S&P base-case operating scenario
We view LGI's business risk profile as well established in the satisfactory range, with what we consider to be superior asset portfolio diversity and growth prospects versus most rated peers. The completion of the acquisition of German cable operator Kabel BW Erste Beteiligungsgesellschaft GmbH in December 2011 further strengthened LGI's large portfolio of cable assets.
Based on our expectations of steady take-up of bundled products (including digital CATV, telephony, and broadband Internet) and the progressive migration of LGI's analog subscriber base toward digital services, we foresee continued positive operating trends for the group in the next two years. On Dec. 31, 2011, only 41% of LGI's customers subscribed to a bundled product. Digital penetration was still low, at less than 50% across LGI's subscriber base, compared with rates at Western European and U.S. peers.
Standard & Poor's projects mid-single-digit organic revenue and EBITDA growth for LGI in 2012, with sustained, strong profitability and group EBITDA margin above 45%. Operating performance should remain solid in Western Europe in 2012, particularly in Germany and Belgium owing to the uptake of triple-play services, largely offsetting the operating challenges of certain activities in Central and Eastern Europe.
S&P base-case cash flow and capital-structure scenario
Despite its sustained EBITDA growth, LGI reported modest free operating cash flow (FOCF) in 2011, in our view, up to $381 million from $223 million in 2010, constrained by heavy network investments. Our FOCF calculation differs from the group's published adjusted free cash flow figure, which excludes certain financial costs and the negative cash flow contribution from its Chilean mobile operations.
Following the increase in LGI's debt after the KBW acquisition, we estimate that Standard & Poor's ratio of adjusted debt to EBITDA for LGI remained at a high 5.9x on Dec. 31, 2011, declining slightly from 6.1x at year-end 2010. Including 12 months of KBW EBITDA in LGI's reported EBITDA, however, we estimate adjusted debt to EBITDA at about 5.3x at the end of 2011.
Sustained revenues and EBITDA growth over the next 18 months could support pronounced improvement in the group's FOCF generation. This, together with $1.1 billion cash proceeds received in May 2012 from the sale of LGI's stake in Austar, could result in a gradual reduction in the adjusted gross debt-to-EBITDA ratio to below 5.25x over the next 12 months. We would view the ratio at this level as adequate to consider a one-notch upgrade of LGI.
We note, however, that additional shareholder returns or acquisitions beyond what we currently anticipate, and continued very high network and other capital investments (at about 20% of sales), could prevent or delay such improvement in credit metrics.
LGI's liquidity is adequate, under our criteria. We expect the group's sources of liquidity, including cash and facility availability, to exceed its uses by 1.6x or more in the next 12 months.
On March 31, 2012, LGI reported unrestricted cash and cash equivalents of $1.7 billion and had about $789 million of borrowing capacity under its various committed facilities, as permitted by covenant compliance calculations on that date. These fully covered its short-term debt, capital lease obligations of $215 million, and accrued interest of $325 million.
Of the unrestricted cash, LGI and its nonoperating subsidiaries held $846 million on March 31, 2012. This reflects LGI's policy of maintaining a liquidity cushion of at least $500 million available to the parent company.
Of the $789 million of undrawn amounts available under its various committed facilities on March 31, 2012, a large part of the total stemmed from credit facilities at UPC Broadband Holding B.V. (UPC; B+/Positive/--) and from Telenet Group Holding N.V. (not rated). The availability of UPC facilities is subject to quarterly financial covenant tests, such as senior debt to annualized EBITDA (4.0x), EBITDA to total cash interest (3.0x), EBITDA to senior interest (3.4x), minimum debt service coverage (1.0x), and total debt to annualized EBITDA covenants (5.75x). Although the headroom under some of these covenants has been consistently tight in the past few years (at or below 10% for leverage covenants for example), LGI actively manages its compliance with these covenants as part of its financial policy to maximize drawings of UPC facilities.
LGI continues to take proactive steps to extend the maturity profile of its borrowings under the UPC bank facilities. The group typically refinances debt well in advance of the maturity dates, often offering the lenders a higher coupon and spread increase as compensation for extending the maturities. About 95% of consolidated debt is due in 2016 and beyond.
The positive outlook signals that we could raise the long-term rating on LGI by one notch in the next 12 months if it is able to post sustained EBITDA and FOCF growth on the back of its Western European operations, and this in turn results in improvement in its adjusted debt-to-EBITDA ratio.
Specifically, we could consider an upgrade if LGI is able to markedly increase its FOCF generation to close to $1 billion, implement some moderation in its financial policy (particularly regarding the use of cash from the disposal of the stake in Austar), and reduce adjusted debt to EBITDA to below 5.25x. That said, before considering a positive rating action, we would assess LGI management's financial policies and plans, particularly with regard to future distributions to shareholders and acquisitions.
The group's focus on its share buyback program as a means of enhancing shareholder value remains a risk from a credit perspective and partly limits rating upside. Deteriorating operating performance, failure to improve and sustain FOCF generation into the $500 million-$1 billion range, a significant increase to the ongoing share buyback program, or an additional large highly leveraged acquisition would likely lead us to revise the outlook to stable.
Related Criteria And Research
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Europe's Cable Industry Is Sending Clear Signals Of Revenue Growth, May 24, 2012