TEXT - S&P raises IAC/InterActiveCorp rating to 'BB+'
Overview -- New York City-based Internet company IAC/InterActiveCorp plans to issue $500 million in senior unsecured notes due 2022. Proceeds will be used for general corporate purposes. -- We are raising our corporate credit rating on IAC to 'BB+' from 'BB' based on our expectation that operating performance will remain solid, and that the company will continue to maintain its relatively conservative financial policy. -- We are assigning a 'BB+' issue level rating to the proposed senior unsecured notes with a '3' recovery rating, indicating our expectation of meaningful (50% to 70%) recovery of principal for debtholders in the event of a payment default. -- The stable outlook is predicated on our assumption of market share gains in key segments, supporting EBITDA growth and good discretionary flow. Rating Action On Dec. 17, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on New York-based Internet company IAC/Interactive Corp. (IAC) to 'BB+' from 'BB'. The rating outlook is stable. At the same time, we assigned our 'BB+' issue level rating (at the same level as the corporate credit rating) to the proposed $500 million senior unsecured notes due 2022 with a recovery rating of '3', indicating our expectation of meaningful (50% to 70%) recovery of principal in the event of a payment default. Rationale The upgrade is based on IAC's solid operating performance and our expectation that financial policy will remain moderate. Although the proposed debt issuance will raise pro forma debt leverage on a trailing 12 month basis to 1.5x from 0.5x, we do not expect debt leverage to exceed 2x, our leverage target for the 'BB+' corporate credit rating. Our corporate credit rating on IAC reflects our expectation that healthy operating performance will continue. It also captures our view that IAC will continue to maintain low debt, generate solid free cash flow, and maintain "strong" liquidity, despite ongoing shareholder returns through share repurchases and dividends. We view the company's business risk profile as "fair,". Despite competition from dominant and better capitalized competitors in the U.S. search market, IAC has been able to modestly grow its market share over the past few years and benefit from overall search advertising growth. Match.com's core operation has been solid, too, despite intense competitive pressure. Risks that IAC faces include market share losses to innovations by competitors that alter consumer Internet usage, and threats from competitive alternatives such as mobile. Additional risks relate to the company's investments in e-commerce startups---some greenfield and some acquired in an early-growth period---that have no assurance of long-term viability. We view the company's financial risk profile as "intermediate," because of its low debt and good conversion of EBITDA into discretionary cash flow. We assess management and governance as "fair" under our criteria, reflecting our view that management's successful operational track record partially mitigates risks of the outsized influence of the chairman, Barry Diller, who has a 43% of voting stake in the company. The company's search and application businesses (Search) accounted for more than one-half of total company revenue, consisting of its toolbar businesses (Applications) and destination Web sites. IAC distributes customized toolbars directly to customers through social and entertainment applications (Mindspark) or through partnerships with third-party software and media companies which, in aggregate, generate half of total Search revenue. The applications segment saw a year-over-year revenue increase of 38% in the third quarter, benefiting from existing and new business partnerships and digital products. Although we have not yet seen evidence of an impact, we believe the toolbar model is less suitable for mobile usage, which we view as a longer-term risk. The remainder of Search revenue is generated by websites (such as Ask.com, Pronto.com and Dictionary.com). During the quarter, the Website segment's revenue increased 49% as a surge in query volume more than offset a decline in cost-per-click (CPC), a measure of pricing. The CPC declined was attributed primarily to a mix shift toward international markets and mobile, where CPCs are lower. According to comScore's Nov. 2012 rankings, Ask.com's (IAC's main search Website) share of the U.S. search market increased to 3.0%, up from 2.9% in November 2011. But the company remains a niche player compared to Google Inc.'s 67.0% share, Microsoft Corp. at 16.2% and Yahoo! Inc. at 12.1%. The company's second-largest business segment, Match, accounted for more than one-fourth of total revenue, provides subscription-based and ad-supported online personal services. Match has had good double-digit percent organic subscriber growth for many quarters, which we expect will moderate slightly. For our 2013 base case scenario, we are expecting organic revenue and EBITDA to grow at a mid-teens percentage rate. Search will