-- We have revised our assessment of Codere's liquidity profile to "weak"
from "less than adequate," mainly due to the looming refinancing risk of its
EUR120 million senior credit facilities maturing in June 2013. We understand
that negotiations are underway, but in our view, there are still some
execution risks until a definite agreement is reached.
-- We also believe Codere faces an increasing risk of tightening covenant
headroom, barring a material improvement of its operating performance in the
first quarter of 2013.
-- We are therefore lowering our corporate credit rating on Codere to
'CCC' from 'B-'.
-- The negative outlook primarily reflects our concerns regarding
Codere's ability to timely refinance its senior credit facilities.
On Dec. 19, 2012, Standard & Poor's Ratings Services lowered to 'CCC' from
'B-' its long-term corporate credit rating on gaming company Codere S.A.
At the same time, we lowered the issue rating on Codere's senior unsecured
notes issued by subsidiary Codere Finance (Luxembourg) S.A. to 'CCC' from
'B-'. The recovery rating on the senior unsecured notes remains unchanged at
'4', indicating our expectations of average (30%-50%) recovery for noteholders
in the event of payment default.
The downgrade reflects our reassessment of Codere's liquidity profile as
"weak" compared with "less than adequate" previously, particularly due to the
looming refinancing risk of its EUR120 million senior credit facilities (SCFs)
maturing in June 2013. These comprise a EUR60 million revolving credit facility
(RCF), and EUR40 million of letters of credit and EUR40 million of surety bonds
(from both of which Codere cannot draw more than EUR60 million at a time).
Although we recognize that some progress has been made in the negotiations, we
believe there are still some execution risks in reaching a definitive
agreement. The downgrade further reflects our belief that Codere also faces an
increasing risk of tightening covenant headroom to below 10%, if operating
performance does not materially recover in the first quarter of 2013 and
absent any low-probability, high-impact events that might significantly
depress Codere's EBITDA.
We also incorporate Codere's substantial exposure to the Argentine market (61%
of the company's consolidated EBITDA in the first nine months of 2012) into
our assessment and rating action, which we believe is likely to be affected by
the increasing risks embedded in Argentina's current macroeconomic framework.
Such concerns include high inflation (which continues to appreciate the real
exchange rate), exchange rate controls, and other actions that have also
contributed to the emergence of a parallel foreign exchange market. Therefore,
we continue to foresee a gradual devaluation of the Argentine currency over
the next few quarters. Additionally, we anticipate that the recent
implementation of the smoking ban in the gaming halls of Buenos Aires on Oct.
1, 2012, will continue to add further strain on Codere's cash flows from
Argentina in the months to come.
In our base-case scenario for 2013, we forecast flat EBITDA growth and
anticipate that the potential aforementioned negative impact in Argentina will
partly be offset by projected solid performance in Codere's other Latin
American businesses, particularly on the back of the full-year contribution of
ICELA, in addition to the expected synergies of Codere's combined operations
in Mexico, the Carrasco casino in Uruguay, which is set to open in early 2013,
and the recent casino openings in Colombia.
We see significant downside risk to our current base-case scenario should a
drastic currency devaluation in Argentina take place, or if further
unpredicted macroeconomic pressures cause Codere's revenues and margin to
contract significantly below our expectations, causing liquidity to severely
tighten and a potential breach of covenants.
Codere's rating is mainly constrained by its financial risk profile, which we
view as "highly leveraged," particularly given the consolidation of its
principal shareholder payment-in-kind (PIK) loan. We also take into account
its dependence on continued access to cash flows located in Latin America,
which remain vulnerable to foreign exchange movements.
Our assessment of Codere's weak business risk profile reflects its substantial
exposure to Latin America, particularly to Argentina and Mexico, which we
regard as generally subject to greater regulatory, foreign exchange, and labor
relations risks than its European operations. We also remain mindful of the
currently more severe cyclical pressures in Spain and Italy, though we note
that these markets represent less than 15% of the group's consolidated EBITDA.
These weaknesses are somewhat mitigated by our view of the company's
cash-generative characteristics, its leading market positions, and limited
maintenance capital expenditure (capex) requirements.
We now view Codere's liquidity as "weak" under our criteria. Although under
our base-case scenario we estimate that Codere's liquidity sources are still
likely to meet its uses by about 1.2x in 2012 and close to 1.0x in 2013, we
acknowledge that these ratios could quickly weaken if Codere is unable to
refinance its SCFs--maturing in June 2013--and if the economic, financial, and
political environment in Argentina deteriorated quicker than expected. We view
the refinancing as particularly important to make sure Codere has enough cash
sources to cope with the expected outflows for the year.
In addition, we are projecting tight headroom under its financial covenants of
below 10% in the next couple of quarters. We note that the continued
availability of the SCF is subject to maintenance covenants, which could be
tested in the event that economic and political conditions in Argentina were
to worsen more than currently anticipated.
The group's liquidity sources benefit from:
-- EUR135.7 million of cash and short-term investments on Dec. 31, 2011 (On
Sept. 30, 2012, EUR116.8 million were available). However, we note that
non-European subsidiaries hold about 70% of the company's cash (including
about 20% in Argentina), so some cash might not be immediately available to
the parent company; and
-- Positive funds from operations (FFO) of about EUR165 million for 2012
and comparable levels in 2013.
