December 7, 2012 / 6:45 PM / 5 years ago

TEXT - S&P cuts Affinion Group Holdings to 'B-'

11 Min Read

Overview
     -- U.S.-based integrated marketer Affinion Group Holdings Inc.'s already 
high debt leverage likely will rise further. Operating performance is under 
pressure stemming from financial institution reregulation.
     -- We are lowering our corporate credit rating to 'B-' from 'B' and 
removing all ratings from CreditWatch, where they were placed with negative 
implications on Aug. 20, 2012.
     -- The stable outlook reflects our expectation that liquidity will be 
adequate over the near term.
 
Rating Action
On Dec. 7, 2012, Standard & Poor's Ratings Services lowered its corporate 
credit rating on U.S.-based integrated marketer Affinion Group Holdings Inc. 
to 'B-' from 'B' and removed all ratings from CreditWatch, where they were 
placed with negative implications on Aug. 20, 2012.

At the same time, we lowered all issue-level ratings on the company's debt by 
one notch, in conjunction with the downgrade. The recovery ratings on these 
debt issues remain unchanged.

Rationale
The downgrade reflects the company's weak near-term operating outlook, 
increasing debt leverage, and only near-term covenant relief provided by the 
recent amendment to the credit facility. Also, operating company Affinion 
Group Inc. is not in compliance with its restricted payments test of 5x. This 
covenant permits it to pay dividends to the parent, Affinion Group Holdings 
Inc., so that the holding company can pay cash semiannual interest payments of 
$18.9 million in May and November on its 11.625% senior notes due 2015. We 
believe that Affinion Group Holdings has the resources to make its next three 
semiannual interest payments, with its current cash resources of slightly more 
than $19 million and the $40 million operating company restricted payment 
provision.

The rating reflects our assessment of the company's business risk profile as 
"weak," because of continued membership attrition in many of its services, 
some affinity partner concentration (especially in the financial services 
industry), and competitive pressures in the membership marketing business. 
Relatively high leverage, a record of acquisitions and special dividends, and 
minimal discretionary cash flow underpin our view of Affinion's financial risk 
profile as "highly leveraged." We assess management and governance as "fair," 
as we believe there are significant risks relating to its private equity 
ownership. 

Affinion is a direct marketer of membership, insurance, and credit card 
ancillary services, primarily sold under the names of affinity partner 
institutions, such as financial institutions and retailers. We consider its 
industry mature and heavily dependent on ongoing spending to acquire new 
members. The company has some customer concentration as the top 10 domestic 
financial institutions contributed 28% of the company's membership business. 
Revenue from its existing customer base has historically generated a 
significant percentage of sales, but organic revenue has been recently 
declining, reflecting weak conditions in the financial services industry. 
Direct mail, which we view as facing declining fundamentals, remains a 
significant marketing channel for the company to acquire new members. We 
expect the company to continue to expand its online marketing efforts, though 
response rates could decline because many players are pursuing a similar 
strategy.

Under our base-case scenario for the fourth quarter of 2012, we expect that 
revenues will decline at a mid- to high-single-digit percent rate as 
regulatory pressures likely will result in lower new campaign launches by 
large financial institution marketing partners. We expect that EBITDA will 
fall roughly 20% due to continued need to spend on marketing. In 2013, we 
expect revenue to decrease at a mid-single-digit percentage rate and EBITDA to 
decline at a mid- to high-single-digit percentage rate. We expect the EBITDA 
margin will fall to about 20% in 2013. Revenues declined 6.1% in the third 
quarter of 2012, while EBITDA increased 5.2% due to lower marketing expenses. 
The EBITDA margin rose to 21% in the 12 months ended Sept. 20, 2012, from 19% 
over the prior 12 months due to reduced restructuring charges and legal 
expenses.

Our base case suggests lease-adjusted gross leverage will increase to high-7x 
area for 2013, based on our outlook for weak performance as a result of 
declining membership. Leverage is well in excess of the more than 5x adjusted 
debt-to-EBITDA indicative threshold that we associate with a "highly 
leveraged" financial risk profile. Lease-adjusted EBITDA coverage of interest 
expense was thin at 1.6x for the 12 months ended Sept. 30, 2012. Our base-case 
scenario indicates that interest coverage will decline to 1.4x in 2013 due to 
weaker operating performance and higher interest expense. The lease-adjusted 
debt-to-EBITDA ratio was high at 6.9x for the 12 months ended Sept. 30, 2012, 
as $259 million in special dividends in 2011 offset the contribution from 
underperforming Webloyalty acquisition.

