DBRS Confirms Yellow Media’s Ratings at R-1 (low), BBB (high), BBB and Pfd-3 (high), Trend Stable

DBRS has today confirmed Yellow Media Inc.’s (Yellow Media or the Company) long-term rating at BBB (high), its subordinate rating at BBB and its preferred share ratings at Pfd-3 (high). Yellow Media’s Commercial Paper remains at R-1 (low); all trends are Stable. The ratings are supported by: (1) a manageable business risk profile with leading positions in both Directories and Vertical Media (roughly 90% and 10% of EBITDA, respectively) and (2) a financial risk profile that has and is expected to continue to improve following its recent conversion to a corporation on November 1, 2010.

DBRS acknowledges that despite its leading positions in both Directories and Vertical Media, the Company continues to face significant risks as it transforms itself from a print placement organization to an online/digital media and marketing service provider that offers more vertically integrated services and solutions to its small- to medium-sized (SME) advertisers. However, while some traditional media companies have not fared well in such a transition that has fragmented audiences and disaggregated business models (in particular, newspaper companies that have seen classified advertising move more rapidly online), there are examples of other media companies that have successfully transformed themselves to thrive in a digital/online world.

DBRS believes this transformation, and both the risks and increased market opportunities, must be carefully navigated by Yellow Media for it to remain equally relevant to its advertisers as well as its users. Recognizing this transformation for some time, DBRS notes that Yellow Media has, in recent years, focused on improving its competitive advantages. This has included: (a) bolstering its national platforms over the past couple of years with new tools and services including offering content (e.g., video and placement products on its websites), website creation, performance marketing services such as search engine marketing (SEM) and search engine optimization (SEO) while expanding into other areas such as ratings and reviews, online shopping destinations and digital coupons (RedFlagDeals.com and Restaurantica, among others); (b) updating its leading brand in March 2010 to incorporate its enhanced online capabilities; (c) training its national sales force to sell this new portfolio of products/services to its SME advertisers; and (d) acquiring key assets to accelerate its transformation, such as Canpages and the creation of Mediative to focus on national advertisers.

While DBRS believes Yellow Media is much better positioned to address this transformation and will likely continue to add capabilities and products/services to its platforms, the Company must now execute on selling these new products and services to its Directory and Vertical Media advertisers. This at a time where both segments have been impacted by the downturn in the economy, coupled with some modest structural impacts with some of its advertisers not faring well over the past two years and/or possibly re-allocating their advertising budgets. These factors have impacted Yellow Media’s Directory and Vertical Media advertiser count numbers (currently 368,000 and 7,661, respectively at Q3 2010, down from 389,000 and 8,707, respectively in Q3 2009) and lowered its Directory renewal rates to just below 90% while its average generating units per advertiser and average revenue per advertiser (ARPA) have continued to grow with new products/service offerings.

This ARPA growth in combination with acquisitions, such as Canpages and Dealer.com, has helped to stem the pressure on Directories EBITDA while Vertical Media has begun to reverse the cyclical pressure felt in 2009 as new services such as its Dealer Smart Solution for auto dealerships have been deployed with good uptake by its customers. EBITDA margins have remained strong and steady for Directories in the 59% range while slightly below previous averages in Vertical Media. DBRS expects EBITDA to improve modestly in 2011 with sales of new services while advertiser counts should begin to stabilize. DBRS believes that in order to maintain EBITDA margins, Yellow Media will need to pursue efficiencies in its traditional services while quickly procuring costs to deliver new businesses. One benefit that DBRS believes Yellow Media has over other traditional media companies (newspaper companies, for example) is a relatively lower fixed-cost base with a high proportion of its costs being variable and tied to sales.

From a financial perspective, DBRS notes that Yellow Media continues to target a reduction in its leverage while maintaining adequate liquidity (currently above $600 million) and terming out its debt maturities that include no major maturities until 2013. While free cash flow is expected to be lower going forward as lower distributions help to offset the Company’s taxability as a corporation, free cash flow of at least $150 million per year for the next couple of years should provide ample ability for Yellow Media to reduce debt and undertake strategic acquisitions. As such, DBRS expects most of Yellow Media’s key credit ratios to improve (such as debt-to-capital remaining below 30% and debt-to-EBITDA declining to below 2.5 times) while cash flow-to-debt is expected to be slightly lower in 2011 due to lower cash flow from operations as a result of becoming taxable.

DBRS will continue to closely monitor Yellow Media’s transformation and the impact, if any, this has on its business and financial risk profiles. DBRS believes that: (1) failure to execute on its transformation strategy and any resulting impact on advertisers, users, EBITDA and EBITDA margins and/or (2) large acquisitions that move Yellow Media away from its core businesses; could put pressure on the Company’s ratings in the future. This could happen despite Yellow Media further reducing leverage which will improve its financial risk profile.

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

The applicable methodologies are Rating Printing & Publishing and Rating Media and Entertainment, which can be found on our website under Methodologies.