Feb 5 (The following statement was released by the rating agency)
Fitch Ratings has assigned Arqiva Financing plc's GBP164m fixed rate Series 2014-1 notes a 'BBB' rating with Stable Outlook, in line with Arqiva Financing plc's existing notes. A full list of Arqiva's notes' ratings is at the end of this release.
With the issuance proceeds, Arqiva has refinanced GBP162.5m of Finco term loan A, leaving GBP57.5m of the term loan outstanding. An index-linked swap (ILS) overlay has also been put over the existing (super senior) ILS to switch the six-month LIBOR payment back to a fixed rate payment, in line with the fixed rate Series 2014-1 notes.
KEY RATING DRIVERS
The ratings reflect Arqiva's continued solid operating performance to date, with EBITDA over the past five years growing at a compounded annual growth rate (CAGR) of 7.7% with FY13 (financial year ending June 2013) EBITDA reaching GBP416.6m (and growing year-on-year by 3.8%). The EBITDA margin has also continuously improved to 50.8% from 37.9% between FY08 and FY13. The ratings also reflect Arqiva's gain of new long-term secured contracts, notably with smart metering until 2028 (with potential for renewal) and two new HD TV muxes (group of broadcast channels) until at least December 2018 (bringing the current total of digital terrestrial television (DTT) muxes licensed to Arqiva to four out of eight), and lower operating costs than previously assumed in Fitch's base case with a reduced muxes licensing cost, namely administrative incentive pricing (AIP), down to minimal levels of approximately GBP400,000 per annum until 2020 and on average by 50% to around GBP20m per annum thereafter.
Arqiva recently also refinanced GBP180m of Finco term loan A on 17 January 2014 with the issuance of a private institutional term loan (ITL), which ranks pari-passu with the secured Finco/senior borrower loans and the WBS issuer/senior borrower loans. Fitch expects the remaining Finco term loan A (GBP57.5m) to be refinanced prior to June 2014, which corresponds to the loan's trigger date for a 50% cash sweep.
In September 2013, Arqiva signed a 15-year GBP625m contract (with a renewal option for another five years) to provide the smart metering (remote reading of meters) for the northern region (one of three designated UK regions). Arqiva will develop, manage and roll out the network to about 9 million Comms Hubs across homes and small businesses. The contract is owned by a subsidiary of Arqiva, which is ring-fenced from the securitised WBS group. However, the latter is expected to capture over 80% of the revenues with the subsidiary effectively having back-to-back servicing agreements with the WBS group and a guarantee from the Holdco (Arqiva Broadcast Holdings Ltd). The Comms Hubs are financed separately through another vehicle, which is also ring-fenced from the WBS group.
Fitch's analysis included assessing how quickly the transaction's debt levels reduce to compensate mid- to long-term revenue risks. These could arise, for example, from potential funding issues (e.g. with cuts from both public and private customers of DTT or radio broadcasting networks) or/and threats from alternative technology (such as IPTV), for instance, lowering the demand for DTT viewing, with key stress points culminating at the contracts' renewals. Fitch's base case factors in these risks and assumes some stresses in satellite and radio revenues in the medium term with low single digit growth, and below inflation increases in revenues for both the digital platform and wireless towers divisions (with nominal stresses at renewal of key contracts).
Based on Fitch's base case (which considers Arqiva's new business developments and no refinancing of the remaining term loans), the relatively rapid deleveraging profile continues to bring some comfort despite being slightly slower than previously. This is compensated to a large extent by the recent long-term business contracts that have been signed. The longer-dated ITL and proposed Series 2014-1 notes, with expected maturities in December 2023 and June 2030, respectively (vs. February 2016 for Finco term loan A), and full cash sweep thereafter until final maturity dates in February 2038 and December 2037, respectively, still allows senior net debt to EBITDA leverage to reduce from a maximum of 6.0x in FY14 to low levels of around 0.6x between FY27 and FY30 (vs. 0.2x previously). This deleveraging profile is largely driven by the cash sweep amortisation features of both the remaining approximately GBP843.5m Finco term loans and the GBP350m Series 2013-1a notes, and the heavy amortisation schedule of the GBP398.5m Series 1 and 2 notes.
