DBRS Assigns Ratings to DHX Media Limited

DBRS Limited (DBRS) has today assigned a provisional Issuer Rating of BB (low) to DHX Media Limited (DHX or the Company) and a provisional rating of BB (low)/RR4 to the Company’s proposed new Senior Unsecured Notes, both with Stable trends. The ratings are based on the Company’s strong brands, the underlying stability and growth potential of children’s content and the potential associated with the growing popularity of digital distribution platforms. The ratings also consider increasing competition, exposure to constantly evolving consumer preferences, as well as risks associated with potential regulatory change and growth through acquisition.

DHX owns the world’s largest independent library of children’s and family television/film content, consisting of over 400 titles and over 11,400 half hours of programming. The Company has also established itself as one of Canada’s premier production houses, creating both new content and relaunching legacy franchises. DHX is capitalizing on content acquisitions and building digital distribution relationships as the popularity and adoption of over-the-top services continues to grow.

DHX’s revenue has nearly tripled over the last five years, increasing to $116 million in F2014 from $40 million in F2010. Growth has primarily been the result of selective acquisitions that have helped build DHX’s content library and production capabilities. Brand acquisitions include Yo Gabba Gabba! in September 2010, Caillou and Inspector Gadget (Cookie Jar Entertainment (Cookie Jar)) in October 2012, Teletubbies (Ragdoll Worldwide (Ragdoll)) in September 2013, DHX Television assets (including the Family Channel) in July 2014 and Degrassi: The Next Generation (Epitome Pictures Inc. (Epitome)) in April 2014. DHX maintains a consistent record of creating and monetizing content. Production-related revenues have grown to $42 million in 2014 from $26 million in 2010 while distribution revenues have nearly quadrupled to over $40 million over the same period.

The Company’s adjusted EBITDA increased significantly to $37 million in F2014 from $4 million in F2010 as the Company has grown the portion of its business dedicated toward higher-margin distribution, merchandising and licensing. DBRS notes that the revenues and earnings over the near term are fairly predictable in the content provision business based on the nature of broadcasting contracts and longer-term digital distribution deals.

DHX’s financial profile is adequate for the current rating category based on the Company’s increasing cash-generating capacity, negligible maintenance capex and reasonable leverage. Historically, DHX has remained free cash flow neutral as operating cash flow has been directed toward investments in television programs and films and nominal maintenance capex (investments in property, plant and equipment). DBRS notes that DHX has maintained a history of relatively balanced financial management, issuing both debt and equity to fund acquisitions. In October 2012, the Company assumed $57 million of debt as part of the Cookie Jar acquisition. DHX issued 11.2 million shares at $3.60 per share in October 2013 to reduce indebtedness, to fund future acquisitions and to fund its working capital deficit among other uses. In F2014, DHX’s Ragdoll acquisition was debt-funded while Epitome was financed through a combination of equity and cash on hand. As of September 2014, and pro forma the television asset acquisitions, DHX had a debt balance of $253 million (including the Echo Bridge Entertainment acquisition).

DBRS expects DHX’s earnings profile to improve within the current rating category as the Company integrates acquisitions, grows its digital distribution channels and expands its content library. In July 2014, DHX undertook a transformational acquisition by purchasing the Family Channel ($80 million in annual revenue, $25 million to $30 million in run-rate adjusted EBITDA) to provide it with a controlled distribution outlet to further build its brands. DBRS expects pro forma consolidated revenues to increase to between $240 and $260 million in F2015. DBRS expects adjusted EBITDA to be approximately $70 million to $80 million in F2015 as the Company grows its higher-margin distribution business. While DHX’s primary focus will be to integrate past acquisitions and monetize its existing library, DBRS expects that the Company will continue to pursue acquisitions on an opportunistic basis.

With the benefit of the cash flow from the DHX Television assets, free cash flow should grow to approximately $30 million in F2015. DBRS expects the pace of proprietary investment in film and television programs to slow over the next few years, which should result in free cash flow growing steadily from this level over the medium term.

DHX is in the process of issuing $150 million of Senior Unsecured Notes to repay bank debt issued to fund the Astral Kids’ acquisition. DBRS notes that the Company is required to pay down 10% (approximately $11 million) of the initial value of its term facility annually. DBRS notes that key credit metrics are adequate for the current rating category pro forma the debt-financed Astral Kids’ asset acquisition. Pro forma lease-adjusted debt-to-adjusted EBITDAR and lease-adjusted EBITDAR coverage stand at 3.5x and approximately 4.8x, respectively.

DBRS believes that future acquisitions will be financed in a balanced fashion such that leverage remains below the step-down thresholds specified in the Company’s credit agreement. DBRS expects credit metrics to improve through a combination of debt reduction and earnings growth but remain within the current rating category in the near to medium term. On the other hand, should lease-adjusted debt-to-adjusted EBITDAR increase to above 4.0x, resulting from either weaker-than-expected operating income and/or more aggressive financial management, the ratings could be pressured.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Television Broadcasting Industry (July 2014), which can be found on our website under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.