DBRS Confirms Videotron Ratings at BBB (low) and BB (high)

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 RR2 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; see separate press release), which continues to depend on cash distributions from both Vidéotron and 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 multiple 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 offer terrestrial video services). DBRS notes that, in September 2010, Vidéotron launched its own wireless network in Québec and in doing so will enter a very competitive market, battling incumbents and other new entrants alike. (Vidéotron spent over $550 million on spectrum licenses in 2008, with total investment expected to exceed $1 billion over roughly five years.) Vidéotron’s bundling efforts have been successful thus far and have unlocked operating leverage, driving EBITDA growth and improved EBITDA margins. However, its wireless network and subscriber loading costs are expected to be a drag on EBITDA and EBITDA margins over the next couple of years. Bundling has also driven average revenue per user (ARPU) levels to over $102 per month in Q2 2011 ($51.86/month in 2005).

DBRS expects similar growth drivers to remain in place for Vidéotron for the remainder of 2011 and in 2012. However, EBITDA is likely to experience pressure from wireless costs. As such, DBRS expects EBITDA to be just above the $1 billion level for 2011, with a possible return to growth in 2012 once the bulk of these start-up costs are incurred and the Company’s wireless business begins to scale. While the wireless business has become 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.

From a financial perspective, Vidéotron has continued to demonstrate healthy operating performance in recent years, although its wireless business has halted its previous high rates of multi-year EBITDA growth. This has translated into a stronger financial risk profile, with gross debt-to-EBITDA remaining below 2.5 times for the past five-and-a-half years and expected to remain at or below this level going forward, even with high capex levels and dividends to QMI. While DBRS expects Vidéotron’s free cash flow deficit to potentially become material in 2011 before declining in 2012 – driven by high capex levels related to its wireless and cable network investments – the size will ultimately depend on dividend levels to QMI. While additional debt could be required over the next 18 months (including using the $100 million in cash available at the beginning of 2011), capital spending should then decline to more typical levels 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 2011 but should remain below 2.5 times over the next 18 months, which is very reasonable for its Issuer Rating.

In order for Vidéotron to improve its BB (high) Issuer Rating, debt levels and investment activity at QMI and the other operating entities will need to be reduced while Vidéotron simultaneously maintains healthy operations and a strong financial risk profile. This would help to unlock the healthy business and financial risk profile that Vidéotron has on a stand-alone basis, which will become even more apparent following its wireless network investment. However, DBRS does caution that significant additional funding and/or debt levels at Vidéotron’s parent, QMI, and/or any material deterioration in Vidéotron’s strong cable operations due to competition or meaningfully increased leverage, 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 2011 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 that the Company increases its secured credit facility and borrows $1 billion under this facility).

At a stressed valuation level, DBRS notes that Vidéotron’s secured bank debt ($1 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 the recovery rating of Vidéotron’s Senior Unsecured Notes at RR2 (70%-100% 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.

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

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