Discretionary cash flow was negligible for the 12 months ended Sept. 30, 2012, 
because of weak profitability and increasing working capital related to recent 
acquisitions and higher capital spending. We expect discretionary cash flow to 
be slightly negative in 2012 due to weaker operating performance and higher 
interest expense.

Liquidity
We believe Affinion has "adequate" liquidity to cover its needs over the next 
12 months, although we believe it will have a narrowing margin of compliance 
with financial covenants by 2014. We will likely revise our assessment of the 
liquidity profile to "less than adequate" in the near term, unless we become 
convinced that the company will be able to maintain an adequate margin of 
compliance.

Our view of the company's liquidity profile incorporates the following 
expectations and assumptions:
     -- We expect that the company's sources will be sufficient to cover uses 
for the next 12-18 months by 1.2x or more. 
     -- We expect that net sources would be positive, even with a 15%-20% drop 
in EBITDA over the next 12 months. 
     -- Compliance with the net senior debt leverage covenant would survive a 
15% drop in EBITDA over the coming 12-18 months.
     -- We believe the company currently has good relationships with its banks 
and has a satisfactory standing in the credit markets.
 
As of Sept. 30, 2012, liquid resources included $40 million in unrestricted 
operating company cash an undrawn $165 million revolving credit facility due 
2015. 

Credit facility financial covenants apply to the Affinion Group Inc. operating 
company and exclude public debt at the Affinion Group Holdings parent. The 
amendment replaces its operating company, Affinion Group Inc., net leverage 
covenant with a net secured leverage test. The new net-secured-leverage test 
is set initially at 4.25x, which steps down to 4.0x at March 31, 2014, 3.75x 
at Sept. 30, 2014, and 3.0x at March 31, 2015. We estimated that the company 
will initially have a margin of compliance of slightly over 25% at year-end 
2012, though the margin of compliance will decline to the mid-to-high teen 
range in 2013 due to weaker operating performance. We believe the margin of 
compliance will decline to under 10% in the second half of 2014 due to 
stepdowns.

Term loan debt maturities are minimal, as the loan amortizes at a 1% rate, or 
$11 million per year, until the $1.1 billion maturity in 2016, which we expect 
will be refinanced. Intermediate-term debt maturities consist of $680 million 
of notes due 2015 and the unused $165 million revolving credit facility due 
2015. 

Recovery analysis
For the complete recovery analysis, see the recovery report on Affinion, to be 
published on RatingsDirect following the release of this article.

Outlook
The stable rating outlook reflects our expectation that the company will be 
able to maintain an adequate margin of compliance with financial covenants 
over the near term. 

We could lower our rating to 'CCC+' if operating performance continues to 
deteriorate, and we conclude that negative discretionary cash flow will exceed 
$20 million in 2013, and the margin of compliance with covenants will narrow 
to under 10%. More specifically, we could lower the rating if we become 
convinced that EBITDA will decline 15% for the full year 2013. Factors that 
could contribute to such a scenario include accelerating membership declines 
and an inability to increase average revenue per member caused by financial 
institution spending cutbacks and a resurgence of economic pressures on 
consumer spending.

Although a remote likelihood, we could raise the rating to 'B' if Affinion 
improves operating performance and we become convinced that the company will 
generate moderately positive discretionary cash flow and establish a 
sufficient margin of compliance with financial covenants to withstand 
step-downs at March 31, 2013 and Sept. 30, 2014.

Related Criteria And Research
     -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 
1, 2012
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
     -- Use Of CreditWatch And Outlooks, Sept. 14, 2009
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
 
Ratings List
Downgraded; CreditWatch Removal
                                        To                 From
Affinion Group Holdings Inc.
 Corporate Credit Rating                B-/Stable/--       B/Watch Neg/--
 Senior Unsecured                       CCC                CCC+/Watch Neg
   Recovery Rating                      6                  6

Affinion Group Inc.
 Senior Secured                         B                  B+/Watch Neg
   Recovery Rating                      2                  2
 Senior Unsecured                       CCC                CCC+/Watch Neg
   Recovery Rating                      6                  6
 Subordinated                           CCC                CCC+/Watch Neg
   Recovery Rating                      6                  6

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