March 14, 2012 / 7:33 PM / in 6 years

TEXT-S&P revises MDC Partners outlook to negative

March 14 - Overview	
     -- New York-based global marketing services company MDC Partner's 	
fourth-quarter 2011 EBITDA was below our expectations.	
     -- Covenant headroom could narrow in the second quarter of 2012 because 	
of revolving credit facility borrowings to fund deferred acquisition 	
consideration payments.	
     -- We are revising our rating outlook on MDC to negative from stable.	
     -- The negative rating outlook reflects our view of increasing potential 	
for a covenant violation barring an amendment or alternative sources of cash.	
	
Rating Action	
On March 14, 2012, Standard & Poor's Ratings Services revised its rating 	
outlook on New York-based MDC Partners Inc., a holding company for a
portfolio of marketing services firms, to negative from stable.	
	
We affirmed our 'B+' corporate credit rating on the company, as well as the 	
'B+' issue-level rating on the company's senior unsecured debt. The recovery 	
rating on the company's senior unsecured debt also remain unchanged at '4', 	
indicating our expectation of average (30% to 50%) recovery for noteholders in 	
the event of a payment default.	
	
Rationale	
The rating outlook revision reflects a steeper EBITDA decline in the fourth 	
quarter of 2011 than we had previously expected. We estimate this will result 	
in fully adjusted leverage (including operating leases and acquisition-related 	
liabilities) in the low-6x area at year-end. As a result, according to our 	
criteria, we are revising our assessment of the company's financial risk 	
profile to "highly leveraged" from "aggressive." In addition, we believe that 	
covenant headroom could narrow in the second quarter of 2012, when a large 	
portion of the company's $51.8 million of near-term deferred acquisition 	
consideration (earn-out) obligations become due. We believe the company will 	
have to meet a large portion of these obligations with borrowings under its 	
revolving credit facility. The total leverage covenant under the company's 	
credit facility agreement steps down to 3.75x at June 30, 2012, from 4.6x, 	
which, in conjunction with more difficult first half year-over-year 	
comparisons, could lead to a slim margin of compliance.	
	
We currently consider MDC's business profile as "fair," given our view of the 	
strong creative reputation of its key agency, Crispin Porter + Bogusky, and 	
its growing digital capabilities. We believe this despite the company's 	
relatively small agency network, limited global presence, and its still high 	
(but declining) concentration of revenue and EBITDA from two key agencies. 	
However, further EBITDA margin compression could cause us to revise our 	
assessment.	
	
MDC is a global provider of marketing services, with revenue concentration in 	
the U.S. (80% of revenue), Canada (16%), and other (4%). The company's 	
subsidiaries provide a comprehensive range of marketing communications and 	
consulting services. The advertising industry is subject to the cyclical 	
nature of advertising, as well as a client's ability to switch to competitors 	
or scale back spending at short notice. MDC has been in an aggressive growth 	
mode over the past two years, spending over $150 million on acquisitions and 	
over $60 million in key talent additions and office expansion. We believe that 	
increased staffing and facilities costs outpaced revenue growth in certain 	
areas. Cost of sales as a percentage of revenue was 72% in 2011, compared to 	
65% in 2009. As a result, the company plans to reduce headcount by roughly 300 	
employees across various agencies, which will most likely lead to modest 	
severance expense in the first half of 2012.	
	
An important industry trend is the shift of advertising and marketing services 	
to online distribution. Digital business now accounts for over 50% of revenue 	
at MDC, and the company's increased capabilities have led to increased market 	
share and net new business wins being up 33% in 2011. We believe acquisition 	
activity will slow in 2012, but we anticipate that the company will continue 	
to explore opportunities in digital and social media, and integrated agencies, 	
in addition to expanding capabilities in media buying and international 	
markets.	
	
Advertising spending visibility remains low in 2012, and we believe that like 	
larger, higher-rated peers, organic revenue growth at MDC will slow compared 	
to 2011. Key industry risk factors include the performance of certain 	
euro-currency markets, as well as anything that stalls the modest momentum in 	
the U.S. economy, such as rising oil prices or deterioration in consumer 	
confidence. Revenue concentration in the U.S., where advertising and marketing 	
spending was stronger, together with recent business wins totaling $104 	
million, supported revenues in 2011.Under our base case scenario (not 	
including the impact of potential acquisitions), we expect revenue to increase 	
at a mid- to high-single-digit percentage rate in 2012. As a result, based on 	
our expectation of higher salary and facilities costs, we believe EBITDA 	
(including distributions from affiliates, but after minority interest expense 	
and equity-based compensation) could increase at a mid-teens rate.	
	
For the fourth quarter, revenue jumped 20.5%, led by organic revenue growth of 	
6.7% and acquisition-related growth of 14%. However, EBITDA (including 	
distributions from affiliates, but after minority interest expense, 	
acquisition deal costs, and equity-based compensation) dropped 40%, primarily 	
the result of a roughly 29% increase in costs of services sold and 81% 	
increase in office and general expenses. The company's EBITDA margin (after 	
net minority distributions and treating stock compensation as expense) 	
declined to roughly 6.2% in 2011, down from 8.6% in 2010 because of expense 	
increases. Despite healthy revenue growth, increases in talent and facilities 	
spending have constrained EBITDA margin improvement. MDC has publicly stated 	
its intention to decelerate operating cost increases in 2012 and focus on 	
margin improvement. Under our base case scenario (excluding potential 	
acquisitions), we believe that the company could restore the EBITDA margin to 	
the mid- to high-6% area in 2012.	
	
