Rating Action: Moody’s downgrades UPC’s CFR to B1 from Ba3 after announcement of intention to acquire Sunrise; outlook is stable
Global Credit Research – 14 Aug 2020
London, 14 August 2020 — Moody’s Investors Service, (“Moody’s”) has today downgraded UPC Holding B.V.’s (UPC or the company) corporate family rating (CFR) to B1 from Ba3 and probability of default rating (PDR) to B1-PD from Ba3-PD. Concurrently, Moody’s has downgraded the instrument ratings on the senior secured credit facilities issued by UPC Financing Partnership and UPC Broadband Holding BV and the senior secured notes issued by UPCB Finance IV Limited and UPCB Finance VII Limited to B1 from Ba3. Moody’s has also downgraded the instrument rating on the senior notes issued by UPC Holding B.V. to B3 from B2. Finally Moody’s has also assigned a B1 instrument rating to the new CHF1,610 million (equivalent) Term Loan B-1 due 2029 to be raised by NewCo I B.V. and NewCo Financing Partnership and EUR213 million revolving credit facility due 2026 to be raised by NewCo I B.V. and NewCo Financing Partnership, both subsidiaries of UPC Holding B.V., and to the new CHF1,616 million (equivalent) Term Loan B-2 due 2029 to be raised by UPC Financing Partnership and UPC Broadband Holding BV. The outlook on the ratings has been changed to stable from negative.
The rating action follows the announcement by Liberty Global plc (Ba3 stable) on 12 August 2020 of the launch of a tender offer to acquire the shares of Sunrise Communications Group AG. Headquartered in Zurich, Switzerland, Sunrise is the second-largest integrated telecom operator in Switzerland with reported revenues of CHF1.9 billion and adjusted EBITDA (as reported by the company before share-based payments and non-recurring events pre-IFRS16) of CHF624 million in 2019.
Liberty Global plans to fund the transaction through a combination of approximately CHF3.5 billion of cash from its balance sheet and approximately CHF3.2 billion of financing, of which CHF1.61 billion equivalent will be raised through a Term Loan B-1 to refinance existing indebtedness of Sunrise. The Sunrise credit pool will also have access to a new EUR213 million revolving credit facility which will be undrawn at closing. The CHF 1.61 billion equivalent Term Loan B-2 will be used to partly fund the acquisition of Sunrise and will be drawn proportionately to the percentage of shares acquired by Liberty Global in Sunrise.
Upon becoming a wholly-owned subsidiary of Liberty Global, assuming an initial minimum 90% shareholding threshold is reached, Sunrise will become part of the UPC credit pool. At that point the Sunrise term loan and revolving credit facility will be converted into an additional facility under the UPC senior facilities agreement by upsizing the term loan B-2 and will benefit from the same guarantee and security package as the existing UPC senior secured credit facilities.
The downgrade of UPC’s CFR to B1 reflects the fact that although the acquisition of Sunrise will result in a de-leveraging of the combined group compared to UPC stand-alone, adjusted gross leverage will remain high and not commensurate with a Ba3 rating. Indeed, pro forma for the acquisition of Sunrise and assuming 100% ownership, UPC’s adjusted leverage was 5.9x as of the end of 2019 compared to 6.5x as of Q1 2020 prior to the transaction. The rating action also reflects Moody’s expectation for limited de-leveraging going forward based on the stated financial policy set by Liberty Global. Targeted leverage (as reported by the company including vendor financing and leases) for the combined group will be 5.0x in line with the pro forma leverage as reported by the company at 4.84x as of the last twelve months (LTM) to Q1 2020. The key difference between the company’s 5.0x reported leverage and Moody’s 5.9x adjusted leverage lies in the treatment of non-cash related party fees and share-based payments, among others.
Prior to this transaction, UPC’s CFR at Ba3 with a negative outlook was weakly positioned within the rating category. However, Moody’s acknowledged that Liberty Global plc, the parent of UPC, benefitted from a large cash balance following the sale of its German and certain Central and Eastern European assets in 2019. Although it was not clear what the parent intended to do with the remaining proceeds, the rating and outlook reflected the possibility for Liberty Global plc to apply part of the cash balance to significantly de-leverage UPC, its 100% owned asset. While Liberty Global plc will contribute significant equity for the acquisition of Sunrise, Moody’s considers that the reduction in leverage is not sufficient to maintain the Ba3 rating and no further equity injections to support further de-leveraging are expected at this stage.
On the positive side, pro forma for the acquisition, UPC will significantly increase its scale to approximately CHF3.5 billion of combined revenue from CHF1.7 billion on a standalone basis as of 2019, and become the clear #2 telecom operator in Switzerland with significant market share in mobile, broadband and pay TV services. Additionally, with the combination of UPC’s fixed assets and Sunrise’s mobile assets, the combined group will become Switzerland’s only other fully integrated telecom operator alongside Swisscom AG (A2 stable). The two companies will be able to better align their assets to more effectively compete in a convergent telecom market without having to individually build operations each company lacks individually. While UPC will be able to use Sunrise’s extensive mobile network, UPC will provide fibre backhaul capacity for Sunrise’s mobile base stations, which is crucial to deliver 5G mobile services.
