Rogers' Shaw deal leaves credit analysts concerned about rising debt load

Rogers Communications Inc.'s planned purchase of Shaw Communications Inc. would be a transformative deal, combining two of Canada's top cable operators. But credit analysts warn the deal will also transform Rogers' balance sheet — and not in a positive way.

Rogers said March 15 that it agreed to buy Shaw in a deal valued at about C$26 billion, including nearly C$6 billion of Shaw debt. Credit analysts responded to news of the deal by raising concerns about Rogers' ability to pay off its debt down the line.

S&P Global Ratings credit analyst Aniki Saha-Yannopoulos said the deal will strengthen Rogers' competitive position in Canada, giving the combined company "a national cable footprint that covers almost 60% of Canada with quad-play capability in their market." Both Rogers and Shaw provide not only wired video, broadband and phone offerings, but also wireless service.

But Saha-Yannopoulos warned that Rogers could face a two-notch downgrade on its current BBB+ long-term credit rating.

"Integration and transition risks, potential restructuring costs, and spectrum investments could result in subdued discretionary free operating cash flow and materially higher leverage in the first couple of years after closing," the analyst said.

During a March 15 webinar, Saha-Yannopoulos quantified just how much higher Rogers' leverage could be: "Assuming it's an all debt financed transaction, we view that it will weaken Rogers' leverage to greater than 5x, [up] from 3x at year-end 2020. Almost a two-category deterioration in leverage."

Rogers ended 2020 with a total debt to EBITDA ratio of 3.6x, according to S&P Global Market Intelligence data. Leverage ratios give a sense of how soon and how easily a company could pay off its debt based on its earnings. The higher the ratio, the harder it will be for a firm to successfully pay off its debt.

Rogers' debt has steadily increased from fiscal 2017 through 2020. In 2017, the company had total debt of C$16.04 billion and a leverage ratio of 2.9x. In fiscal 2020, the company had a total debt of C$21.26 billion.

"In our mind, debt repayment discipline will be key ... Whether management has the ability and the willingness to continue to use its cash flow to repay debt," added Saha-Yannopoulos on the webinar.

Similarly, Fitch Ratings placed Rogers' BBB+ long-term issuer default rating on Rating Watch Negative following the March 15 deal announcement. Fitch, like S&P, warned of a leverage ratio "in excess of 5x" for Rogers following the transaction's close.

During a call with analysts, Rogers CFO Anthony Staffieri acknowledged the company's leverage will be high upon closing. But he believes the combined entity can quickly bring it down.

"On closing, our leverage ratio is expected to be just over 5x debt-to-EBITDA. However, we expect our leverage to quickly move to under 3.5x within 36 months of close, and we expect to retain our investment-grade credit rating throughout this period," the CFO said.

William Densmore, a senior director at Fitch Ratings, said he believes Rogers would take "necessary actions" to maintain commitments to deleveraging targets if EBITDA and free cash flow generation are below expectations.

These necessary actions could include asset sales, according to the analyst.

"Assets that could be monetized are material and include Rogers' stake in Cogeco Communications Inc. and parent Cogeco Inc. (valued at roughly CAD1.8 billion), sports and media stakes, and real estate," wrote Densmore. "Rogers could also use hybrid debt and common stock issuances to reduce leverage," he added.

In October 2020, the boards of Cogeco Inc. and Cogeco Communications Inc. unanimously rejected a revised unsolicited, nonbinding takeover offer from Altice USA Inc. and Rogers. Altice USA aimed to scoop up Cogeco's U.S. assets while Rogers sought to increase its share of Cogeco's Canadian assets.

Staffieri said he does not expect asset sales to be necessary.

"There's no need for us to look at selling any of our assets. Any decision with respect to Cogeco or other assets would be completely independent of this. And there's no decision to sell any of those assets," he said.

If the Shaw acquisition is approved by regulators, Densmore believes remedies may be required because of the "overlap of the wireless operations with both companies maintaining a national network with a higher customer concentration in Ontario."

The deal, which is expected to close in the first half of 2022, must be approved by several Canadian regulators, including the Competition Bureau, the Ministry of Innovation, Science and Economic Development, and the Canadian Radio-television and Telecommunications Commission.

Rogers CEO Joe Natale said the company has already been talking to regulators. While he did not comment on any divestitures that may be required specifically, he noted 80% of Shaw's revenues and 97% of its free cash flow are earned from the wireline business, which does not compete directly Rogers.

Moreover, he noted the lines between wireless and wireline are becoming increasingly blurred with next-generation 5G service, which requires both wireless spectrum and deep fiber penetration for backhaul.

"5G really is an amalgamation of wireline and wireless coming together to offer capabilities and connectivity that wasn't possible, given the economics of traditional landline [and] traditional 4G capabilities. So we believe that's an important factor in this discussion," the executive said.