-- Las Vegas-based gaming operator Boyd Gaming Corp. closed on its acquisition of Peninsula Gaming LLC last month.
-- We are lowering our corporate credit rating on Peninsula to ‘B’ (the same level as Boyd) and subsequently withdrawing it, as Peninsula is now an indirect wholly owned subsidiary of Boyd.
-- We are also affirming our ‘B’ corporate credit rating on Boyd and assigning final issue-level ratings to Peninsula’s credit facilities.
-- The stable rating outlook reflects our expectation that credit measures will remain at a level that is in line with the rating over the intermediate term and that Boyd will be able to successfully negotiate an amendment to covenants, which we believe is necessary given the aggressive pace of step-downs and our performance expectations.
On Dec. 13, 2012, Standard & Poor’s Ratings Services lowered its corporate credit rating on Peninsula Gaming LLC to ‘B’ from ‘B+’ and removed it from CreditWatch, where it was placed with negative implications on May 17, 2012, following the announcement that Boyd had entered into an agreement to acquire Peninsula. We subsequently withdrew our corporate credit rating on Peninsula Gaming LLC, because it now is an indirect, wholly owned subsidiary of Boyd Gaming Corp.
At the same time, we assigned issue-level and recovery ratings to Peninsula’s new $875 million credit facilities, consisting of a $50 million priority revolving credit facility and an $825 million term loan, both due Nov. 17, 2017. We assigned the revolver our issue-level rating of ‘BB-’ (two notches higher than our ‘B’ corporate credit rating on Boyd Gaming Corp.) and our recovery rating of ‘1’, indicating our expectation of very high (90% to 100%) recovery for lenders in the event of a payment default. We assigned the term loan our issue-level rating of ‘B+’ (one notch higher than the corporate credit rating) and a recovery rating of ‘2’, indicating our expectation of substantial (70% to 90%) recovery for lenders in the event of a default. Our rating assignment follows the concurrent closing of the company’s new credit facility with the acquisition and our review of final documentation.
We also affirmed our ‘B’ corporate credit rating on Boyd Gaming Corp. The rating outlook is stable. Rationale The corporate credit rating on Boyd reflects our assessment of the company’s financial risk profile as “highly leveraged” and its business risk profile as “fair,” according to our rating criteria.
Our corporate credit rating also reflects a consolidated view of the combined Boyd and Peninsula portfolio of properties, despite the fact that different assets secure different pieces of the capital structure. We believe Peninsula is integral to Boyd’s current identity and future strategy, as it operates in the same line of business, and represents a source of cash flow diversification away from Las Vegas, a key focus of the company. Boyd wholly owns and manages Peninsula and the Peninsula properties represented 34% of consolidated property level EBITDA for the 12 months ended Sept. 30, 2012, which, in our view is significant.
Given our perception of the strategic relationships that will exist between these entities and common management following the acquisition, we expect management to make decisions regarding operating and financial strategies with a view toward the collective group of companies. We believe that if a payment default were to occur at either Boyd or Peninsula, management would most likely consider alternatives regarding the capital structure of the consolidated group, which could include a comprehensive restructuring or a bankruptcy filing.
However, in notching our issue-level ratings from the corporate credit rating, we recognize the distinct financing structures and associated collateral. Our assessment of Boyd’s financial risk profile as highly leveraged reflects the company’s high debt leverage, minimal covenant cushion, and an expectation-based on step-downs and performance expectations-that the company will need covenant relief to address near-term step-downs.
Somewhat offsetting these negative financial risk factors is our expectation that Boyd has satisfactory relationships with its lenders and will be successful in amending covenant levels, it will generate positive free operating cash flow that it can use to repay debt, and that wholly owned EBITDA interest coverage will remain near or above 2x. Our assessment of Boyd’s business risk profile as fair reflects a geographically diverse portfolio (notwithstanding some second-tier assets in competitive markets), an experienced management team, and improved EBITDA margins following the acquisition of Peninsula as Peninsula had high EBITDA margins compared with other commercial gaming operators.
We believe the Peninsula acquisition strengthens Boyd’s business risk profile as Peninsula’s assets are of relatively good quality and face limited competition. Additionally, the Peninsula acquisition improves Boyd’s overall geographic diversity and reduces Boyd’s reliance on the Las Vegas locals market, which has been more challenged than other markets in recent years given competition and the volatility in that market during the recent economic recession. Pro forma for the acquisition, in the 12 months ended Sept. 30, 2012, Las Vegas locals property EBITDA represented 24% of combined property level EBITDA (down from 37% prior to the acquisition).
Boyd is one of the largest gaming companies in the sector and, following its acquisition of Peninsula Gaming in November 2012, owns 21 casino properties across seven states, as well as a 50% share of the Borgata in Atlantic City. In 2013, we expect consolidated EBITDA will increase in the mid-single-digit percentage area. Our performance expectations are largely driven by our assumptions about the Midwest & South segment, which now represents approximately 70% of property level EBITDA.
We expect the overall Midwest & South segment (excluding Kansas Star) will grow modestly in 2013, and we expect Peninsula’s Kansas Star property will generate between $90 million and $100 million of EBITDA in 2013. Despite the opening of the permanent facility, we expect revenue growth will begin to abate somewhat following the property’s initial strong ramp-up. Additionally, we expect EBITDA margin at the property to be pressured somewhat in 2013 given additional costs related to incremental amenities that are opening.
Our performance expectations incorporate flat to low-single-digit growth in the Las Vegas locals and downtown Las Vegas segments. We expect these markets to remain highly competitive, but believe that a modest growth trajectory on the Las Vegas Strip, incorporating our expectations for positive trends in visitor volume, convention attendance, and room rates, will spur modest improvement in the Las Vegas locals market over the next few years.
