliance narrows to less than 20% (taking into account the fourth quarter 2012 leverage test step-down), as a result of operating performance trends. Specifically, this could occur if the company resumes debt-financed acquisitions or experiences increased competition or economic pressures that cause EBITDA to decline 3% while the company pays down only the mandatory amortization on its debt. Conversely, we do not expect to raise the rating. While, in our opinion, the AutoTrader.com rating benefits from the majority ownership by Cox, the magnitude of that implied credit support is limited and not sufficient, by itself, to raise the AutoTrader.com corporate credit rating into the investment-grade category. Accordingly, a potential upgrade for AutoTrader.com would be predicated on a substantial improvement in its stand-alone credit metrics, something that, in our view, is not likely in the foreseeable future given management's growth and shareholder return objectives. Related Criteria And Research -- 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 -- 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 Ratings Affirmed; Outlook Revision To From AutoTrader.com Inc. Corporate Credit Rating BB+/Stable/-- BB+/Negative/-- Senior Secured BB+ Recovery Rating 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.