DBRS Confirms Vidéotron Ltée Ratings, All Trends Stable

DBRS has today confirmed Vidéotron Ltée’s (Vidéotron or the Company) Issuer Rating at BB (high), its Secured Bank Debt rating at BBB (low), with a RR1 recovery rating, and its Senior Unsecured Notes at BB (high), with a RR3 recovery rating. The trends on all ratings are Stable. Vidéotron’s BB (high) Issuer Rating is supported by its strong market position in Québec, with a cable footprint that covers 2.6 million homes, services 1.8 million basic subscribers and generates strong operating metrics and good operating leverage. Despite this, DBRS notes that Vidéotron’s Issuer Rating remains constrained by the leverage at its parent, Quebecor Media Inc. (QMI), which continues to depend on Vidéotron, along with cash distributions from other operating subsidiaries, to support its own interest costs and funding requirements.

Vidéotron continues to benefit from subscriber growth in digital, high-speed Internet and telephony, with a rising number of subscribers taking two or three of its services. This is in a marketplace that remains highly competitive, with satellite and telco operators also providing these services and continuing to invest in their networks to enhance their services (e.g., the telcos with fibre deployments are bolstering their data speeds, which allows them to launch terrestrial video services). DBRS notes that, in early September 2010, with a goal of adding wireless service to its bundles, Vidéotron will deploy its own wireless network in Québec and, in doing so, will enter a very competitive market, battling incumbents and other new entrants alike. Vidéotron’s bundling efforts have been successful thus far and have unlocked the Company’s operating leverage, driving EBITDA growth and improved EBITDA margins to 49% in the latest period – a very strong level for a North American cable operator. Bundling has also driven average revenue per user (ARPU) levels to near $95 per month in Q2 2010 ($51.86/month in 2005) and lowered subscriber churn levels.

DBRS expects similar growth drivers to remain in place for Vidéotron for the remainder of 2010 and in 2011. However, EBITDA growth is expected to be constrained in 2010 by start-up operating costs from the Company’s wireless service launch in Q3 2010. As such, DBRS expects EBITDA to be below the current $1 billion level for 2010, with a possible return to growth in 2011 or 2012 once the bulk of these start-up costs are incurred and as its new wireless business begins to scale. While the wireless business is becoming increasingly competitive in Canada, DBRS believes that Vidéotron, with its existing subscribers, bundling capabilities and distribution channels, should be successful with its extension into the wireless market, barring any deployment issues.

From a financial perspective, Vidéotron has continued to demonstrate strong operating performance in recent years, which has driven EBITDA growth of 20% or more for the past four years. This has translated into a stronger financial risk profile, with gross debt-to-EBITDA remaining below 2.5 times for the past four years and expected to remain at or below this level going forward, even with the Company’s wireless network investment and launch. While DBRS expects Vidéotron’s free cash flow deficit to be meaningful in 2010 – driven by peak capex levels related to its wireless network investment – the majority of this was pre-funded with a $300 million notes issue in Q1 2010. While additional debt could be required over the next 18 months, capital spending should decline to levels more typical in the range of 15% to 20% of revenue, driving free cash flow (after cash tax savings) going forward. As a result of these factors, DBRS does anticipate that the Company’s gross debt-to-EBITDA will weaken in 2010 but will remain below 2.5 times over the next 18 months, which is reasonable for its assigned ratings.

DBRS notes that should Vidéotron’s wireless deployment be successful – in tandem with continued healthy results and reasonable leverage – positive rating action may be warranted over time. However, DBRS does caution that, while currently not anticipated, significant additional debt levels at Vidéotron’s parent, QMI, and/or material deterioration in Vidéotron’s strong cable operations due to competition, could lead to pressure on the Company’s ratings.

DBRS has stressed Vidéotron under a default scenario whereby it could possibly default on its debt obligations over a 2010 to 2013 time frame under certain assumptions outlined below. In this default scenario, Vidéotron would be in a negative free cash flow position and would require additional debt to fund itself (DBRS has assumed the Company increases its secured credit facility and borrows $1.25 billion under this facility).

At a stressed valuation level, DBRS notes that Vidéotron’s secured bank debt ($1.25 billion) has outstanding recovery prospects under a base case default/recovery scenario. As such, DBRS has confirmed Vidéotron’s Secured Bank Debt recovery rating at RR1 (90%-100% expected recovery) and its instrument rating of BBB (low), one notch above Vidéotron’s BB (high) Issuer Rating. This is consistent with DBRS’s leveraged finance rating methodology.

DBRS notes that Vidéotron’s senior unsecured debt ($2.1 billion, including derivatives) has good recovery prospects under a base case default/recovery scenario. As such, DBRS has confirmed Vidéotron’s Senior Unsecured Notes recovery rating at RR3 (50%-70% expected recovery) and its instrument rating of BB (high), the same as Vidéotron’s BB (high) Issuer Rating, as this senior unsecured debt ranks behind the Company’s secured bank debt.

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

The applicable methodologies are Rating Cable and DBRS Rating Methodology for Leveraged Finance, which can be found on our website under Methodologies.