All ratings remain on CreditWatch Negative where we originally placed them on June 8, 2012.
The downgrade reflects our view that there are increasing uncertainties regarding the refinancing of CEDC's convertible notes due March 15, 2013. We understand the agreement that CEDC signed in April 2012 with Russian Standard Corporation (Russian Standard) to back the refinancing of its $310 million convertible notes (of which about $270 million was outstanding at the end of June 2012) is under re-negotiation.
The accounting review of the financial statements of CEDC, announced on June 4, 2012, has concluded with restatements which exceeded the threshold set in the refinancing agreement with Russian Standard. In addition, CEDC filed its second-quarter 2012 results with some delay--on Oct. 9, 2012--but then announced on Nov. 10, 2012, that these results could no longer be relied on. CEDC also did not file its third-quarter 2012 results on time on Nov. 9, 2012, and has announced that it currently targets filing on Nov. 19, 2012.
These three events constitute a breach of some of the clauses of the refinancing agreement. Therefore, at this stage, the refinancing agreement does not hold, and, as per management information, negotiations between CEDC and Russian Standard are ongoing.
In our opinion, CEDC's persistent governance issues and material internal control weaknesses are putting significant pressure on its liquidity position. The recent events could lead to a failure in the refinancing of the 2013 convertible notes, since at this stage we understand that Russian Standard has no obligation to support the refinancing. Without the support from Russian Standard, we think that CEDC will likely default on these notes at maturity on March 15, 2013. We believe that CEDC's current poor operating performance and weak standing in capital markets will prevent the group from either repaying or refinancing the notes.
CEDC's performance and metrics have weakened materially over the past three years. EBITDA shrunk to $65 million in 2011 from more than $200 million a few years ago, and the ratio of Standard & Poor's adjusted debt to EBITDA exceeded 18x at the end of 2011, and funds from operations (FFO) turned negative.
We see limited upside in the future, because vodka markets are tough in Poland and Russia. Consumption is declining, while, at the same time, customers switch from local vodkas (which is the segment in which CEDC operates) to international spirits. In Russia, CEDC's biggest market, there have been two excise duty increases so far in 2012, and another 30% hike is scheduled for Jan. 1, 2013. Excise duty increases more negatively affect the local and typically cheaper vodkas. We therefore anticipate a significant negative volume impact on CEDC's Russian activities in the future.
We continue to view CEDC's liquidity as "weak," under our criteria.
Our "weak" assessment reflects the following factors:
-- Persistent deterioration in CEDC's performance and credit ratios in 2010, 2011, and the first two quarters of 2012;
-- The absence of any particular core bank relationships;
-- Our view of CEDC's poor standing in capital markets, given its wide bond spreads and falling share price. The recent accounting review and announcements of the restatements of the second-quarter 2012 financial statements further restrict CEDC's access to capital markets, in our view; and
-- The upcoming March 2013 $310 million debt maturity (convertible bonds), which exceeds CEDC's sources of cash.
Negotiations on the refinancing of the $310 million convertible bonds are ongoing, but we believe that persistent weaknesses in internal control and governance could rend the current negotiations unsuccessful.
The CreditWatch negative reflects our view that persistent weaknesses in internal control and governance could render the current negotiations on the refinancing of the looming convertible notes unsuccessful. This would most likely lead to CEDC's defaulting at maturity of the convertible notes on March 15, 2013.
We will continue to closely monitor CEDC's progress on the refinancing of the convertible notes.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Central European Distribution Corp.
Corporate Credit Rating CCC/Watch Neg/-- CCC+/Watch Neg/--
Senior Unsecured CC/Watch Neg CCC-/Watch Neg
CEDC Finance Corporation International, Inc.
Senior Secured* CCC/Watch Neg CCC+/Watch Neg
*Guaranteed by Central European Distribution Corp.