September 11, 2017 / 12:38 PM / 15 days ago

Fitch Rates Intralot's planned EUR450m Bond 'BB-(EXP)'

(The following statement was released by the rating agency) LONDON/PARIS, September 11 (Fitch) Fitch Ratings has assigned Intralot Capital Luxembourg S.A's planned EUR450 million bond an expected senior unsecured rating of 'BB-(EXP)' with a Recovery Rating of 'RR3'. The bond is rated one notch above Intralot's Long-Term Issuer Default Rating of 'B+'/Stable. Proceeds from the notes, which mature in September 2024, will be used for early redemption of the company's EUR250 million 6% notes due in 2021 as well as other outstanding credit facilities. The planned notes are guaranteed by Intralot SA and some material subsidiaries, and will rank pari passu with all existing and future unsecured indebtedness of the issuer that is not subordinated to the notes, including senior credit facilities that are not secured. The final rating of the notes is contingent upon receipt of final documents conforming to the information already received by Fitch and confirmation of the final amount and tenor of the notes. The planned bond issue will marginally enhance Intralot's financial flexibility by extending the average debt maturity profile and reducing interest costs. Despite improved performance continuing into the first half of 2017, Intralot's high leverage remains not fully aligned with a 'B+' rating but we expect Intralot will deleverage from 2018. The rating profile remains well anchored around a business profile that is commensurate with a 'BB' rating category for the sector. Any evidence of deteriorating operating environment, contracts not being renewed or renewed on worse terms, or unexpected cash leakages, could however be negative for the rating. KEY RATING DRIVERS Recurring Contracted Revenue Base: Intralot's credit profile benefits from more than 85% of revenues recurring and contracted up until 2021, with only three contracts up for renewal in 2018. The group has recently secured long-term contract renewals in the U.S. market, resulting in the securing of EUR35 million of EBITDA until 2025 in that market. This number should increase to about EUR50 million per annum if the new Illinois contract is secured. Due to high switching costs, we expect many of the contracts will be renewed in the future, although we continue to believe these could be on lower margins and may require a higher renewal fee. Margin Impacted by Business Mix: The strong growth of Licenced Operations (+21.9% in H117) is having a negative impact on group EBITDA margins, which were 12.6% in the first half of 2017 compared to 14% last year. Licenced Operations represented 78% of total group sales in H117 versus 73% in H116. This is a significantly less profitable division than Technology and Management Contract Businesses, which has not performed as anticipated this year mainly due to weaker performance in Turkey and some one-off effects in the US. The top-line growth is leading to a higher actual level of EBITDA. While margins are lower than our previous expectations, absolute EBITDA is in line with our forecasts. We expect that operating performance in the management contract and technology contract businesses will normalise from the second half of 2017, and forecast an overall EBITDA margin of 12.4% for the year, improving slightly thereafter. EBIT margins remain above the minimum threshold of 7% supporting the 'B+' rating. Weak Free Cash Flows: We expect free cash flow (FCF) to be negative in 2017 and 2018, mainly due to one-off investments related to the new Illinois contract and some contract renewal fees and to then turn positive. FCF can be volatile as a result of upfront investments related to new contracts of contract renewals. However, this does contribute to steady operating cash-flow generation due to its recurring profit stream and is a key credit support. After 2018 the group does not have any major contract renewals until 2021 and therefore capex should remain at lower levels. Capex Driving Higher Leverage: Fitch expects funds from operations (FFO) adjusted gross leverage to increase to 6.5x in 2018 (FFO adjusted net leverage will reach about at 5.0x) due to higher capex than was previously expected. This level of leverage is not commensurate with a 'B+' rating which indicates low financial headroom. However, we anticipate continued deleveraging from 2018 through improvements in the group's underlying operating performance following this expenditure. In addition, our base-case projections do not factor in any proceeds from the expected sale of the group's stake in Gamenet during the IPO process, or the disposal of other assets. These options provide additional flexibility for Intralot and if executed successfully could result in significant net debt reduction, bringing net leverage back within out sensitivity guidance for the current rating level. Reputable Gaming Operator, Technology Supplier: Intralot has established itself in the international gaming sector as a reputable provider of, among other products, systems to manage lotteries through software platforms and hardware terminals, and in betting, a large algorithm-based sportsbook. This has enabled it to win important contracts for the supply of technology and the management of lotteries in the US and Greece and for sports betting in Turkey and Germany. Scope for Growth: The gradual liberalisation of gaming markets, governments' keenness on finding ways to raise tax proceeds and the increasing supply of new games, should all provide increasing opportunities for Intralot. The company should be able to leverage on its experience and reputation and also benefit from the limited number of reputable suppliers in the industry, allowing the group