6 Min Read
Dec 6 - Standard & Poor's Ratings Services said today that it assigned MDC Partners Inc.'s proposed $80 million add-on to the unsecured notes due 2016 an issue-level rating of 'B', with a recovery rating of '4', indicating our expectation for average (30% to 50%) recovery for noteholders in the event of default. The company plans to use proceeds to pay down its revolving credit facility and for general corporate purposes. Under our base-case scenario, we expect that leverage (including our adjustments for operating leases, earn-outs, and put obligations) could remain well above 4x through at least 2013. As a result, over the next 12 to 18 months, we expect to continue to characterize the company's financial risk profile as "highly leveraged," which includes leverage in the 4x to 5x range, based on our criteria. Elevated financial risk, together with continued economic uncertainty and our "fair" assessment of the company's business risk profile, are key considerations in the 'B' rating. Our governance assessment is fair. Pro forma for the note offering, lease-adjusted debt (including deferred acquisition consideration and put obligations) to EBITDA (before noncash stock compensation, including affiliate distributions and adjustments for deferred acquisition consideration, but after minority interest) was very high, at roughly 8x as of Sept. 30, 2012, up from 6x in 2011. The spike in leverage was because of EBITDA declines, as well as borrowings under the revolving credit facility to fund deferred acquisition consideration payments in 2012. Typical of the industry, consideration for MDC's acquisitions is usually structure as an upfront portion, often at PBT (profit before tax) multiples of 3x to 4x, with additional consideration in the form of contingent deferred acquisition payments. To date, these payments have been lumpy, limiting the company's liquidity position in certain periods and causing the need for credit amendments to loosen financial covenants. As of Sept. 30, 2012, the current portion of deferred acquisition consideration was $82.7 million or roughly 76% of EBITDA. Although high, MDC should be able to address this payment with a combination of revolver borrowings given the increase in availability from this transaction and free cash flow. Under our base-case scenario, we believe that leverage could fall to the mid- to high-5x area in 2012. In 2013, assuming the company pays the current portion of earn-out obligations, we believe leverage could drop to the mid-4x area. Further leverage reduction will depend on the pace of EBITDA recovery, as well as future acquisition activity and the ongoing level of acquisition-related liabilities, which we have assumed will be in the $40 million to $50 million range longer term. Discretionary cash flow (operating cash flow, less capital expenditures and after dividends and minority distributions) was negative for the 12 months ended Sept. 30, 2012, mainly because of EBITDA declines, high dividend payments, and working capital cash usage as a result of acquisition activity. Due to EBITDA growth and working capital benefits of media-related acquisitions in the first half of the year, we expect discretionary cash flow to be positive in the fourth quarter. As a result, under our base-case scenario, we believe the company could convert 30%-40% of EBITDA to discretionary cash flow for the full-year 2012. A key rating factor will be the company's ability to generate ongoing positive discretionary cash flow, despite the level of acquisition activity. Our rating outlook is stable. The stable rating outlook reflects our expectation that MDC will generate positive discretionary cash flow for 2012 and 2013, and that leverage will begin to decrease as EBITDA rebounds and talent-related spending subsides. Over the next year, we view both an upgrade and downgrade as equally unlikely. We could raise the rating over the long term, if leverage drops to less than 4x on a sustained basis, compliance with financial covenants remains above 20%, and the company maintains adequate liquidity and establishes a less aggressive financial policy. We believe the company could achieve these measures in 2014, assuming stronger economic trends, and barring a continuation of aggressive debt-financed acquisition activity. We expect such a scenario would entail continued mid- to high-single-digit percent organic revenue growth, and a steady reduction in deferred acquisition-related liabilities. Conversely, although less likely in our view, we could lower the rating if the company does not begin to generate sustainable positive discretionary cash flow, or if covenant headroom falls below 15% with an expectation of further narrowing, stemming from operating weakness and acquisition or earn-out related payments. RELATED CRITERIA AND RESEARCH -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 RATINGS LIST MDC Partners Inc. Corporate Credit Rating B/Stable/-- New Ratings MDC Partners Inc. $80M unsecd nts* B Recovery Rating 4 *This is an add-on. New total is $420M 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.