The outlook revision reflects our view that operating performance will remain stable in 2012-2013 ahead of the launch of four new satellites that are likely to support long-term growth. We think free operating cash flow (FOCF) will gradually improve after being negative in 2012. Moreover, in our opinion, adjusted gross debt to EBITDA will remain below 3.5x and adjusted funds from operations (FFO) to gross debt above 20% in the next two years. The ratings on Inmarsat reflect our assessment of the group's "significant" financial risk profile and its "satisfactory" business risk profile.
We expect revenues to be flat in 2012-2013, excluding revenues stemming from the LightSquared agreement, which has been suspended until March 2014, and to gradually increase in 2014-2015 into a mid-single-digit annual percentage rate--assuming the new satellites are launched according to plan. This is supported by continued positive developments in the marine segment in the first half of 2012, offsetting the decline in the land segment, and further growth opportunities after the launch of future Ka-band services. We also expect the adjusted EBITDA margin, excluding LightSquared, to remain stable compared with 2011, at about 56%.
We expect FOCF to be about negative $80 million in 2012 and slightly negative in 2013 because of the large satellite-related investments in a relatively short period. Capital spending should be about $1.2 billion for the Inmarsat-5 program (three Ka-band satellites to be launched between the third quarter of 2013 and the fourth quarter of 2014) and $370 million for the Alphasat program (one L-band satellite to be launched in the second half of 2013), most of which was or will be spent in 2011-2013. We see FOCF returning to positive in 2014, when the new satellites should start generating cash flows and capital spending should fall significantly.
We still perceive Inmarsat's financial policy as "aggressive" after an annual dividend increase of 10% in 2011 and in 2012 and the announcement of a $250 million share buy-back program, which took place when the group was spending large amounts of capital.
However, we now think it likely that shareholder remuneration in 2013 and 2014 will increase only modestly, assuming a smaller annual dividend increase than in previous years and a postponement of the remaining $142 million to be spent under the current share buy-back program. This assumption is based on our understanding that the share buy-back program was linked to the LightSquared agreement, now suspended, and management's public guidance of net leverage peaking at about 3x in 2013.
Under our base-case assessment, we anticipate that adjusted gross debt to EBITDA will rise to 3.3x in 2013 from 3.0x in 2012, and adjusted FFO to gross debt will weaken to 23% in 2013 from 28% in 2012. As we expect credit metrics to improve in 2014, we no longer think they could deteriorate beyond our indicative targets of 3.5x and 20%, respectively, which we deem adequate for the ratings.
We assess Inmarsat's liquidity as "adequate" under our criteria. This reflects our view that the group's sources of liquidity will cover its uses by more than 1.2x for the 12 months to Dec. 31, 2012. As of June 30, 2012, we estimate that Inmarsat's liquidity sources over the subsequent 12 months will be about $1.5 billion. These include:
-- Cash and liquid investments of $377 million;
-- Our forecast of FFO of about $500 million; and
-- About $700 million available under a committed $750 million senior credit facility due June 2016 and the $700 million Export-Import Bank of the United States facility due 2023, which may be drawn down until May 2014 to fund the group's Ka-band satellite investments. The credit facilities are subject to financial covenants, under which we anticipate that Inmarsat will maintain adequate headroom.
We estimate Inmarsat's liquidity needs over the same period to be about $900 million, including:
-- Forecast capital expenditures of up to $650 million;
-- Dividends of $188 million in 2012 and potentially more in 2013; $10 million spent each year in share repurchases in 2012 and 2013; and
-- Small annual debt amortization requirements of $38 million.
We understand that no holder of the convertible bond issued by the top holding Inmarsat PLC has opted for early redemption in October 2012. We have consequently removed the associated financial liabilities from our 12-month liquidity needs assumptions because the next put option is in October 2014.
The issue rating on Inmarsat Investments Ltd.'s $750 million revolving credit facility (RCF) is 'BBB' The recovery rating on this senior secured facility is '1', indicating our expectation of very high (90%-100%) recovery prospects in the event of a payment default.
The $850 million senior unsecured notes issued by Inmarsat PLC's indirect subsidiary Inmarsat Finance are rated 'BB+', in line with the corporate credit rating on Inmarsat. The recovery rating on this debt is '4', indicating our expectation of average (30%-50%) recovery for creditors in the event of a payment default.
In order to determine recoveries, we simulate a hypothetical default scenario. Under this scenario, we assume a decline in demand for the group's existing services and a limited take-up of new services, thereby increasing price pressure and eroding revenues. These conditions could be compounded by potential satellite failures. Our analysis assumes that Inmarsat would most likely default from an inability to refinance its senior secured credit facility in 2016. We could envisage a later default, for example, when the senior notes mature. However, we would anticipate that the capital structure would be broadly the same at a later point of default as we would expect the company to have future financing needs to fund additional replacement satellites for the Inmarsat 4s.
We value Inmarsat on a going-concern basis, given the nature of the assets and high barriers to entry in the satellite communications industry. However, we believe that recovery values are likely to be intrinsically linked to the value of the satellites. We have therefore used a discrete-asset valuation to estimate the value available to creditors.
We value Inmarsat's assets at about $1.9 billion at our hypothetical point of default in 2016, allowing for a haircut to asset values. Our valuation takes into account the group's current asset base, its $370 million investment in the new AlphaSat satellite to be launched in 2013, and the $1.2 billion investment program for the construction and launch of the three Ka-band satellites in 2013-2014. While we do not assign a specific value to the spectrum licensed to Inmarsat, we believe that it could be sold in the event of a default, particularly in the U.S., and would support current recovery prospects for debtholders. That said, in our opinion, recovery prospects for the unsecured noteholders remain very sensitive to increases in the amount of pari passu or priority debt, which could result in us lowering our issue and recovery ratings on the senior unsecured notes.
From our valuation of $1.9 billion, we deduct priority liabilities of about $120 million, primarily comprising enforcement costs and 50% of pension liabilities. We then deduct about $1.43 billion of senior secured debt outstanding at default, which includes six months of prepetition interest, and assumes a fully drawn RCF at default. However, we do not assume that the $150 million uncommitted accordion facility is utilized. This leaves about $350 million for the senior unsecured noteholders from our estimate of about $880 million outstanding at default (including six months' prepetition interest).
The stable outlook reflects our view that Inmarsat's FOCF will improve gradually after bottoming out in 2012, and that adjusted gross debt to EBITDA will remain below 3.5x and adjusted FFO to gross debt over 20%.
We could downgrade Inmarsat if we were to foresee the group's generating significantly negative FOCF over a prolonged period, which, if combined with shareholder returns above the level we have assumed, would result in credit measures below our expectations for the current ratings.
We view the possibility of an upgrade as remote, given expectations for negative discretionary cash flow over the next two years.
RELATED CRITERIA AND RESEARCH
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
CreditWatch/Outlook Action; Ratings Affirmed
Inmarsat Holdings Ltd.
Inmarsat Investments Ltd.
Inmarsat Ventures Ltd.
Corporate credit rating BB+/Stable/-- BB+/Negative/--
Inmarsat Finance PLC
Senior Unsecured(1) BB+ BB+
Recovery Rating 4 4
Inmarsat Investments Ltd.
Senior Unsecured(2) BBB BBB
Recovery Rating 1 1
(1)Guaranteed by Inmarsat Investments Ltd.
(2)Guaranteed by Inmarsat S.A., Inmarsat Global Ltd., and Inmarsat Ventures Ltd.)