DBRS Confirms YPG Holdings at BBB (high) and R-1 (low) with a Stable Trend

DBRS has today confirmed the Medium-Term Notes rating of YPG Holdings Inc. (YPG or the Company) at BBB (high) and its Commercial Paper rating at R-1 (low). DBRS has also confirmed its ratings on the Company’s subordinated debt at BBB and preferred shares at Pfd-3 (high). The trend on all ratings is Stable.

The ratings are supported by the following: (1) a manageable business risk profile to date, with YPG’s Directories segment (more than 90% of EBITDA) exhibiting stable results, while cyclical pressure remains evident in its Vertical Media (less than 10% of EBITDA) and (2) its improving financial risk profile, which has been a direct result of debt reduction efforts afforded by its reduced distribution rate in May 2009.

In terms of YPG’s business risk profile, DBRS acknowledges that there are significant risks on the horizon as the Company repositions its businesses to adapt to an increasingly digital world. However, to date DBRS has seen no evidence that this transformation has materially changed the Company’s business risk profile in terms of its leading position as the incumbent directory company across Canada, servicing more than 405,000 local small and medium-sized customers.

DBRS notes that some of the risks that YPG faces are both internal and external. The internal risk is not unlike that faced by other forms of media such as getting its advertising customers to purchase an increasing number of online services each year while remaining relevant to the end user that supports its business model. While other traditional media companies have not fared well in such a transition (in particular, newspaper companies that have seen classified advertising move rapidly online), there are examples of other media companies that have successfully transformed themselves to not only survive but thrive in a digital world.

DBRS believes that YPG is prudently focusing on its customers and innovating to meet their changing needs while arming its sales force with expanded tools and services. By doing so, YPG is focused on the local advertisers and their fundamental need to drive leads, traffic and/or viewers and not solely on the medium (i.e., print directories), which may become less relevant going forward. Additionally, YPG has made a more meaningful effort to remain relevant to its users by enhancing its website and launching smartphone applications that marry YPG’s geo-coded listings with these GPS-enabled devices. From an online perspective, DBRS notes that two-thirds of YPG’s traffic originates from its website, with one-third coming from its online partners.

DBRS believes that YPG’s sales force remains one of its largest barriers to entry as external competitors try to encroach on its business to gain a piece of its lucrative EBITDA margins and free cash flow. These competitors include other media, directory and/or search engine companies that are trying to offer YPG’s customers print and/or online advertising services with more of a self-service approach as opposed to YPG’s full-service approach. To date, YPG’s sales force continues to add value in terms of both consultation and advertising services, which ultimately continue to deliver leads for these customers. As such, despite the economic downturn, DBRS expects YPG’s renewal rates with its advertisers to remain healthy for 2009 at approximately 90%.

DBRS continues to carefully monitor YPG’s transition in its Directories segment and, in particular, the impact, if any, on its business risk profile. DBRS pays close attention to YPG’s customer renewal and churn rates, usage, online revenue, EBITDA and EBITDA margins. To date, these factors have remained steady, with modest EBITDA growth (flat on an organic basis) to $835 million expected for 2010 on revenue of $1.4 billion and strong industry-leading EBITDA margins of about 59%. For 2010, DBRS believes that growth in online and new services such as search engine marketing (SEM) will continue to offset lower print revenue.

For the Vertical Media segment, which has felt the impact of lower volumes in automotive and real estate given the downturn in the economy and possibly some structural changes in these verticals, the transition to digital is being approached in a different manner. YPG is attempting to not only reposition this business online (where a number of competitors operate), it has also undertaken to focus on lead generation for auto dealerships and real estate brokerages and boards as opposed to its traditional media-placement business model. By doing so, YPG is attempting to vertically integrate itself further back in the value chain. Specifically, as part of this transition, YPG’s Dealer Smart Solutions, a platform that services automotive dealers’ inventory, advertising and lead-generation needs, will be deployed nationally in 2010. DBRS believes that EBITDA, after expecting to be down significantly in 2009 (roughly one-third to approximately $70 million), should start to reverse this trend as the economy turns and as this segment’s digital transition begins. This type of platform could be applied to other verticals such as real estate, which could make this segment’s revenue and EBITDA less susceptible to the ebb and flow of economic cycles.

From a financial perspective, DBRS notes that the free cash flow from its reduced distribution and proceeds from its preferred share issuance in 2009 will accelerate its de-leveraging plans for the remainder of 2009 and 2010. This should take debt-to-EBITDA from nearly 3.0 times in 2008 to 2.50 times or less, and cash flow-to-debt should improve from 0.29 times in 2008 to more than 0.30 times. This is expected to strengthen YPG’s financial risk profile before it converts back to a corporation on or before January 1, 2011, and the tax burden shifts to YPG. Additionally, YPG continues to have strong liquidity with its credit facility and will have made good progress in tackling its 2011 maturities with its 2009 debt financing and redemptions, but it will have more to do, including renewing its credit facility, which matures in 2012, and its Series 1 preferred shares, which can be retracted at the end of that year..

DBRS expects to continue to closely monitor YPG’s digital transformation and vertical integration and the impact, if any, that this may have on its overall business risk profile. DBRS believes that (1) any resulting changes that negatively affect its advertisers, users, EBITDA and EBITDA margins and/or (2) large acquisitions that moves YPG away from its core could put pressure on the Company’s ratings in the future. This could be despite the expectation that YPG will use its excess free cash flow for continued de-leveraging into 2010 before ultimately converting to a corporation. DBRS notes that its payout in the 60% to 70% range of cash earnings per unit as a corporation appears manageable given its current business risk profile.

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

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

This is a Corporate (Telecom/Media/Technology) rating.