continue to be the main growth driver but we expect the year-over-year comparison will become more difficult. Factors that could preclude such growth include the potential for increased investments in lower-margin businesses like Local, because of costs associated with entering new international markets. Increased investments in loss-making businesses in the Media and Other segments and higher promotional spending at Search and Match could also affect profitability. Longer term, we view growth in the EBITDA margin as dependent on improving profitability in the Local business segment and maintaining efficient marketing spending at Search. In the third quarter of 2012, revenue and EBITDA (excluding noncash impairments and stock compensation expense) outperformed our expectations, growing at a very healthy rate of 38% and 40%, respectively, over the prior-year period. Performance was led by a 43% revenue increase in the Search business, resulting from solid growth in query volumes at Websites and Applications segment. Within the Match segment, organic revenue increased 5% as Core revenue and subscribers both increased by 8%, above our expectations. For the 12 months ended Sept. 30, 2012, the EBITDA margin improved to 14.3% from 12.3% in the prior-year period benefiting from strong performance at Search and Match. Pro forma for the proposed debt issuance, lease-adjusted leverage increased to 1.5x from 0.5x as of Sept. 30, 2012. We assess IAC's financial risk profile as "intermediate" as the pro forma leverage is still well below the indicative ratios of 2.0x to 3.0x in our criteria. Pro forma lease adjusted EBITDA coverage of interest was 11.1x. For the 12 months ended Sept. 30, 2012, IAC generated $375 million of discretionary cash flow and converted 81% of EBITDA into discretionary cash flow. This represents a decline from 112% in the prior-year period due to higher capital spending and dividend distributions. The board doubled the dividend, effective with the third quarter of 2012, amounting to 19% of EBITDA of the 12 months ended Sept. 30, 2012. We believe the most probable uses of cash over the intermediate term will continue to be share repurchases, acquisitions, and dividends. The rating incorporates the assumption that the company will pursue a prudent shareholder return strategy without a meaningful increase in debt leverage over the near to intermediate term. Liquidity In our view, IAC's liquidity profile is "strong". Our assessment incorporates the following expectations and assumptions: -- We expect sources of liquidity to exceed uses by well over 1.5x over the next 18 to 24 months. -- We believe cash sources would remain positive, even if EBITDA declines by 30%. -- In our view, IAC can absorb low-probability, high-impact events because of its high cash balances and healthy cash flow generation. -- We believe the company has a strong standing in credit markets. Liquidity sources include cash and short term investment balances of more than $1 billion (pro forma for the debt issuance) as of Sept. 30, 2012, the expected completion of a new $300 million revolving credit facility due 2017 (not rated by us), and expected discretionary cash flow of more than $320 million in 2013. Cash is mainly used for share repurchases, dividends, and acquisitions, as the company has very low working capital and capital expenditure requirements. Near-term debt maturities are minimal. Under IAC's new revolving credit facility, the company would be subject to a maximum debt leverage ratio covenant of 3x, which does not tighten over the life of the credit agreement. We expect that IAC will maintain a significant cushion of compliance with this covenant. Recovery analysis For the complete recovery analysis, please see our recovery report on IAC/InterActiveCorp., to be published on RatingsDirect. Outlook The stable rating outlook is based on our view that operating performance will remain healthy and that IAC will keep its debt leverage below 2x while maintain adequate liquidity. We do not consider either an upgrade or a downgrade as likely over the intermediate term. We could raise the rating if IAC is able to increase its critical mass in Ask.com and Match, profitably diversify into new segments, and decrease its revenue dependence on Google. On the other hand, we could lower the rating if Ask.com loses market share and if risks associated with developing businesses significant escalate. Additionally, we could lower the rate if debt leverage exceeds 2x without the prospect of a reversal. Such scenario would likely entail a decline in IAC's overall competitiveness. 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 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List IAC/InterActiveCorp. Upgraded; Outlook Action To From Corporate Credit Rating BB+/Stable/-- BB/Positive/-- Senior Unsecured BB+ BB Recovery rating 3 3 Senior Secured BBB BBB- Recovery rating 1 1 New Rating Senior Unsecured $500 mil sr nts due 2022 BB+ Recovery Rating 3
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