(The following statement was released by the rating agency)
July 02 -
Summary analysis -- Verisure Holding AB --------------------------- 02-Jul-2012
CREDIT RATING: B/Stable/-- Country: Sweden
Primary SIC: Security systems
Credit Rating History:
Local currency Foreign currency
06-Feb-2012 B/-- B/--
The rating reflects Verisure Holding AB's (Verisure's) high debt leverage, significant exposure to Spain, operations in the highly competitive residential household alarm monitoring arena, and any potential reputational risks arising from poor service standards. These constraints are partially offset by the group's leading position in the residential alarm monitoring market in its key geographic markets of Spain, Sweden, and Norway (where it generates the bulk of its revenues); its portfolio of good-quality customers; and strong cash generation ability of the business.
In our base case, we anticipate Securitas Direct to continue to maintain a net subscriber growth rate in the high single digits for financial year 2012 (ending Dec. 31). We also anticipate the bulk of new subscribers will from outside Spain, particularly France and the Benelux countries. Subscriber growth, along with increases in average revenue per user (ARPU), could result in overall low-teens revenue growth in 2012.
Due to the risk of a further uptick in the cancellation rate among portfolio customers, the company outlined a strategy to invest in service excellence and a customer retention program, particularly in Spain where macroeconomic fundamentals continue to face challenges. This, along with change in customer and country mix, caused EBITDA margins of the portfolio business to decline during the first quarter. We anticipate a similar margin trend from the portfolio business for rest of 2012. However, we believe the group's overall EBITDA margin will improve to about 34% for financial 2012 because of the change in the accounting policy whereby a higher proportion of customer acquisition costs are being capitalized.
Significant additional interest burden under the new capital structure--installed as part of the recent secondary buy-out of Securitas Direct--will result in lower funds from operation (FFO). This will be partly offset by the effect of the accounting policy change regarding customer acquisition costs, which will see an increase of funds from operations (FFO) of about EUR50 million. In the base case, we anticipate negative FOCF for financial 2012 because FFO will not be sufficient to fully finance capital expenditure (capex). We anticipate that the group will draw down on its revolving credit facility to fund the remaining capex for financial 2012. We also note that additional spending is generally required to acquire new customers during downturns, as potential customers seek to minimize their expenses. We currently do not envisage any debt-financed acquisitions or any shareholder payments in our base case over the next two years.
We assess Securitas Direct's liquidity as "adequate" under our criteria, supported by our view that liquidity sources will exceed group funding needs by more than 1.2x. On Jan. 1, 2012, the group's liquidity comprised: EUR12.2 million in cash balances; EUR262 million available under the EUR279 million committed credit facility (maturing in August 2017); and cash flow from operations, which we estimate at about EUR130 million for financial 2012.
We understand that the group will use liquidity largely for capex, a function of the aggressiveness of management's plan to acquire new customers. Following the successful placement of the notes, there are no debt maturities over the next five years. Although there are no maintenance covenants under the various senior secured notes (series A and B), senior secured loans, and the mezzanine facility, the RCF is subject to a financial covenant. We assess that the group currently has sufficient headroom under this covenant, and that it will remain satisfactory over the next 12 months.
The issue rating on the EUR600 million first-lien senior secured notes series A, due 2018, issued by Verisure, is 'B', in line with the corporate credit rating. The recovery rating on the notes is '3', indicating our expectation of meaningful (50%-70%) recovery in the event of a payment default.
The issue rating on the EUR271.5 million second-lien senior secured notes series B, borrowed by Verisure, is 'CCC+', two notches below the corporate credit rating. The recovery rating on the notes is '6', indicating our expectation of negligible (0%-10%) recovery in the event of a payment default.
As per the priority agreement, the second-lien senior secured notes series B will rank below the first-lien senior secured notes series A and the first-lien senior secured loan series A.
The recovery ratings on the first- and second-lien senior secured debt are supported by a fair valuation. However, they are constrained by likely prior-ranking liabilities, the potential for cross-jurisdictional insolvency issues (in Spain and Sweden), and what we deem to be a relatively weak security package.
The holders of the RCF, the first-lien senior secured notes and loan series A, and the second-lien senior secured notes series B, benefit from essentially the same security package. However, under the terms of the intercreditor agreement, the holders of the RCF will rank first for the proceeds of the collateral, followed by the series A first-lien senior secured debtholders, the series B second-lien senior secured noteholders, and finally, the mezzanine noteholders.
In order to determine recovery prospects, we simulate a default scenario. Under our hypothetical default scenario, we expect the churn rate among the existing portfolio of clients to increase due to the degradation of economic conditions, especially in Spain. To offset these conditions, the group would continue investing materially in acquiring new customers, thereby increasing installation costs. These costs would be compounded by excessive financial leverage and a large interest burden.
As a result, we assume that with a restructured balance sheet Verisure would be able to keep, to a large extent, its long-term subscriber contracts and customer relationships for a sustainable business model. Under our simulated default scenario, we assume that a default would occur in 2014, at which point we anticipate that EBITDA would have declined to about SEK1.2 billion. In our default scenario, we expect the cancellation rate to more than double from the current level, and the level of customer acquisitions to increase to the high teens. We also simulate the cost of acquiring new customers to increase by about 14% from the current level.
We value the business assuming a going-concern sale at the point of default. Our assumption is based on Securitas' leading position in the Spanish security services market for homes and small businesses. Our going-concern valuation yields a stressed enterprise value of about SEK6.8 billion, equivalent to 5.5x EBITDA.
In order to determine recoveries, we deduct SEK3.3 billion from the stressed enterprise value, mainly comprising finance leases, debt at the subsidiary level, enforcement costs, and the super senior RCF (including six months of prepetition interest). This leaves a net stressed enterprise value of SEK3.4 billion for the different debtholders.
Assuming about SEK6.6 billion of first-lien senior secured debt (including the series A notes and loan) outstanding at default, we see sufficient value for recoveries in the 50%-70% range, translating into a recovery rating of '3'. This leaves no residual value for the second-lien senior secured noteholders, which equates to a recovery rating of '6'.
The stable outlook reflects our view that Securitas Direct is likely to continue to post high-single-digit revenue growth as the penetration potential for residential security alarm services in Europe increases. The rating anticipates a steady reduction in debt to EBITDA from its current high of almost 10x (including preferred equity certificates and shareholder loans), to about 9x by the end of 2012.
In light of the group's currently high leverage and material PIK debt in the capital structure, we see rating upside as limited. Over the medium term, an upgrade would depend on the group's ability to deleverage. We anticipate that the extent and pace of deleveraging will depend largely on the aggressiveness of management's growth plans.
We could lower the ratings if we saw a more aggressive customer acquisition strategy than in our base case; a substantial increase in cancellation rates; a longer payback period for new customers; increased capital spending; weakened liquidity; or slower deleveraging than we anticipate.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009