DBRS Confirms Yellow Media’s Ratings at BB, B (high) and Pfd-4 (low), Trend Remains Negative

DBRS has today confirmed Yellow Media Inc.’s (Yellow Media or the Company) Issuer Rating at BB, its Medium-Term Notes at BB with an RR4 recovery rating, its Exchangeable Subordinated Debentures at B (high) with an RR6 recovery rating and its Preferred Shares at Pfd-4 (low). The trend on its Issuer Rating, debt and preferred shares remains Negative (DBRS lowered its ratings on Yellow Media on September 28, 2011).

DBRS notes that Yellow Media’s unsecured debt has average recovery prospects while its subordinated debt has poor recovery prospects under a base case default/recovery scenario. As such, DBRS has confirmed Yellow Media’s Medium-Term Notes recovery rating at RR4 (30% to 50% expected recovery) with an instrument rating of BB and confirmed its Exchangeable Subordinated Debentures recovery rating at RR6 (0% to 10% expected recovery) with an instrument rating at B (high).

Yellow Media’s Issuer Rating at BB reflects two primary factors: (a) increased concern regarding the timing, execution and success of Yellow Media’s transition from print to digital; and (b) limited financial flexibility and liquidity while facing tighter credit facility covenants and a steady stream of debt maturities beginning in 2013. The Negative trend reflects the above factors along with the uncertainty in the Company’s ability to not only execute on its transformation but to demonstrate its digital strategy is working while generating/attaining the liquidity necessary to continue to support this digital transition and its evolving capital structure over the medium term. DBRS notes that these factors are not mutually exclusive.

In terms of Yellow Media’s business risk profile, it appears that the multi-year transition from print to digital that DBRS has noted for the past number of years has seen an inflection point in 2011. This has included accelerated print pressure as advertisers cut back their traditional print directories spending (while average revenue per advertiser (ARPA) remains steady at $3,441, total advertisers and advertiser renewal rates continue very modest erosion) and healthy digital growth that also comes with additional costs that collectively are not able to compensate for the decline in print revenue. As a result, DBRS expects Yellow Media will continue to face material pressure on its EBITDA and cash flow from operations (in addition to becoming cash taxable in 2011) over the near to medium term (this expectation and a higher cost of capital led to a $2.9 billion goodwill writedown in September 2011). This pressure is not expected to be fully offset by reduced financing costs and the elimination of its common share dividend effective in Q4 2011. Furthermore, DBRS notes that despite this pressure over the near to medium term, the Company has reiterated its medium-term goals for its digital transition by 2014, which include stabilizing EBITDA margins at approximately 50%, generating 50% of its revenue from digital and reacquiring growth. DBRS believes it is uncertain at this stage whether the Company’s transition will meet these medium-term goals.

From a financial risk perspective, DBRS notes that Yellow Media’s limited financial flexibility and liquidity are compounded by little access to the capital markets. This puts the Company in a position of being largely reliant on its internally generated free cash flow as its primary source of liquidity to repay its debt maturities. While DBRS notes that reduced debt in 2011 (largely paid for with proceeds from the sale of Trader Corporation and LesPAC Inc., as well as free cash flow), the lower resulting interest expense and the reduction and ultimate elimination of its common share dividend in Q4 2011 will help in terms of free cash flow, these will only partially offset the aforementioned pressure on EBITDA as the print-to-digital transition continues. Despite these factors, DBRS expects the Company should be able to generate free cash flow of $200 million or more per year (DBRS has assumed cash taxes are paid in the year they are incurred) in 2012. However, DBRS notes that over the four years from 2013 to 2016, roughly two-thirds of Yellow Media’s total debt ($1.9 billion as at September 30, 2011) matures. In 2013, the Company faces its largest maturity year (likely to be approximately $400 million) as its credit facility matures in February, followed by notes in July and December. DBRS notes that a number of terms and conditions under its credit facility were amended in September, including a reduction of the revolver from $500 million to $250 million, the quarterly amortization of its $250 term loan and tighter financial covenants. DBRS expects to monitor Yellow Media’s progress on gaining further liquidity and meeting its financing and debt repayment needs throughout 2012 as it gets closer to its 2013 maturities.

DBRS notes that Yellow Media must demonstrate meaningful traction with its digital transition while attaining additional liquidity to help with refinancing needs to keep its Issuer Rating in the BB range. Alternatively, should its transition take longer while print pressure continues to accelerate, Yellow Media may not have the ability to handle its debt maturities by means of internally generated free cash flow as they mature.

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

The applicable methodology is Rating the Newspaper and Magazine Publishing Industry, which can be found on our website under Methodologies.