However, we expect improvement in the locals market to somewhat lag improvement on the Las Vegas Strip. We do not anticipate a return to meaningful growth or to previously generated levels of revenue and EBITDA in the locals market over at least the next few years. Our performance expectations also reflect our economists’ expectations for modest growth in GDP and consumer spending in 2013.
Under our performance assumptions, we expect consolidated leverage to remain above 7x over the intermediate term, a level we believe is aligned with a ‘B’ corporate credit rating. Through the first nine months of 2012, Boyd has underperformed our full-year expectations for 15% growth in EBITDA, largely on weakness in its Las Vegas segment, as EBITDA increased 7%. Peninsula has outperformed our expectations, with revenue increasing 60% and EBITDA nearly doubling.
We had initially expected Peninsula to experience revenue and EBITDA growth of approximately 50% and 75%, respectively, in 2012.
Under our performance expectations, the company’s sources of liquidity (including cash and revolver availability) exceed uses over the next 12 months by 1.2x, but we assess Boyd’s liquidity profile as less than adequate according to our criteria. Relevant factors in our assessment of Boyd’s liquidity profile include the following:
-- We do not believe that covenant headroom under Boyd’s tightest covenant is sufficient to withstand an EBITDA decline of 10% without a breach.
-- We believe that Boyd has generally satisfactory relationships with lenders and will be successful in securing an amendment to covenant levels.
-- We believe that net sources would remain positive if EBITDA declines 15% over the next 12 months, even excluding access to its revolver. At the end of the third quarter, Boyd’s covenant cushion under its three financial maintenance covenants remained extremely tight.
Given the aggressive pace of step-downs in the senior secured and total leverage covenants, which tighten again in the fourth quarter of 2012 and throughout 2013, we believe Boyd will need to secure an amendment to covenant levels. We do not expect Boyd will likely be able to meet the step-down in the total leverage covenant in the fourth quarter.
The company indicated on its earnings call that it has had conversations with lenders regarding an amendment. We believe Boyd can secure an amendment to alleviate covenant pressure and expect that to occur over the near term. Peninsula’s credit agreement also includes financial maintenance covenants, including an interest coverage ratio set at 2.0x and a total leverage covenant that starts at 7.25x and tightens by 0.25x every couple quarters. Given our performance expectations, we believe that Peninsula will maintain adequate cushion under its covenants.
Boyd’s liquidity sources include availability under its $960 million revolving credit facility and Peninsula’s $50 million revolving credit facility, a moderate cash balance, and internally generated cash. We expect the company to continue to generate positive levels of free operating cash flow, as we believe that cash from operations will exceed capital expenditures at both Boyd and Peninsula.
In 2013, we expect capital spending to remain primarily limited to maintenance-levels of capital spending following the completion of the permanent facility in Kansas. We have factored in capital expenditures of about $120 million across the consolidated portfolio. We expect the company to focus its free operating cash flow primarily for debt repayment. Debt maturities are manageable in 2013, and are limited to about $50 million in term loan amortization payments under Boyd’s and Peninsula’s credit facility. Maturities step up in 2014 and 2015, as Boyd’s 6.75% senior subordinated notes mature in 2014, and its credit facilities in 2015. Recovery analysis Boyd’s senior secured debt is rated ‘BB-’ (two notches higher than the ‘B’ corporate credit rating on the company) with a recovery rating of ‘1’, indicating our expectation of very high (90% to 100%) recovery for lenders in the event of a payment default. The company’s senior notes are rated ‘B’ (at the same level as the corporate credit rating) with a recovery rating of ‘4’, indicating our expectation of average (30% to 50%) recovery for noteholders in the event of a payment default.
Boyd’s senior subordinated notes are rated ‘CCC+’ (two notches lower than the corporate credit rating) with a recovery rating of ‘6’, indicating our expectation of negligible recovery for noteholders in the event of payment default. Peninsula’s priority revolving credit facility is rated ‘BB-’ (two notches higher than our ‘B’ corporate credit rating on Boyd Gaming Corp.) with a recovery rating of ‘1’, indicating our expectation of very high (90% to 100%) recovery for lenders in the event of a payment default. Its term loan is rated ‘B+’ (one notch higher than the corporate credit rating) with a recovery rating of ‘2’, indicating our expectation of substantial (70% to 90%) recovery for lenders in the event of a default. Peninsula’s senior notes are rated ‘CCC+’ (two notches lower than the corporate credit rating) with a recovery rating of ‘6’, indicating our expectation of negligible recovery for noteholders in the event of payment default. (For the complete recovery analysis, please see Standard & Poor’s recovery reports on Boyd Gaming Corp., published July 5, 2012, and Peninsula Gaming LLC, published July 31, 2012, on RatingsDirect.)
The stable rating outlook reflects our expectation that credit measures will remain at a level that is in line with the rating over the intermediate term, including consolidated leverage above 7x, and that Boyd will be able to successfully negotiate an amendment to covenants, which we believe is necessary given the aggressive pace of step-downs and recent performance.
We have factored in an expectation for a mid-single-digit percentage increase in EBITDA in 2013. Rating upside potential is limited over the intermediate term, as we would likely not consider a higher rating until the company addresses the likelihood of a covenant violation and we are confident that debt to EBITDA will improve to closer to 6.0x within the next 12 to 18 months and be sustained there over the longer term. We will consider a lower rating if Boyd does not demonstrate progress towards an amendment to its covenants over the near term.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Parent/Subsidiary Links; General Principles, Oct. 28, 2004