Dec 10 -
-- U.K.-based cinema operator Odeon's 2012 EBITDA generation may fall significantly short of our forecast, despite the contribution of recent investments.
-- We are revising our outlook on Odeon to negative from stable and affirming our 'B' long-term corporate credit rating.
-- The negative outlook reflects our view that Odeon's business risk profile has weakened and that its credit ratios may deteriorate in 2012.
On Dec. 10, 2012, Standard & Poor's Ratings Services revised its outlook on U.K.-based cinema operator Odeon & UCI Cinemas Group Ltd. (Odeon) to negative from stable. At the same time, we affirmed our 'B' long-term corporate credit rating on the company.
The outlook revision reflects our view that the weaker performance of the first and third quarters of 2012 points to a weakening of Odeon's business risk profile, although we still view it as "fair" as our criteria define this term, and that its credit ratios may deteriorate in 2012.
We now forecast that reported EBITDA generation will decline to about GBP80 million in 2012 from GBP93 million in 2011 according to our calculations, which is well below our previous estimate of about GBP90 million, because of adverse economic conditions and the impact of sporting events, namely the UEFA European Football Championship and the 2012 Summer Olympic games in London. This forecast entails significant uncertainties because it implies that the fourth quarter will account for more than one-half of total EBITDA, thanks to a supportive movie line-up. We believe that Odeon's adjusted debt-to-EBITDA ratio will rise to about 13x by year-end 2012 from 12x in 2011, or to 9x from 8.6x excluding shareholder loans.
In our opinion, Odeon's inability to stabilize EBITDA generation despite the contribution of recent acquisitions shows that its business model may have deteriorated. So far, geographic diversity has supported the company's "fair" business risk profile because it makes Odeon less reliant on Hollywood productions than its U.S. counterparts. Yet box office revenues have fallen more in Spain, Portugal, and Italy--which together account for about 40% of Odeon's total revenues--than in the U.K. We anticipate that these countries will remain under pressure, especially Spain, where value-added tax on cinema tickets has increased sharply. Recent quarterly performances have also highlighted that Odeon's cost structure is primarily fixed, in our view. Despite cost-cutting efforts, EBITDA has fallen by 42% during the first nine months of 2012, while revenues have declined by only 7%. This exacerbates the uncertainties related to the quality of the film line-up and the effect of the economic downturn.
We now think Odeon's credit measures may weaken in 2012, while we initially thought that they were going to stabilize. We now forecast that the cash EBITDA-to-interest ratio will be roughly in line with our 1.5x threshold in 2012 (which translates into an adjusted EBITDA-to-interest ratio of about 1x) against our previous forecast of 2x. Investments prevent the company from reducing its debt. We anticipate negative free operating cash flow generation on a reported basis for 2012 because capital expenditures should exceed funds from operations (FFO). Although Odeon has made no acquisitions in 2012, we believe that it still intends to expand through external growth. As a result, Odeon must increase its EBITDA to reduce its leverage. On the positive side, liquidity remains adequate, underpinned by a lack of meaningful short-term debt maturities and a GBP90 million revolving credit facility (RCF) maturing in 2017.
We view Odeon's liquidity as "adequate" under our criteria, supported by our estimate that its liquidity sources will exceed funding needs by more than 1.2x over the next 12 months.
On Sept. 30, 2012, we assessed liquidity sources to be worth approximately GBP115 million. These include:
-- GBP15 million of cash;
-- GBP65 million available under the RCF; and
-- About GBP35 million of projected FFO for the next 12 months.
On the same date, we estimated liquidity needs in 2012 as being around GBP45 million, comprising:
-- GBP3 million of finance leases; and
-- About GBP40 million of capital expenditures.
We do not factor in seasonal working-capital swings since Odeon is currently close to the low point of the cycle. Intrayear variation usually amounts to about EUR30 million, with a cash peak after the Christmas period and a trough at midyear, except for 2012, when liquidity reached a low point in October.
