DBRS Downgrades Corus Entertainment Issuer Rating and Assigns Provisional Rating to New Senior Unsecured Notes

DBRS Limited (DBRS) has today downgraded Corus Entertainment Inc.’s (Corus or the Company) Issuer Rating to BB from BB (high). The existing Senior Unsecured Notes have also been downgraded to BB from BB (high); the recovery rating remains at RR4. DBRS has also assigned a provisional rating of B (high) with a recovery rating of RR6 to the proposed Senior Unsecured Notes, two notches below Corus’s revised Issuer Rating. The trends are all Stable.

The ratings are supported by Corus’s established Canadian market positions in television (TV) and radio broadcasting and strong cash generation, while also reflecting an increasingly competitive environment, pending regulatory changes and cyclicality of advertising and merchandising revenue. This action follows DBRS’s review of the Company’s intended acquisition of Shaw Media Inc. (Shaw Media) and removes Corus’s current ratings from Under Review with Developing Implications. DBRS notes that the existing Senior Unsecured Notes with a recovery rating of RR4 will be redeemed on closing of the Shaw Media acquisition, at which time DBRS will discontinue the rating on those Notes.

On January 13, 2016, DBRS placed the ratings of Corus Under Review with Developing Implications following the Company’s announcement that it had agreed to acquire Shaw Media from Shaw Communications Inc. (Shaw) for $2.65 billion (the Transaction). The acquisition is predicated on Corus receiving minority shareholder approval and customary regulatory approvals.

Since then, the Company has completed the equity offerings associated with the Transaction. A minority shareholders’ vote regarding the Transaction is expected to take place in early March 2016. In addition, the proposed business combination is progressing through the necessary regulatory approval processes. DBRS does not anticipate an adverse decision from the Canadian Radio-television and Telecommunications Commission, given the regulator’s track record of regarding both Shaw and Corus as a single entity because both companies are controlled by the Shaw family.

The purchase price for the acquisition will be satisfied by Corus paying Shaw $1.85 billion in cash and issuing 71 million Corus Class B non-voting participating shares to Shaw (the Corus shares; valued at $800 million). As such, Shaw will own roughly 38% of Corus’s outstanding shares and will retain three seats on Corus’s board of directors. Additionally, Shaw has agreed to participate in Corus’s dividend reinvestment program (DRIP) and a 100% lockup of the Corus shares for at least 12 months following the Transaction’s close, with specific sale restrictions thereafter.

Corus will use the proceeds from the equity issuances, new bank debt and upcoming Notes offerings to finance the acquisition, redeem the existing Notes and refinance existing credit facilities. The Company has issued approximately $295 million of equity (through a public subscription receipt offering and a $32 million subscription receipt offering to the Shaw family). Corus has also arranged a new $2.0 billion term credit facility and a new $300 million revolving credit facility. Corus will issue up to $300 million of Senior Unsecured Notes, which rank below the above noted $2.3 billion of secured bank debt; this leads to the recovery rating of RR6. The Company will repay existing bank debt of $71 million (as at February 8, 2016, under its current $500 million revolving facility), and intends to redeem the existing 4.25% $550 million Senior Unsecured Notes due February 2020. The existing $150 million term facility was repaid at maturity on February 3, 2016.

In its review, DBRS focused on (1) the business risk profile of the combined entity, including the benefits and risks associated with integration and realization of operating synergies; (2) assessing the cash-generating capacity of the combined entity, including the impact that the newly issued shares will have on free cash flow after dividends; (3) the Company’s deleveraging plan following the Transaction; and (4) the Company’s longer-term business strategy and financial management intentions.

DBRS Analysis

(1) Business Risk

DBRS believes that the Transaction’s primary benefit to the Company’s business risk profile is the material enhancement of its scale and revenue diversification. The inclusion of Shaw Media’s 19 specialty TV channels and the Global Television network will bring Corus to a total of 45 specialty and 15 conventional TV channels; 39 radio stations; the Nelvana animation studio; and digital assets. Furthermore, the combined entity would have a much lower exposure to the challenged radio segment at 10% of sales on a pro forma basis versus 20% of revenues before the acquisition. In its last update of Corus’s ratings, DBRS noted that the Company’s organic revenues were under pressure due to the general softness in the ad¬vertising market in both the TV and radio segments. More importantly, DBRS noted that the Canadian media sector was experiencing significant structural challenges, including competition driven by digital disruption and regulatory changes. As such, maintaining advertising revenue and prevent¬ing subscriber-base erosion over the longer term may become increasingly difficult.

