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Fitch Rates Viacom's Junior Subordinated Debt 'BB+'; Affirms 'BBB' IDR and Negative Outlook
February 21, 2017 / 4:01 PM / 9 months ago

Fitch Rates Viacom's Junior Subordinated Debt 'BB+'; Affirms 'BBB' IDR and Negative Outlook

(The following statement was released by the rating agency) NEW YORK, February 21 (Fitch) Fitch Ratings has assigned a 'BB+' rating to Viacom Inc.'s (Viacom) issuance of 40-year junior subordinated debentures. The rating reflects standard notching for a hybrid instrument with its risk characteristics. In addition, Fitch affirmed Viacom's 'BBB' Issuer Default Rating (IDR). The Rating Outlook is Negative. Proceeds from the offering are expected to be used to repay the October 2017 and September 2018 maturities. The issuance is modestly deleveraging given the equity-like characteristics of the junior subordinated debentures and Fitch's 50% equity treatment of this type of hybrid instrument. The Negative Outlook reflects that while Fitch views the company's hybrid issuance and resulting modest debt reduction positively, pro forma leverage will remain elevated above our 3.5x threshold level, weakly positioning the company in the 'BBB' rating category. The Negative Outlook also incorporates Viacom's continued weaker than anticipated operating performance and the significant execution risk regarding its turnaround strategy amid increasing secular challenges. Fitch recognizes the company's planned de-leveraging efforts; however, we would consider a negative rating action if incremental debt reduction or improved operating trends fail to bring gross leverage down to levels more consistent with the 'BBB' rating category. Viacom's new management team has recently taken actions to address operating performance and define a turnaround strategy. Specifically Viacom will re-focus on its "flagship" cable networks (Nick, Nick Jr., MTV, Comedy Central, BET and the re-branded Paramount Network) and re-allocate content spending toward these core brands. Viacom also intends to manage content and talent more cohesively across its properties and use IP and talent from Media Networks segment to bolster its film slate at Paramount. This follows Viacom's Jan. 19 announcement that Chinese film companies, Shanghai Film Group (SFG) and Huahua Media, will provide an estimated $1 billion cash investment to fund 25% of Paramount's film slate costs over the next three years. Fitch believes that Viacom has outlined a more coherent strategy to reinvigorate content and talent and deploy it more rationally across its media properties, and we view this positively as the appropriate strategy to take given persistent operational woes. However, Fitch remains concerned about the significant risk surrounding execution of these efforts to stabilize performance. Positive momentum in Media Networks will take time as Viacom works to re-vitalize its core brands with improved content that resonates with audiences and there will be a lag between improved ratings at Viacom's cable networks in key demos and the potential for improved advertising and affiliate fee growth. Fitch expects the shift in focus towards the six "flagship" cable networks could relieve some pressure in affiliate renegotiations with multichannel programming video providers (MPVDs) as existing contracts expire. However, we think this strategy shift, which de-emphasizes Viacom's other cable networks, reflects the increasing secular pressure in the pay-TV ecosystem and the impact this is having on content providers. KEY RATING DRIVERS Appropriate Financial Strategy: The changes to Viacom's capital allocation policy, namely the reduction of its dividend, suspension of its share repurchase program and the reallocation of free cash flow (FCF) to reduce debt coupled with changing its strategic focus to its six "flagship" cable networks, are appropriate given the current operating environment. Fitch also views positively Viacom's efforts to de-risk Paramount's film slate through an estimated $1 billion cash investment from Chinese film companies SFG and Huahua Media, which will provide some modest improvement to Paramount's operating performance and Viacom's consolidated operating cash flow. Leadership Transition: On Dec. 12, 2016, National Amusements Inc. (NAI) announced that it ended its exploration of a possible merger between CBS Corp. and Viacom. Concurrently, Viacom named Bob Bakish as its permanent CEO. While Fitch would have considered a possible re-combination with CBS Corp. a positive for Viacom's credit profile, the removed uncertainty regarding Viacom's leadership transition is a positive development for Viacom as an independent company. Since Bakish was named permanent CEO, he has taken a number of steps to change internal management in an effort to break down silos within the organization and has outlined a more coherent strategy and restructuring for the overall company. Limited Financial Flexibility: While the recently announced hybrid issuance, the de-risking of the Paramount film slate and the reduction of the dividend will improve overall financial flexibility, operational headwinds, elevated leverage combined with ongoing investment in original programming and production are still expected to pressure FCF generation and limit the company's overall financial flexibility. Cable Network Portfolio Anchors Ratings: The dual-stream, recurring, high-margin revenue base of the cable networks remains the foundation for Viacom's ratings. While a level of viewership ratings volatility at any given cable network is factored into the current ratings, Fitch remains concerned about the weakened TV ratings at Viacom's cable networks. Fitch expects that management's newly outlined turnaround strategy will take time to show improvements. While Fitch does not