TEXT-S&P cuts Codere corp credit rating to 'CCC'
Overview -- We have revised our assessment of Codere's liquidity profile to "weak" from "less than adequate," mainly due to the looming refinancing risk of its EUR120 million senior credit facilities maturing in June 2013. We understand that negotiations are underway, but in our view, there are still some execution risks until a definite agreement is reached. -- We also believe Codere faces an increasing risk of tightening covenant headroom, barring a material improvement of its operating performance in the first quarter of 2013. -- We are therefore lowering our corporate credit rating on Codere to 'CCC' from 'B-'. -- The negative outlook primarily reflects our concerns regarding Codere's ability to timely refinance its senior credit facilities. Rating Action On Dec. 19, 2012, Standard & Poor's Ratings Services lowered to 'CCC' from 'B-' its long-term corporate credit rating on gaming company Codere S.A. . At the same time, we lowered the issue rating on Codere's senior unsecured notes issued by subsidiary Codere Finance (Luxembourg) S.A. to 'CCC' from 'B-'. The recovery rating on the senior unsecured notes remains unchanged at '4', indicating our expectations of average (30%-50%) recovery for noteholders in the event of payment default. Rationale The downgrade reflects our reassessment of Codere's liquidity profile as "weak" compared with "less than adequate" previously, particularly due to the looming refinancing risk of its EUR120 million senior credit facilities (SCFs) maturing in June 2013. These comprise a EUR60 million revolving credit facility (RCF), and EUR40 million of letters of credit and EUR40 million of surety bonds (from both of which Codere cannot draw more than EUR60 million at a time). Although we recognize that some progress has been made in the negotiations, we believe there are still some execution risks in reaching a definitive agreement. The downgrade further reflects our belief that Codere also faces an increasing risk of tightening covenant headroom to below 10%, if operating performance does not materially recover in the first quarter of 2013 and absent any low-probability, high-impact events that might significantly depress Codere's EBITDA. We also incorporate Codere's substantial exposure to the Argentine market (61% of the company's consolidated EBITDA in the first nine months of 2012) into our assessment and rating action, which we believe is likely to be affected by the increasing risks embedded in Argentina's current macroeconomic framework. Such concerns include high inflation (which continues to appreciate the real exchange rate), exchange rate controls, and other actions that have also contributed to the emergence of a parallel foreign exchange market. Therefore, we continue to foresee a gradual devaluation of the Argentine currency over the next few quarters. Additionally, we anticipate that the recent implementation of the smoking ban in the gaming halls of Buenos Aires on Oct. 1, 2012, will continue to add further strain on Codere's cash flows from Argentina in the months to come. In our base-case scenario for 2013, we forecast flat EBITDA growth and anticipate that the potential aforementioned negative impact in Argentina will partly be offset by projected solid performance in Codere's other Latin American businesses, particularly on the back of the full-year contribution of ICELA, in addition to the expected synergies of Codere's combined operations in Mexico, the Carrasco casino in Uruguay, which is set to open in early 2013, and the recent casino openings in Colombia. We see significant downside risk to our current base-case scenario should a drastic currency devaluation in Argentina take place, or if further unpredicted macroeconomic pressures cause Codere's revenues and margin to contract significantly below our expectations, causing liquidity to severely tighten and a potential breach of covenants. Codere's rating is mainly constrained by its financial risk profile, which we view as "highly leveraged," particularly given the consolidation of its principal shareholder payment-in-kind (PIK) loan. We also take into account its dependence on continued access to cash flows located in Latin America, which remain vulnerable to foreign exchange movements. Our assessment of Codere's weak business risk profile reflects its substantial exposure to Latin America, particularly to Argentina and Mexico, which we regard as generally subject to greater regulatory, foreign exchange, and labor relations risks than its European operations. We also remain mindful of the currently more severe cyclical pressures in Spain and Italy, though we note that these markets represent less than 15% of the group's consolidated EBITDA. These weaknesses are somewhat mitigated by our view of the company's cash-generative characteristics, its leading market positions, and limited maintenance capital expenditure (capex) requirements. Liquidity We now view Codere's liquidity as "weak" under our criteria. Although under our base-case scenario we estimate that Codere's liquidity sources are still likely to meet its uses by about 1.2x in 2012 and close to 1.0x in 2013, we acknowledge that these ratios could quickly weaken if Codere is unable to refinance its SCFs--maturing in June 2013--and if the economic, financial, and political environment in Argentina deteriorated quicker than expected. We view the refinancing as particularly important to make sure Codere has enough cash sources to cope with the expected outflows for the year. In addition, we are projecting tight headroom under its financial covenants of below 10% in the next couple of quarters. We note that the continued availability of the SCF is subject to maintenance covenants, which could be tested in the event that economic and political conditions in Argentina were to worsen more than currently anticipated. The group's liquidity sources benefit from: -- EUR135.7 million of cash and short-term investments on Dec. 31, 2011 (On Sept. 30, 2012, EUR116.8 million were available). However, we note that non-European subsidiaries hold about 70% of the company's cash (including about 20% in