The junior debt leverage is in line with Fitch's last review, and therefore still commensurate with a 'B-' rating, reducing under Fitch's base case (assuming a generic refinancing scenario) from 7.3x in FY14 to below 6.7x in 2020 (at maturity of the HY notes), only marginally mitigating refinancing risk. The junior debt remains therefore highly speculative as it is also deeply subordinated and exposed to dividends pay-out disruptions from the WBS group (which could trigger their default).
Fitch's synthetic base case debt service coverage ratios for the senior bonds are at around 1.5x for the next 15 years and 1.7x for the next 20 years. Given the expected deleveraging and comfort from the short- to medium-term cash flow generation, these levels are deemed adequate. However, lower ratios could be viewed negatively given the higher (long-term) obsolescence risk of Arqiva's underlying technology compared with other WBS transactions with the same rating. The transaction continues to benefit from strong structural features, especially for the senior debt, including a solid security package, a full suite of performance-related cash lock-up triggers, and untypical cash sweep mechanisms (notably for the Finco term loans, the Series 2013-1a and 2014-1 notes, and the ITL, which are features not usually seen in UK WBS transactions with the exception of CPUK Finance Ltd). The transaction's structure also differs from typical WBS transactions in that the debt-issuing vehicles are not orphan SPVs. However, given structural protections in the transaction's legal documentation, the potential conflicts of interest (due to the non-orphan status of the SPVs and their directors also being directors of other group companies) are deemed remote and consistent with the notes' ratings.
An unforeseen change in regulation (by Ofcom) with regard to any changes in its pricing formulas (for DTT or radio broadcasting), licensing costs (e.g. AIP) or even spectrum allocations could hit Arqiva's future cash flow and impact the ratings. In addition, the risk of alternative and emerging technologies (such as IPTV) could threaten Arqiva's revenues either through technology obsolescence risk and/or lower ad-pool available to linear TV content providers. This risk is currently mitigated by potentially the fast deleveraging of the transaction (assuming cash sweep amortisation) and the long-term contracts securing significant revenues.
SUMMARY OF CREDIT
The transactions are the refinancing of senior and junior bank debt of Arqiva Financing No.1 and No. 2 Limited through the issuances of GBP1,313m of WBS notes, GBP180m of institutional term loan (ITL), plus GBP843m of Finco term loans (the underlying WBS issuer/senior borrower loans ranking pari-passu with the underlying secured Finco/senior borrower loans and the ITL), and GBP600m of structurally subordinated HY notes. The remaining Finco term loans are expected to be refinanced under the WBS programme.
Arqiva's operations consist of its ownership of UK's terrestrial TV & radio broadcasting infrastructure, wireless towers and satellite transmission services. Arqiva benefits from typically secured long-term contracts with customers of mainly strong credit profile, and high barriers to entry with monopolistic positions in key communications infrastructure segments notably in UK DTT and radio broadcasting, all under the regulation of UK-based Ofcom, and a dominant position in the wireless towers sector with 25% market share.
Arqiva's ratings are as follows:
Arqiva Financing plc (whole business securitisation (WBS) issuer):
GBP164m 5.340% Series 2014-1 notes (WBS) due 2037: assigned 'BBB', Stable Outlook
GBP350m 4.040% Series 2013-1a notes (WBS) due 2035: 'BBB'; Stable Outlook
GBP400m 4.882% Series 2013-1b notes (WBS) due 2032: 'BBB'; Stable Outlook
Arqiva PP Financing plc (WBS issuer - US Private Placement (USPP)):
USD358m (GBP235.5m equivalent) Series 1 guaranteed secured senior notes (WBS) due 2025: 'BBB'; Stable Outlook
GBP163m Series 2 guaranteed secured senior notes (WBS) due 2025: 'BBB'; Stable
Arqiva Broadcast Finance plc (High Yield (HY) issuer):
GBP600m 9.500% senior notes (HY) due 2020: 'B-'; Stable Outlook