At the same time, the group's liquidity uses include:
-- EUR46 million of debt maturities for 2012 and, according to our
estimates, similar figures for 2013;
-- EUR180 million of capex for 2012, excluding the recent acquisition of
the additional stake in ICELA. We anticipate capex to be significantly reduced
in 2013 to about EUR75 million;
-- EUR107 million payment for the renewal of five licenses in Argentina;
-- Given that the SCF matures in less than 12 months, if Codere is not
able to refinance, they might need to fund the outstanding amounts under both
the RCF and the letters of credit and surety bonds lines, which we estimate
would be about EUR90 million at the time of maturity.
We are also wary of Codere's short-term liabilities relating to deferred
gaming tax payables to three main Spanish regional governments (Madrid,
Catalonia, and Valencia) amounting to about EUR45 million and EUR50 million in
2012 and 2013. The regional governments might claim these sums, given their
budgetary deficits and liquidity concerns. However, we currently do not
include this possibility in our base-case scenario.
Given Codere's growing business in Argentina and Mexico, and the weak economic
environment in Spain and Italy, we think that liquidity depends greatly on
continued access to cash flows from Latin America as well as to its SCF. We
understand that management doesn't intend to further upstream significant
amounts of cash from Argentina in the remainder of 2012 and not until at least
the second-quarter of 2013. It has announced its intention to use local cash
sources to fund the recent license renewal fees. Nonetheless, we acknowledge
the potential impact of foreign exchange movement, particularly in Argentina,
which is only partly hedged in 2012 and currently unhedged for 2013.
The issue rating on the EUR760 million senior notes and $300 million senior
notes issued by Codere Finance (Luxembourg) S.A. is 'CCC', in line with the
long-term corporate credit rating on Codere. The recovery rating on these
notes is '4', indicating our expectation of average (30%-50%) recovery for
noteholders in the event of a payment default. The notes are guaranteed on a
senior basis by Codere and on a senior subordinated basis by subsidiary
Our recovery and issue ratings are supported by our valuation of Codere as a
going concern, underpinned by its leading market positions and strong barriers
to entry in the highly regulated gaming sector. On the other hand, the issue
and recovery ratings are limited by our view of the security package and
noteholder protection as weak. This is because the company could raise up to
EUR200 million of senior bank debt according to the euro notes' documentation
(compared with $400 million permitted in the dollar notes' documentation),
including the EUR120 million credit facility that would rank ahead of the notes.
The ratings also reflect the uncertainties related to Codere's operations in
Latin American jurisdictions, and the company's exposure to the Spanish
insolvency regime, which we view as unfavorable for creditors (see "Update:
Jurisdiction-Specific Adjustments To Recovery And Issue Ratings," published
June 20, 2008).
Under our simulated default scenario, we forecast a hypothetical default in
2013, mainly triggered by the company's inability to refinance its EUR120
million credit facilities due in June 2013, combined with a significant
devaluation of the Argentine peso. Our default scenario also assumes that the
difficult political and economic conditions in Argentina would accelerate
margin contraction in Codere's Argentine business.
We assume an EBITDA decline to about EUR167 million and a stressed enterprise
value of about EUR750 million at our hypothetical point of default in 2013. Our
valuation on Codere is based on an enterprise value to EBITDA multiple of
4.5x, which reflects our anticipation of a lower valuation of the group's
Argentine operations at the point of default.
From the stressed enterprise value, we deduct priority liabilities of about
EUR107 million, comprising enforcement costs and finance leases. We also deduct
about EUR260 million of debt ranking ahead of the euro and U.S. dollar senior
notes, including the debt of Codere's various subsidiaries and the EUR120
million SCF that we assume would be fully drawn by the point of default.
The residual value is sufficient for average recovery in the 30%-50% range for
senior noteholders, comprising about EUR1,030 million in the year of default.
However, we see some volatility in the recovery prospects, given that Codere
could incur additional debt ranking ahead of the notes, according to the
documentation. We also consider that a more severe depreciation of the
currencies in Argentina or Mexico could lead to materially lower recovery
prospects for the senior noteholders, given that this debt is denominated in
euros and U.S. dollars.
The negative outlook primarily reflects our concerns regarding Codere's
ability to timely refinance its SCF.
We could lower the rating on Codere if it is unable to refinance its SCF in a
timely manner, or if a further significant macroeconomic and political
deterioration in Argentina materializes over the next few months causing
additional pressure on revenues, margins, and liquidity.
Any positive rating action would be conditional on a revision of our current
assessment of Codere's liquidity. This would initially entail a successful
refinancing of its SCF as well as the maintenance of adequate covenant
headroom on a sustainable basis, in light of the currently weak macroeconomic
environment in Argentina.
Related Criteria And Research
-- Criteria For Assigning 'CCC+', 'CCC', And 'CC' Ratings, Oct. 1, 2012
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18,
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Corporate Credit Rating CCC/Negative/-- B-/Negative/--
Codere Finance (Luxembourg) S.A.
Senior Unsecured CCC B-
*Guaranteed by Codere S.A.
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