The combined entity generated sales of approximately $1.9 billion in revenues and adjusted EBITDA of $619 million on a pro forma basis in 2015. The combined entity will have 34.5% market share in domestic English language TV viewership, which compares with 35.0% and 11.0% for Bell Media and Rogers Media, respectively. That said, these major competitors have a significant presence in the attractive sports broadcasting market. On the other hand, Corus will achieve a market leading position in women, children and family programming in Canada, providing the Company with its own comparative advantage for advertising and subscription revenues as competition intensifies. DBRS believes that the combination should also bolster Corus’s negotiating position with broadcast distributors, enhance its range of promotional opportunities and improve its pricing power with advertisers. In terms of operating margins, the combination is expected to result in a gradual improvement over the medium term to the mid-30% range from the low-30% range, largely because of roughly $40 million to $50 million of annual cost synergies within 24 months and $15 million in immediate corporate overhead reductions.

(2) Financial Risk Profile

In terms of financial profile, the Transaction is expected to result in a significant increase in the Company’s debt balance (approximately $2.3 billion) and financial leverage. Pro forma gross debt-to-last 12 months (LTM) EBITDA is expected to peak at the time of closing at roughly 3.9 times (x) from 2.8x for the LTM ended Q1 F2016. That said, the Company intends to deleverage to below 3.0x by the end of F2018 primarily by applying the majority of free cash flow (after dividend payments) to debt repayment in the first year and then to scheduled principal repayments and growth in EBITDA thereafter.

In its Under Review press release, DBRS noted that Corus’s credit risk profile could remain commensurate with the BB (high) rating category; however, in its review, DBRS assessed that the mounting risks in the media sector would make it difficult for some companies, including Corus, to maintain organic operating income. This could lead to pressure on free cash flow and impede the Company’s ability to deleverage at the intended pace, especially given high total dividend distribution (particularly with the increase in common shares associated with the Transaction). Notwithstanding Shaw’s DRIP commitment until the end of F2017, DBRS assessed the Company’s free cash-generating capacity without a DRIP take-up beyond this point. DBRS forecasts that Corus’s free cash flow (after dividends)-to-total debt will be less than 10% after the DRIP commitment period. As such, DBRS believes that the Company’s Issuer Rating is better positioned at the high end of the BB rating category, where it has greater flexibility to absorb moderate declines in revenue and earnings.

(3) Outlook

Although DBRS notes that the Transaction has significant scale benefits, Corus remains concentrated in the TV broadcasting sector. DBRS has noted for some time that the Canadian media sector is experiencing significant structural challenges, including competition driven by digital disruption and regulatory changes. DBRS expects trends of cord cutting and shaving of TV services in favour of over-the-top services to accelerate. Furthermore, the structural transition toward newer forms of digital advertising from traditional TV and radio broad¬casting amid competition from Internet and mobile advertising is also expected to persist. Pending regulatory changes set to be implemented in the coming months (“skinny basic” in March 2016 and “pick-and-pay” in December 2016) could exacerbate these pressures further by giving consumers greater discretion over their TV bundles. DBRS believes that these factors will continue to contribute to less predictable and potentially lower organic revenues and earn¬ings quality for Corus over the near to medium term.

DBRS recognizes that the combined company may be better positioned to withstand revenue pressures over the near to medium term and allow it to better compete with vertically integrated rivals, such as Bell Media and Rogers Media, than each company could have achieved separately. However, in light of the uncertainty regarding how consumers will adjust their TV-viewing patterns and how the advertising environment will evolve in a new pick-and-pay environment, DBRS believes that Corus’s medium-term leverage gross debt-to-EBITDA target of 3.0x may be difficult to achieve within the specified time frame, but is a sound objective that is more than adequate to maintain the current ratings. DBRS would not consider a negative rating action over the near to medium term unless there was a material decline in revenue, operating income and free cash flow (after dividends) while financial leverage remained above 3.5x.

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 methodologies are Rating Companies in the Television Broadcasting Industry, Rating Companies in the Radio Broadcasting Industry, and DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers, 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.