TEXT - S&P may cut Cogeco Cable Inc rating
Overview -- Montreal-based cable services provider Cogeco Cable Inc. has entered into an agreement to acquire Vancouver-based data center services provider Peer 1 Networks Enterprises Inc. (not rated). -- The C$634 million purchase will raise Cogeco Cable's pro forma adjusted debt-to-EBITDA ratio to the high-3x area. -- As a result, we are placing our 'BB+' long-term corporate credit rating on Cogeco Cable on CreditWatch with negative implications. -- The CreditWatch placement reflects the company's higher debt leverage and our concerns about its ability to reduce debt leverage to our 3.5x target in the near term. Rating Action On Dec. 21, 2012, Standard & Poor's Ratings Services placed its ratings on Montreal-based cable services provider Cogeco Cable Inc. and its subsidiaries, including its 'BB+' long-term corporate credit rating on the company, on CreditWatch with negative implications. This CreditWatch placement follows Cogeco Cable's announcement today that it has entered into an agreement to acquire Vancouver-based data center services provider Peer 1 Network Enterprises Inc. (not rated) for C$634 million; the price includes the assumption of about C$109 million in debt. The purchase price represents a valuation of about 15x annualized run-rate EBITDA of US$43 million for Peer 1 based on results from the three months ended Sept. 30, 2012. We understand that Cogeco Cable has secured C$625 million of committed bank financing to fund the purchase. The transaction is subject to Peer 1 shareholder and regulatory approvals, and we expect it to close by early February 2013. Peer 1 is an Internet infrastructure provider, delivering managed, dedicated, co-location and network services through 19 data centers and 21 points-of-presence located in 14 cities across North America and Europe, connected together by its own Internet protocol backbone network. The company's services are designed to enable its customers to focus on their businesses rather than the complexities of maintaining or expanding their Internet infrastructure. Peer 1's principal target market is small and midsize businesses whose activities increasingly depend on the Internet. The company has a customer base of more than 10,000 businesses and derives the vast majority (78%) of its revenue from managed and dedicated hosting services. Rationale Standard & Poor's views the Peer 1 purchase as having a neutral overall impact on Cogeco Cable's "satisfactory" business risk profile. We view the acquisition as consistent with the company's focus on evolving its business telecom operations, which in our opinion have higher growth prospects than the company's residential cable operations, which are facing increased competition and market maturity. We estimate that, on a pro forma basis, Peer 1 will represent about 10% of Cogeco Cable's consolidated revenue, while the company's combined business telecom operations could represent close to 17% of consolidated pro forma revenue with mid-teen-percent revenue growth potential in the next couple of years. Although Peer 1's profitability (at 27.5% EBITDA margin for the three months ended Sept. 30) is substantially lower than that of both Cogeco Cable's residential cable and commercial telecom operations, we believe profitability and return on capital should improve as data center utilization rates at existing sites increase and additional capacity is created at modest incremental investment. More notably, we expect the acquisition to improve Cogeco Cable's scale and scope in the fast-growing data center business, an aspect that, in our opinion, is critical to the division's long-term viability and success. Financially, the acquisition will increase Cogeco Cable's adjusted debt-to-EBITDA ratio to the high-3x from about 3x pro forma the recently completed C$1.4 billion debt-funded purchase of U.S.-based cable provider Atlantic Broadband LLC (B+/Watch Pos/--). We view this level of debt leverage to be high for the ratings and greater than our publicly articulated downgrade threshold of 3.5x for Cogeco Cable. While we expect some deleveraging from EBITDA growth and possibly modest debt reduction in the medium term from excess cash flow, we remain concerned about the company's ability and willingness to deleverage to our target credit ratios on as sustained basis given its acquisitive growth agenda. Cogeco Cable is the second-largest cable operator in the provinces of Ontario and Quebec in terms of basic cable TV subscribers. The company offers analog and digital cable TV, high-speed Internet, and digital telephony services to more than 1.6 million households, typically in midsize urban communities. The company also provides data connectivity and co-location services to business customers. On Nov. 30, 2012, Cogeco Cable completed the C$1.4 billion purchase of U.S.-based Atlantic Broadband, a midsize cable system operator serving approximately 250,000 basic subscribers. CreditWatch The CreditWatch negative placement indicates that we could either affirm or lower the ratings on Cogeco Cable in the near future. Standard & Poor's will likely resolve this CreditWatch once it has evaluated the company's future capital allocation plan, specifically its ability and willingness to reduce leverage to below our 3.5x target on a sustained basis. In addition to the company's near-to-medium term growth plans, we will also assess Cogeco Cable's liquidity position given the increased scale and scope of operations and large drawdown on its bank facilities to fund two large acquisitions. Given the possibility of additional senior secured debt at Cogeco Cable to support the Peer 1 purchase, our review will also assess the impact, if any, on the '1' recovery rating of the company's senior secured debt. Related Criteria And Research -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Cogeco Cable Inc. Ratings Placed On CreditWatch/Recovery Rating Unchanged To From Corporate credit rating BB+/Watch Neg/-- BB+/Stable/-- Senior secured debt BBB/Watch Neg BBB Recovery rating 1 1
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