RPT-Fitch: No Rating Impact on Turnstone MidCo2 from Dental Directory Group Buy and Tap Issue

Tue May 6, 2014 5:42am EDT

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May 6 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings says that UK-based primary care dental services provider Integrated Dental Holdings' (IDH) acquisition of The Dental Directory (DD) has no impact on IDH's credit profile. Fitch rates IDH's parent, Turnstone Midco 2 Ltd, Issuer Default Rating (IDR) 'B+' with a Stable Outlook.

In addition, we believe that IDH's announced bond tap issue of GBP100m to refinance amounts drawn under its revolving credit facility (RCF) will not affect the 'BB-'/'RR3' ratings on IDH Finance plc's outstanding GBP200m (GBP300m pro forma for the tap issue) senior secured floating rate notes. This is because the increased senior debt is matched by a growing revenue-generating asset base resulting from on-going bolt-on M&A and therefore does not change our opinion regarding above-average recovery prospects for senior secured creditors, nor the already low recoveries for IDH's GBP75m second lien notes, which are rated 'B-'/'RR6'.

The acquisition of DD, a leading multi-channel distributor of dental supplies and consumables to the dental sector, will further cement IDH's vertical integration in the dental clinics value chain. Despite a mild erosion expected in EBITDA margin in FY15 (ending March 2015), Fitch assumes some cost savings in procurement over the medium term and some diversification to the business profile of the group. This is mitigated by slightly slower deleveraging than previously assumed.

DD's enterprise value is mainly debt-funded by drawings on the RCF. Once the drawn RCF is refinanced via the planned issue of additional notes, the RCF is expected to be drawn again over the next few years to support continuing bolt-on acquisitions of dental clinics in the UK, in line with the management strategy of increasing scale in a fragmented market. Adjusting for contribution of such acquisitions, Fitch forecasts slight deterioration in funds from operations (FFO) adjusted net leverage to over 6.0x for FY15. However, over the longer-term positive free cash flow (FCF) along with the increasing scale of the business and profitability should support deleveraging, sending FFO adjusted net leverage lower to 5.0x-5.5x range by March 2018.

We continue to assume that IDH's acquisition strategy will be aimed at taking advantage of the fragmented dentistry market in the UK. The acquisition of small practices with 'evergreen contracts' with the NHS is a sensible strategy as it complements the group's operations and thus does not bear major integration costs. However, failure to integrate the latest and future acquisitions, leading to either the revenue contribution of new practices being below historical levels, or an erosion of group profitability due to cost overruns could put pressure on the already stretched credit metrics.

Fitch will continue to focus on IDH's ability to generate positive free cash flow (FCF) to help support the on-going acquisition activity, as financial headroom under the current ratings remains limited for large debt-funded acquisitions over the next two years. Reduced FCF margin below 4% of sales due to significant profitability erosion, combined with aggressive future acquisitions translating into sustained higher-than-expected leverage, could be detrimental to the ratings.

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