The combined group will generate significant synergies from the integration of UPC and Sunrise. Liberty Global plc estimates that cost and capital expenditure savings will amount to approximately CHF229 million, the bulk of which Moody’s believe will be realized in the first three years. Cost and capital expenditure savings will come from the sharing of existing infrastructure to provide services for each entity’s customers at lower cost compared to on a standalone/wholesale basis, the migration of UPC’s mobile traffic to Sunrise’s network, and the reduction of general and administration costs. Additionally, there is significant potential to realize revenue synergies through the cross-selling of fixed and mobile services to the existing 5.2 million video, broadband and mobile subscribers. Notwithstanding the joint venture’s strong industrial logic, there are still some execution risks. While Moody’s positively notes Sunrise’s track record of revenue growth driven by positive net adds across mobile, broadband and pay TV, UPC has been facing significant headwinds in the context of increasing competition in the Swiss telecom market. In the first six months of 2020, UPC experienced a decline of 3.1% for rebased revenue and 7.9% for rebased EBITDA. Moody’s does not forecast any stabilization before 2022.
The combined group will benefit from an adequate liquidity position supported by the existing EUR500 million revolving credit facility at UPC and the new EUR213 million revolving credit facility at Sunrise, both of which are undrawn at the closing of the transaction. While Moody’s forecasts that the combined group will generate positive free cash flow before dividends supported by stable capital expenditures thanks to the recent upgrade of UPC’s cable network and the realization of synergies, the rating agency assumes that excess cash will be used for shareholder distributions in order for the combined group to maintain its leverage at around 5.0x as reported by the company.
Whilst environmental and social risks are not meaningful for this rating action, Moody’s notes that UPC’s rating is constrained by the financial policy set up by Liberty Global plc to maintain a high leverage at around 5.0x (as reported by the company) with increasing shareholder distributions as the combined group delivers higher EBITDA and excess cash flows.
UPC’s B1-PD PDR is at the same level as the CFR, reflecting the company’s expected recovery rate of 50% typically assumed for a capital structure that consists of a mix of bank and bond debt. The claims at the operating subsidiaries, including trade payables, pension obligations and lease rejection claims, have been ranked highest in order of priority. The senior secured bank credit facilities are ranked second in priority of claims, pari passu with the senior secured notes issued by certain trust-owned special-purpose entities that were created for the primary purpose of facilitating the offering of the notes. The second-ranking position of the senior secured debt reflects the fact that it is secured only over the shares in the obligors held by any member of the senior secured group or any obligor, and over intercompany loans made by the obligors. The guarantor coverage test for the senior secured debt is on a consolidated basis, and so, the guarantees are from the borrower group (including only holding companies) representing a minimum of 80% of EBITDA on a consolidated basis. The senior secured debt instruments have been assigned a B1 rating. The senior unsecured notes issued by UPC, rated B3, are ranked last in priority of claims, reflecting the fact that they are structurally subordinated to the senior secured debt. The new Term Loan B-2 will be made available as an additional facility under UPC’s existing credit agreement. While the Term Loan B-1 will initially be part of the Sunrise restricted group, Moody’s assumes that Liberty Global will achieve 100% ownership of the target, at which point it will merge the Sunrise credit pool into that of UPC and the Term Loan B-1 and the new EUR213 million revolving credit facility will be converted into UPC credit facilities ranking pari passu with UPC’s existing senior secured credit facilities.
The stable outlook reflects (1) Moody’s expectation that UPC’s pressure on revenues and EBITDA will be mitigated by growth at Sunrise over the next two years, (2) the company will maintain adjusted leverage at or below 6.0x, and (3) Liberty Global plc will achieve 100% ownership of Sunrise so that it can merge the Sunrise credit pool into UPC. The rating agency notes however that the transaction is subject to execution risk due to the high threshold required in order to rapidly merge the credit pools. If Liberty Global plc will not be able to achieve the threshold and the distinct credit pools were to remain, Moody’s may revisit the rating positioning of the instrument ratings in order to reflect the respective leverage of the credit pools and the relative seniority/subordination of the different instruments. This could result in potential downward pressure on the UPC credit pool instrument ratings and potential upward pressure on the Sunrise credit pool instrument ratings.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Upward pressure on the rating could develop over time if (1) UPC’s operating performance improves materially with the timely realization of synergies and the eventual upside from convergent opportunities leading to sustainable revenue and EBITDA growth; (2) its adjusted Gross Debt/EBITDA ratio (as calculated by Moody’s) falls below 5.0x on a sustained basis; and the company maintains a strong cash flow generation.
Downward ratings pressure could develop if (1) UPC’s Moody’s adjusted Gross Debt/EBITDA ratio rose well above 6.0x on a sustained basis; and/or (2) operating performance deteriorates driven by increasing competition or problems in executing the integration of Sunrise. Negative pressure could also arise if liquidity were to deteriorate materially.
The principal methodology used in these ratings was Telecommunications Service Providers published in January 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1055812. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
UPC is a European cable company that operates principally in Switzerland, but also in Poland and Slovakia.
For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
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Sebastien Cieniewski VP - Senior Credit Officer Corporate Finance Group Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Peter Firth Associate Managing Director Corporate Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454
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