to expand into new geographies. Intralot is also well positioned to benefit from opportunities in the US. Limited Linkage with Greece: Intralot generates less than 10% of its EBITDA in Greece (rated 'B-'). We view Greece's low sovereign rating as neutral for Intralot's ratings given its contractual requirement to maintain large portions of its cash outside Greek banks. Currently, less than 10% of cash is held in Greece, and following the new transaction, the group will have less reliance on funding from Greek banks due to a higher capital markets allocation. Intralot's wide geographic diversification of its business and lack of meaningful reliance on Greek banks for funding mitigates its exposure to Greece and other countries with a 'b' economic environment. DERIVATION SUMMARY Intralot is positioned well in the 'B' rating category compared to its peers. The main differentiating factor being its visibility of revenue from recurring contracted EBITDA. Intralot has smaller revenue and EBITDA than Ladbrokes Coral (BB/Stable), William Hill, IGT, and Scientific Games. However, it does have good geographic diversification and benefits from the more profitable emerging markets. It also has an established position in the US, and is well placed for potential future growth opportunities. Compared to peers at the 'B' rating level, Intralot has certain differentiating characteristics, such as the above-mentioned contracted EBITDA and specialist supplier technology expertise. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - revenue growth of about 12% in 2017 as a result of strong growth in licenced betting operations, falling back to mid-single digits thereafter driven by a combination of new contracts and some organic growth; - EBITDA margin falling to 12.4% in 2017 and remaining between 12.7%-12.8% thereafter; - rental expenses lower as a result of leases associated with expiring contracts; - minority profits fully paid out fully as dividends, EUR39 million in 2017, EUR44 million in 2018; - capex higher in 2017 and 2018 due to contract renewals and investments in new contracts which we assume will be partially funded by debt drawdowns; - capex falling back to about EUR45m per annum from 2019; - no common dividends. RECOVERY ASSUMPTIONS: In our bespoke going-concern recovery analysis we look at Intralot's 2016 EBITDA of EUR106 million (after deducting attributable EBITDA to minority interests) and this is further discounted to arrive at an estimated post-restructuring EBITDA available to creditors of around EUR84.8 million. We apply a conservative distressed EV/EBITDA multiple of 4.5x to Intralot's wholly owned operations. We also estimate EUR100 million of additional value stemming from minority interests, mainly from emerging markets, resulting from attributable FY16 EBITDA from minorities of EUR68 million discounted by 50% and applying a conservative EV/EBITDA valuation of 3.0x. In terms of distribution of value, all unsecured debt including the planned new bond would recover 58% in the event of default (assuming that the EUR125 million unsecured RCF will be fully drawn). This is consistent with an 'RR3' and an instrument rating of 'BB-', one notch above the IDR. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Revenue growth and steady profitability supported by a stronger return on capital on existing and future contracts with limited capex outlays - FFO adjusted net leverage reducing sustainably below 3.0x (or FFO gross lease adjusted leverage below 4.0x), with cash deposited predominantly at investment grade-rated counterparties - FFO fixed charge cover above 3.0x, unaided by favourable interest carry - Evidence of sustained positive FCF generation in the low to mid-single digits of sales. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Evidence that new contracts or renewals are occurring at materially less favourable conditions for Intralot, resulting in continuing weak EBIT margins of under 7%, large upfront concession fees or capex outlays (2016: 8.2%) - FFO adjusted net leverage sustainably above 4.5x (or FFO adjusted gross leverage above 5.5x) (FY16: 4.3x and 5.6x respectively) - FFO fixed charge cover below 2.0x (2016: 1.8x) -Material reduction in liquidity without a commensurate reduction in gross debt levels LIQUIDITY Comfortable Liquidity Following Refinancing: We expect the group's liquidity profile will improve following the completion of the planned refinancing transaction. EUR500 million of bonds maturing in 2021 will leave only one older EUR250 million bond outstanding due 2021, while the new notes will not be repayable until September 2024. The plan to repay the outstanding credit facilities is also beneficial, effectively pushing the 2019 maturity to 2024. We expect the group will have cash on balance sheet of about EUR175 million at end-2017 and this will be complemented by approximately EUR125 million in committed unsecured credit facilities. Contact: Principal Analyst Patrick Durcan Analyst +44 20 3530 1298 Supervisory Analyst Sophie Coutaux Senior Director +33 1 44 29 91 32 Fitch France S.A. 60 Rue de Monceau 75008 Paris Committee Chairperson Pablo Mazzini Senior Director +44 20 3530 1021 Date of Relevant Rating Committee: 16 May, 2017 Summary of Financial Statement Adjustments - Regular minority dividends adjustments: We deduct the estimated amount of recurring dividends paid to/dividends received from minorities of EUR41 million (2016) from our calculation of FFO. Leases: Although operating leases are modest, Fitch has adjusted the debt by adding 8x of annual operating lease expense related to long term assets of EUR64 million (2016). Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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