Argentina), so some cash might not be immediately available to the parent company; and -- Positive funds from operations (FFO) of about EUR165 million for 2012 and comparable levels in 2013. At the same time, the group's liquidity uses include: -- EUR46 million of debt maturities for 2012 and, according to our estimates, similar figures for 2013; -- EUR180 million of capex for 2012, excluding the recent acquisition of the additional stake in ICELA. We anticipate capex to be significantly reduced in 2013 to about EUR75 million; -- EUR107 million payment for the renewal of five licenses in Argentina; and -- Given that the SCF matures in less than 12 months, if Codere is not able to refinance, they might need to fund the outstanding amounts under both the RCF and the letters of credit and surety bonds lines, which we estimate would be about EUR90 million at the time of maturity. We are also wary of Codere's short-term liabilities relating to deferred gaming tax payables to three main Spanish regional governments (Madrid, Catalonia, and Valencia) amounting to about EUR45 million and EUR50 million in 2012 and 2013. The regional governments might claim these sums, given their budgetary deficits and liquidity concerns. However, we currently do not include this possibility in our base-case scenario. Given Codere's growing business in Argentina and Mexico, and the weak economic environment in Spain and Italy, we think that liquidity depends greatly on continued access to cash flows from Latin America as well as to its SCF. We understand that management doesn't intend to further upstream significant amounts of cash from Argentina in the remainder of 2012 and not until at least the second-quarter of 2013. It has announced its intention to use local cash sources to fund the recent license renewal fees. Nonetheless, we acknowledge the potential impact of foreign exchange movement, particularly in Argentina, which is only partly hedged in 2012 and currently unhedged for 2013. Recovery analysis The issue rating on the EUR760 million senior notes and $300 million senior notes issued by Codere Finance (Luxembourg) S.A. is 'CCC', in line with the long-term corporate credit rating on Codere. The recovery rating on these notes is '4', indicating our expectation of average (30%-50%) recovery for noteholders in the event of a payment default. The notes are guaranteed on a senior basis by Codere and on a senior subordinated basis by subsidiary guarantors. Our recovery and issue ratings are supported by our valuation of Codere as a going concern, underpinned by its leading market positions and strong barriers to entry in the highly regulated gaming sector. On the other hand, the issue and recovery ratings are limited by our view of the security package and noteholder protection as weak. This is because the company could raise up to EUR200 million of senior bank debt according to the euro notes' documentation (compared with $400 million permitted in the dollar notes' documentation), including the EUR120 million credit facility that would rank ahead of the notes. The ratings also reflect the uncertainties related to Codere's operations in Latin American jurisdictions, and the company's exposure to the Spanish insolvency regime, which we view as unfavorable for creditors (see "Update: Jurisdiction-Specific Adjustments To Recovery And Issue Ratings," published June 20, 2008). Under our simulated default scenario, we forecast a hypothetical default in 2013, mainly triggered by the company's inability to refinance its EUR120 million credit facilities due in June 2013, combined with a significant devaluation of the Argentine peso. Our default scenario also assumes that the difficult political and economic conditions in Argentina would accelerate margin contraction in Codere's Argentine business. We assume an EBITDA decline to about EUR167 million and a stressed enterprise value of about EUR750 million at our hypothetical point of default in 2013. Our valuation on Codere is based on an enterprise value to EBITDA multiple of 4.5x, which reflects our anticipation of a lower valuation of the group's Argentine operations at the point of default. From the stressed enterprise value, we deduct priority liabilities of about EUR107 million, comprising enforcement costs and finance leases. We also deduct about EUR260 million of debt ranking ahead of the euro and U.S. dollar senior notes, including the debt of Codere's various subsidiaries and the EUR120 million SCF that we assume would be fully drawn by the point of default. The residual value is sufficient for average recovery in the 30%-50% range for senior noteholders, comprising about EUR1,030 million in the year of default. However, we see some volatility in the recovery prospects, given that Codere could incur additional debt ranking ahead of the notes, according to the documentation. We also consider that a more severe depreciation of the currencies in Argentina or Mexico could lead to materially lower recovery prospects for the senior noteholders, given that this debt is denominated in euros and U.S. dollars. Outlook The negative outlook primarily reflects our concerns regarding Codere's ability to timely refinance its SCF. We could lower the rating on Codere if it is unable to refinance its SCF in a timely manner, or if a further significant macroeconomic and political deterioration in Argentina materializes over the next few months causing additional pressure on revenues, margins, and liquidity. Any positive rating action would be conditional on a revision of our current assessment of Codere's liquidity. This would initially entail a successful refinancing of its SCF as well as the maintenance of adequate covenant headroom on a sustainable basis, in light of the currently weak macroeconomic environment in Argentina. Related Criteria And Research -- Criteria For Assigning 'CCC+', 'CCC', And 'CC' Ratings, Oct. 1, 2012 -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded To From Codere S.A. Corporate Credit Rating CCC/Negative/-- B-/Negative/-- Codere Finance (Luxembourg) S.A. Senior Unsecured CCC B- *Guaranteed by Codere S.A. 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.