Lease-adjusted debt (including earn-outs and put obligations) to EBITDA (after 	
net distributions to noncontrolling interests, but before noncash stock 	
compensation) was high, at 5.5x as of Sept. 30, 2011. For full-year 2011, we 	
estimate that fully adjusted leverage was slightly higher, in the low-6x area. 	
 Under our base case scenario, assuming a constant level of 	
acquisition-related liabilities and excluding the impact of potential 	
acquisitions, we believe that fully adjusted leverage could decline to the 	
low- to mid-5x area in 2012.	
	
Discretionary cash flow (operating cash flow, less capital expenditures and 	
after dividends and minority distributions) was negative for the 12 months 	
ended Sept. 30, 2011, mainly because of working capital cash usage as a result 	
of acquisition activity. We estimate that discretionary cash flow was also 	
negative for the full year, in the $35 million to $40 million area, owing to 	
working capital cash usage. A key rating factor will be the company's ability 	
to generate positive discretionary cash flow in 2012, which will partly depend 	
on acquisition activity. 	
	
Liquidity	
In our opinion, MDC has "adequate" liquidity to cover its needs over the next 	
12 months, despite covenant headroom that suggests "less than adequate" 	
liquidity according to our criteria. We believe the company's credit metrics 	
and bank relationships provide a degree of financial flexibility if the 	
company were to need another amendment. Our assessment of the company's 	
liquidity profile incorporates the following expectations and assumptions:	
     -- We expect sources of liquidity (including cash and access to the 	
revolving credit facility) to exceed its uses by more than 1.2x over the next 	
12 months.	
     -- We expect net sources to remain positive, even if EBITDA declines more 	
than 15%.	
     -- Compliance with maintenance covenants would not survive a 15% drop in 	
EBITDA from levels as of Dec. 31, 2011, and compliance could fall below 5% in 	
the second quarter barring an amendment.	
     -- The company has flexibility to reduce acquisition and capital spending 	
in order to bolster liquidity, if need be.	
     -- We believe MDC has good relationships with its banks, based on recent 	
credit agreement amendments, and has a satisfactory standing in the credit 	
markets.	
	
MDC's sources of liquidity include cash balances of $8.1 million as of Dec. 	
31, 2011, and access to its $150 million secured asset-based revolving credit 	
facility (unrated). Based on covenant limitations in the senior note 	
indentures, the company was able to borrow an incremental $41.2 million under 	
the revolver as of Dec. 31, 2011. In 2012, assuming a neutral impact from 	
working capital and excluding potential acquisitions, we estimate cash flow 	
from operations could be in the $35 million to $40 million range. Uses of 	
liquidity over the next 12 months include capital expenditures that we 	
estimate in the $20 million area, annual dividends of about $16.5 million, and 	
the deferred acquisition consideration (earn-outs), the current portion of 	
which totaled $51.8 million as of Dec. 31, 2011.	
	
The credit agreement contains financial covenants, including a maximum senior 	
leverage ratio of 2.0x, a maximum total leverage ratio of 4.15x, a minimum 	
fixed-coverage ratio of 1.25x, and a minimum EBITDA requirement of $90 	
million. As of Dec. 31, 2011, we estimate the company had less than 10% 	
cushion against the 4.15x maximum leverage ratio, which, based on its February 	
2012 amendment, loosens to 4.6x on March 31, 2012 to accommodate more 	
difficult first-quarter comparisons. The covenant steps down to 3.75x in the 	
second quarter of 2012, where it will remain over the life of the facility. 	
Barring an amendment or alternative sources of cash, we believe the company 	
could have difficulty meeting the second quarter step-down. However, based on 	
the company's recent credit amendments in September 2011 and February 2012, 	
when MDC was able to loosen covenants and not incur additional interest costs, 	
we believe the company has good relationships with its banks.	
	
Recovery analysis	
See Standard & Poor's recovery report on MDC Partners published Oct. 28, 2011 	
on RatingsDirect.	
	
Outlook	
Our negative rating outlook reflects our expectation that headroom against 	
financial covenants will narrow in the second quarter of 2012, potentially 	
requiring an amendment. In addition, the outlook reflects the company's 	
negative discretionary cash flow in 2011 and low visibility into 2012. 	
	
We could lower the rating over the near term if it becomes apparent that a 	
covenant violation is likely in the second quarter, which we believe could 	
happen if EBITDA doesn't grow at a mid-single digit percentage rate or faster 	
in the first half of 2012. We could also lower the rating because of further 	
sizable debt-financed acquisitions or EBITDA deterioration that precludes the 	
company from building a 15% to 20% cushion against financial covenants and 	
generating positive discretionary cash flow in 2012. We believe such a 	
scenario would entail higher-than-expected operating cost increases, due to 	
international expansion and talent acquisition. 	
	
We could revise the outlook to stable if the company begins to build a more 	
substantial cushion against financial covenants and we see a clear indication 	
of its financial policy moving toward lower leverage through decelerating 	
operating cost growth and acquisition activity.	
	
Related Criteria And Research	
     -- 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	
     -- Standard & Poor's Revises Its Approach To Rating Speculative-Grade 	
Credits, May 13, 2008	
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008	
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008	
Ratings List	
	
Ratings Affirmed; Outlook Action	
                                 To               From	
MDC Partners Inc.	
 Corporate Credit Rating         B+/Negative/--   B+/Stable/--	
 Senior Unsecured                B+	
   Recovery Rating               4	
	
Complete ratings information is available to subscribers of RatingsDirect on 	
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 	
by this rating action can be found on Standard & Poor's public Web site at 	
www.standardandpoors.com. Use the Ratings search box located in the left 	
column.

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