Odeon's liquidity is underpinned by the lack of debt maturities and amortizations before 2017, when the RCF matures. Although a part of Odeon's private equity certificates is due in 2016, we understand that a failure to repay these instruments would not trigger a cross default of the RCF or the senior secured notes. We note that the RCF does not have maintenance covenants.
The issue rating on the GBP300 million and EUR200 million senior secured notes issued by Odeon & UCI Finco PLC [Odeon & UCI Finco PLC] is 'B'. The recovery rating on these notes is '4', indicating our expectation of average (30%-50%) recovery in the case of a payment default. The issue rating on the GBP90 million super senior RCF issued by Odeon & UCI Bond Midco Ltd. is 'BB-'. The recovery rating on this facility is '1', indicating our expectation of very high (90%-100%) recovery in the case of a payment default. Both entities are subsidiaries of Odeon.
Recovery prospects for the RCF and the notes are supported by our view of the business as a going concern in a hypothetical default scenario and by the instruments' security and guarantee packages. While the RCF has super priority status, recovery prospects for the notes are limited by subordination. This also includes a claim under a call option relating to lease agreements for 31 U.K. cinemas that Odeon entered in 2007 with a separate property group (Propco), owned by Terra Firma (not rated).
Our simulated default scenario contemplates a default in 2015, due to a combination of significant ticket price competition and a streak of unappealing films leading to lower box office revenues, as well as some unsuccessful acquisitions of movie cinemas, requiring higher investment than anticipated. Under this hypothetical scenario, we expect EBITDA to decline to approximately GBP71 million by 2015. Our going-concern valuation yields a stressed enterprise value of approximately GBP390 million, which is equivalent to a 5.5x stressed EBITDA multiple.
We deduct from the stressed enterprise value priority liabilities of approximately GBP110 million, comprising mostly finance leases, enforcement costs, and an adjustment for assets subject to Propco's call option, which we assume Propco would exercise. We then subtract the super senior RCF of GBP93 million (including six months of prepetition interest), which we assume would be fully drawn by the time of default, leading to recovery prospects for RCF lenders in the 90%-100% range. This leaves approximately GBP195 million of value for the senior secured noteholders. We project that the senior secured notes would amount to GBP495 million at default, including six months of prepetition interest, leading to 30%-50% recovery for the bondholders.
For the full recovery analysis, please see "Recovery Report: Odeon & UCI Cinemas Group Recovery Rating Profile", published on June 12, 2012, on RatingsDirect on the Global Credit Portal.
The negative outlook reflects our view that Odeon's financial performance may decline significantly in 2012 and that its credit ratios will deteriorate as a result. Our base-case scenario for 2012 factors in a low single-digit decrease in revenues and a decline of the reported EBITDA margin to about 11% from 12.8%. We expect that EBITDA generation will subsequently grow moderately.
We could lower the rating if we revised our assessment of the company's business profile downward to "weak" from the current "fair". This could be the case if we believed that the financial performances of Odeon's U.K. and Germany operations no longer offset the deterioration of those in Southern Europe, if Odeon appeared unable to restore its profitability, or if we believed that its competitive position had deteriorated. We would also consider a downgrade if the company appeared unable to maintain an adjusted EBITDA-to-interest ratio of about 1.0x, which translates into a cash EBITDA-to-interest ratio of 1.5x. Finally, negative rating pressure could also arise if we perceived that liquidity had deteriorated.
We could revise the outlook to stable if the company significantly increased its EBITDA generation on a like-for-like basis and if it appeared able to sustainably maintain its credit ratios above our estimates.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
CreditWatch/Outlook Action; Ratings Affirmed
Odeon & UCI Cinemas Group Ltd.
Corporate Credit Rating B/Negative/-- B/Stable/--
Odeon & UCI Bond Midco Ltd.
Senior Secured* BB- BB-
Recovery Rating 1 1
Odeon & UCI Finco PLC
Senior Secured* B B
Recovery Rating 4 4
*Guaranteed by Odeon & UCI Cinemas Group Ltd.