DBRS Downgrades Yellow Pages’ Stability Rating, Confirms Corporate Ratings

DBRS has today downgraded the stability rating of Yellow Pages Income Fund (Yellow Pages or the Fund) to STA-2 (high) from STA-1 (low) following the 31.6% reduction of the Fund’s cash distribution per unit to $0.80 from $1.17. This new distribution rate of $0.80 per unit will be paid on June 15, 2009. Additionally, DBRS has confirmed YPG Holdings Inc.’s (YPG or the Company) corporate ratings at R-1 (low)/BBB (high)/BBB/Pfd-3 (high). The trends are Stable.

The downgrade of the Fund’s stability rating reflects the reduced distribution stemming from the downturn in the economy and its objective to strengthen its financial flexibility. The Company feels this reduction was necessary as a precautionary measure which will allow it to strengthen its balance sheet. The reduced distribution had not been anticipated by DBRS as management believed that it could grow its distributable cash organically (and leave its distribution flat at $1.17 per unit) allowing it to target a 70% payout at the end of 2010.

The Company also today indicated that a payout of between 60% to 70% of cash earnings per share is its new preliminary target payout as a corporation beginning in 2011. The Company feels that this range and the additional financial flexibility from its reduced distribution over the 18 months ended December 31, 2010, will allow it to better manage the transition to becoming taxable as a corporation. DBRS notes that taxes accrued in 2011 under a corporate structure will begin to be paid in 2012.

The confirmation of YPG’s short- and long-term ratings reflect: (a) a relatively stable business risk profile despite some cyclical pressure on its results (notable in its Vertical Media segment); and (b) the expected improvement in its financial risk profile given the additional financial flexibility from its lower distribution.

DBRS notes that as part of YPG’s Q1 2009 results released today, its consolidated adjusted revenue and EBITDA were down very slightly versus the previous year. Helping to mitigate some of this pressure, the Company had initiated some cost cutting measures in the second half of 2008. These actions, along with a focus on further cost containment over the next couple of years, will help to mitigate some of this cyclical pressure on YPG’s results.

DBRS notes that YPG’s largest segment, Directories (over 80% of revenue and over 88% of EBITDA), appeared to hold up well in the latest quarter despite a difficult economic environment with relatively stable EBITDA (excluding acquisitions) and EBITDA margins at 59.3%. Furthermore, despite the economy reducing its expected revenue and EBITDA growth rates, Directories continued to exhibit steady customer renewal rates (above 90%) and continues to grow its online revenues (now roughly one-eighth of its total Directories revenue). This online growth continues to mitigate print revenue pressure with this trend expected to continue. As part of its online strategy YPG continues to improve its online capabilities, selling this as part of a bundle of print/online to its customers.

However, this was not the case in YPG’s Vertical Media segment (under 20% of revenue and 12% of EBITDA), which suffered significant pressure in the latest quarter as a result of the economic downturn with revenue down nearly 23% and EBITDA down over 30%. The downturn has been particularly hard on the automotive and real estate categories which comprise the majority of this segment’s revenue and EBITDA. While this is a smaller part of YPG’s overall business, the timing and magnitude of the recovery for this segment is unclear. YPG has taken sizable cost cutting initiatives in this segment and expects to save $22 million on an annualized basis by the end of 2009.

In the meantime, DBRS notes that YPG continues to migrate its Vertical Media business away from a traditional media placement business and more to a marketing solution business for automotive dealers and the real estate industry. This transition, if successful, could make the revenue and EBITDA in the automotive category less susceptible to the ebbs and flows of economic cycles.

From a financial perspective, DBRS notes that YPG anticipates that the additional free cash flow generation from the reduced distribution (roughly $300 million from June 2009 to the end of 2010) will be directed toward debt reduction. This is expected to strengthen YPG’s financial risk profile and help it to manage its maturities in the 2011 and 2012 timeframe. DBRS notes that during these two years, over $500 million in debt matures and a $300 million preferred security could be retracted at the end of 2012.

While DBRS is comfortable with YPG’s current corporate credit ratings, DBRS notes that the conversion into a corporation along with its additional financial flexibility could lead YPG to pursue additional acquisitions. DBRS cautions that a strategy which moves the Company away from its core directory operations could pressure the business risk profile and hence its corporate credit ratings. This pressure could be compounded if its online conversion of its existing businesses does not allow it to maintain its customers, revenue and EBITDA margin profile.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Printing and Publishing, which can be found on our website under Methodologies.

This is a Corporate (Publishing & Media) rating.