expect Viacom to lose any distribution deals, continued ratings softness could weaken its negotiating position. However, this may be mitigated by the company's focus on the six "flagship" networks and the resulting de-emphasis on Viacom's less prominent networks, which could improve Viacom's efforts to renegotiate affiliate agreements. Growing Secular Risks Present: The ongoing secular threats presented by changing media consumption, emerging distribution platforms and technology evolution and adoption have had a negative effect on Viacom's operating performance. Fitch recognizes the risks inherent in the company's strategies to address the secular threats and adapt to changing industry dynamics, monetize changing viewing habits, and recapture a target audience that continues to shift away from viewing media in a linear, measured environment. Advertising Revenue Exposure Highlights Risks: Rating concerns include exposure to cyclical advertising revenues (at 37% of revenues, moderate relative to peer group) and the company's capacity to adapt to ever-changing media consumption patterns and technology platforms. Fitch's ratings recognize the volatility within Viacom's operating profile given the exposure to cyclical advertising revenues and the hit-driven nature of its cable networks and film studio; however, there is minimal tolerance within the current ratings for further weakening of Viacom's operating profile. KEY ASSUMPTIONS Fitch's key assumptions within the rating case include: --Media Networks: Flat revenues in 2017 approaching low single-digit growth in the years following. --Filmed Entertainment: Low- to mid-single-digit growth. --Near-term EBITDA margin pressure in both Media Networks and Filmed Entertainment. --Dividend remains at half of FY 2016 for the ratings horizon. --Share buyback activity remains suspended. --Fiscal 2017 borrowings include $1.4 billion senior unsecured October 2016 issuance and proceeds from junior subordinated debentures. --Fiscal 2017 debt repayments include 2017, 2018 maturities. --Leverage under 3.5x by FYE 2018 approaching 3x by 2019. RATING SENSITIVITIES Positive: Upward ratings momentum is unlikely during the current ratings horizon given Viacom's persistent weak operating performance and the secular pressures on its business model. Negative: Fitch notes that gross leverage was high at 4.2x for the TTM period ending Dec. 31, 2016. While the proposed junior subordinated notes will slightly reduce leverage, Fitch expects pro forma leverage will remain elevated above our 3.5x threshold level, weakly positioning the company in the 'BBB' rating category. Fitch recognizes the company's planned de-leveraging efforts, however Fitch would consider a negative rating action if incremental debt reduction or improved operating trends fail to bring gross leverage down to levels which Fitch views as more consistent with the 'BBB' rating category. Failure to gain traction from the turnaround strategy, particularly in regard to ratings and advertising momentum at Media Networks, could also result in negative pressure on the ratings, notwithstanding the company's commitment to more conservative fiscal policies. LIQUIDITY Viacom's weakening operating profile is diminishing its financial flexibility. In step with the company's weakened operating results, FCF generation, margin and FCF leverage metrics have also deteriorated. Led by its Media Networks segment, the company generated approximately $903 million of FCF (defined as cash flow from operations less capital expenditures and dividends) during the LTM period ended Dec. 31, 2016, reflecting a 44% decline relative to company's reported FCF generation during its fiscal year end 2015. Fitch expects that the estimated $1 billion cash investment in Paramount by Chinese film companies, which will fund 25% of Paramount's film slate costs over the next three years will provide some upside to operating cash flow over the ratings horizon. However, operational headwinds, higher cash taxes along with higher programming costs are expected to continue hindering FCF generation through fiscal 2017. Fitch expects FCF generation after dividends during fiscal 2017 to approximate roughly $900 million. In Fitch's view, Viacom's liquidity is adequate and supported by expected FCF generation. Additional financial flexibility is provided by the company's $2.5 billion revolving credit facility (fully available as of Dec. 31, 2016 and there was no outstanding commercial paper) and $443 million of cash on hand as of Dec. 31, 2016. Viacom has deemed substantially all of the cash held by its foreign subsidiaries as permanently reinvested in its foreign operations and does not intend or foresee a need to repatriate any of this cash. Commitments under Viacom's revolver expire on Nov. 18, 2019. The credit facility contains an interest coverage covenant requiring coverage for the most recent LTM period to be at least 3x. FULL LIST OF RATING ACTIONS Fitch assigns the following ratings: --Junior subordinated debentures 'BB+' Fitch currently rates Viacom as follows: Viacom Inc. --Long-Term IDR 'BBB'; --Senior unsecured notes and debentures 'BBB'; --Senior unsecured bank facility due 2019 'BBB'; --Short-Term IDR 'F2'; --CP 'F2'. The Rating Outlook remains Negative. Contact: Primary Analyst Patrice Cucinello Director +1-212-908-0866 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Rachael Shanker Associate Director +1-212-908-0649 Committee Chairperson David Peterson Senior Director +1-312-368-3177 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Date of Relevant Rating Committee: Feb. 16, 2017 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --No material adjustments have been made that have not been disclosed in public fillings of this issuer. 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