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May 16 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned France-based Lion/Seneca France 2 S.A.S. (Afflelou) a final Long-term foreign currency Issuer Default Rating (IDR) of ‘B’ with a Stable Outlook. Fitch has also assigned 3AB Optique Developpement S.A.S.’s EUR365m senior secured notes due 2019 and super senior revolving credit facility (RCF) final ratings of ‘BB-'/‘RR2’ and Lion/Seneca France 2 S.A.S.’s EUR75m senior notes due 2019 final ratings of ‘CCC+'/‘RR6’.
The final ratings follow a review of the final documentation which materially conforms to information received when assigning the expected ratings (see ‘Fitch Assigns Afflelou ‘B(EXP)’ IDR, Proposed Senior Secured Notes ‘BB-(EXP)’ dated 14 April 2014 at www.fitchratings.com).
The ratings reflect Afflelou’s high leverage and a competitive European optical market, which are balanced with its robust market position and positive market fundamentals in France.
Third-largest French Player
Afflelou benefits from a strong market share of 11% in France in a fairly fragmented market. Its robust market position is supported by strong brand recognition due to large advertising spend, and by regular launches of new products and concepts. The on-going price war in the French market led management to extend the brand strategy and to create the low-cost Claro concept.
Pressure on Profitability to Ease
The group EBITDA margins fell to 21.7% in 2013 from 38.4% in 2010 driven by a change in mix between franchised and directly operated stores that was exacerbated by the on-going price war. In Fitch’s view, despite the benefits of having the Claro banner, there could be a cannibalisation effect and a risk of margin dilution. These risks are captured in the ratings. However, Fitch expects EBITDA margins to stabilise within the next two years based on cost efficiencies.
Positive Underlying Market Drivers
The French optical retail market represented 76% of Afflelou’s 1H14 revenues and is the largest in Europe at approximately EUR5.5bn in 2013. It benefits from positive underlying drivers such as an ageing population, rising exposure to digital displays, technological progress, high reimbursement levels for glasses and increasing health awareness leading to greater resilience to economic downturns. The Spanish market benefits from the same demographic drivers, but is less favourable as it has contracted in the past five years due to a different product segmentation skewed towards sunglasses.
Limited Impact from Reimbursement Pressure
Although the French optical retail market benefits from an attractive reimbursement policy, it could suffer from some regulatory changes from as soon as 2015 to introduce price floors and ceilings. In Fitch’s view, this should not materially affect the company as public reimbursement represents only 5% of the total purchase, and the ceiling currently negotiated for private insurance is approximately the same as the company’s average customer spending.
Late Mover to Internet
Afflelou was less reactive than its competitors in its e-commerce strategy and only launched a website in March 2014, with a limited product offering. In the optical industry in France, the e-commerce distribution channel is not extensively developed at the moment. However, Fitch believes that recent legislation in the country should drive the growth of this new distribution channel and allow pure players with a low cost base to differentiate themselves in a market with high growth potential.
Neutral Effect from Refinancing
Afflelou’s debt refinancing has brought forward slightly its average maturities, with total debt being broadly the same. The high bank fees incurred will be partly offset by the fact that the debt structure will be 100% cash pay compared with the former bank loan structure comprising a growing payment in kind (PIK) coupon for the mezzanine loan facility.
Manageable Credit Metrics
Following the closing of the refinancing, Fitch-calculated gross funds from operations (FFO) adjusted leverage reached close to 7x. However, the company’s franchisor business model implies low working capital and capital expenditures requirements allowing healthy cash flow generation that may be used for acquisitions if opportunities arise. Along with the bullet debt maturity profile after the refinancing, Fitch expects gross FFO adjusted leverage to slowly improve to 6.4x in FY17.
Superior Recoveries for Senior Secured
We consider that the distressed valuation of the company would be maximised in a going concern scenario as the business is fairly asset-light (franchisor business model). In addition, we believe that should Afflelou default, this would not be the result of a broken business model but rather due to an adverse regulatory change (reimbursement policy) or unmanageable financial leverage. We have used a discount of 20% to the most recent LTM EBITDA of EUR77m reflecting neutral free cash flow (FCF) at this level of discounted EBITDA in FY14, and 5.5x distressed enterprise value/EBITDA multiple in line with ‘B’ category peers in the sector. Our analysis results in superior recovery prospects for both the super senior RCF and senior secured notes at ‘RR2’ (capped due to the French jurisdiction) and very limited recovery prospects for the senior notes at ‘RR6’.
Positive: Future developments that could lead to positive rating actions include:
- Stable to improving EBITDA margin above 22%
- FFO gross adjusted leverage below 5x
- FFO fixed charge cover of 2.5x or higher
Negative: Future developments that could lead to negative rating action include:
- FFO gross adjusted leverage above 7x or no evidence of deleveraging from closing, for example because of operating underperformance or on-going acquisition activity
- Any sign that internet is becoming a serious threat, reflecting in negative like-for-like sales growth on a sustained basis
- Unsuccessful integration of new material acquisition/s
- EBITDA margin consistently below 21%
- FFO fixed charge cover of 1.8x or below
- FCF margin below 8%
All these ratios are based on Fitch-calculated metrics.