September 4, 2012 / 9:05 PM / 5 years ago

TEXT-S&P cuts Reader's Digest to 'CCC-'

Overview
     -- U.S. publisher and direct marketer Reader's Digest announced it could 
violate its total leverage credit facility financial covenant.
     -- The company's discretionary cash flow deficit has been greater than we 
had expected, and deficits are not narrowing.
     -- We are lowering our corporate credit rating two notches to 'CCC-' from 
'CCC+' and lowering the issue-level ratings on the company's debt.
     -- We would lower our corporate credit rating further if the company 
can't address its potential financial covenant breach and its debt obligations 
accelerated.

Rating Action
On Sept. 4, 2012, Standard & Poor's Ratings Services lowered its corporate 
credit rating on New York City-based Reader's Digest Assn. Inc. two notches to 
'CCC-' from 'CCC+'. At the same time, we removed the ratings from CreditWatch 
with negative implications, where they were placed on July 31, 2012. The 
outlook is negative.

We also lowered our issue-level rating on its senior secured notes due 2017 to 
'CC' from 'CCC'. The recovery rating on its senior secured loan remains at 
'5', indicating our expectation of 10% to 30% recovery of principal in the 
event of payment default. 

Rationale
The downgrade reflects the deterioration in the company's liquidity profile 
and profitability, as well as its recent announcement of a potential covenant 
breach. We project that the company could violate its total leverage and cash 
interest coverage covenants in the reporting period ending Sept. 30, 2012. It 
is our understanding that the company is in discussions with its lenders to 
obtain covenant relief.

Reader's Digest's direct-mail and publishing businesses are subject to 
significant medium-term structural risks. We view a meaningful decline in 
liquidity or a covenant violation as a key short-term catalyst that would 
contribute to a payment default.

In our opinion, there are significant uncertainties and limited visibility 
surrounding Reader's Digest's revenues and earnings prospects given its 
declining businesses and ongoing restructuring requirements. In our 2012 and 
2013 base-case scenario, we believe that revenues could continue to decline at 
a double-digit rate because of the impact of divestitures, a weak economy, 
anemic consumer demand in Europe and the U.S., and secular pressures on the 
business. We believe that EBITDA could continue to decline at a greater rate 
because of the company's burdensome cost structure and our expectation of high 
restructuring costs.

Sales compared to the same period last year, pro forma for the sale of 
"Everyday with Rachael Ray" magazine, fell 18.7% in the three months ended 
June 30, 2012. Covenant EBITDA decreased to $34.3 million from $57.1 million 
stemming from an inability to reduce costs at the same pace as revenue 
declines. Cash balances are the primary source of liquidity as the company 
does not have a revolving credit facility. Liquid cash balances were only 
about $42 million as of June 30, 2012, after subtracting about $62 million of 
cash held by foreign subsidiaries, while negative discretionary cash flow was 
about $92.9 million for the 12 months ended June 30, 2012. 

On Aug. 23, 2012, the company announced it had reached a settlement with the 
Federal Trade Commission (FTC) to pay up to $23.8 million to settle disputes 
regarding its marketing campaign for Ab Circle Pro. The settlement requires an 
initial payment of $5 million, $5 million within 180 days, and $3.8 million 
within 270 days of the entry of the consent order. In addition, the company 
could make an additional payment of up to $10 million within a year based on 
consumer refund claims.  

In our opinion, a potential covenant violation, continuing cash flow deficits, 
required FTC payments, and our expectations for  weak consumer spending in 
Europe (where the company generates a significant proportion of sales) will 
place significant pressure on Reader' Digest's "weak" liquidity profile and 
has escalated the possibility of a payment default in the near term. 

Outlook
We will lower the rating if the company can't address its potential financial 
covenant breach and therefore its debt obligations are accelerated. Much less 
likely, and depending on the success of the company's international business 
transformation to a partnership and royalty model, we could revise the outlook 
to stable or raise the ratings if the company improves its liquidity. 

Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Use Of CreditWatch And Outlooks, Sept. 14, 2009
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List
Downgraded; CreditWatch/Outlook Action
                                        To                 From
Reader's Digest Assn. Inc.
RDA Holding Co.
 Corporate Credit Rating                CCC-/Negative/--   CCC+/Watch Neg/--

Reader's Digest Assn. Inc.
 Senior Secured                         CC                 CCC/Watch Neg

Downgraded; CreditWatch/Outlook Action
                                        To                 From
Reader's Digest Assn. Inc.
 Senior Secured
  Local Currency                        CC                 CCC /Watch Neg
   Recovery Rating                      5                  5
0 : 0
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