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Recovery: When The Credit Cycle Turns: Recovery Prospects In The U.S. Media Sector

In this article, we define the U.S. media sector as companies S&P Global Ratings rates using the media and entertainment key credit factors (see "Key Credit Factors For The Media And Entertainment Industry," Dec. 24, 2013). In certain sections when we cite our other published analyses, those articles refer to the broader media, entertainment, and leisure sector, which includes certain leisure and business services companies in addition to media and entertainment companies.

Low Credit Quality And Defaults Have Persisted In The Sector Since The Financial Crisis, Yet First-Lien Recovery Remains Meaningful

Recovery prospects for the U.S. media sector are important for CLO and high-yield investors given the sector's relatively high concentration of lower-quality credits and the sector's significant holdings by CLOs. As of mid-year 2019, media and entertainment companies constituted over 8% of broadly syndicated CLO 2.0 holdings. Further, media, entertainment, and leisure companies constitute the third-highest sector tally of weakest links (issuers rated 'B-' or lower by S&P Global Ratings with negative outlooks or ratings on CreditWatch with negative implications; see "Argentine Companies Boost The Weakest Links Tally To Its Highest Since 2016," Sept. 11, 2019).

Chart 1

image

Further, the media sector had numerous bankruptcy filings following the Great Financial Crisis in 2008, particularly in the print and publishing subsectors, though like most corporate sectors (other than commodities and retail), bankruptcy filings have been limited since 2015. For the sector's 30 bankruptcies between 2008 and 2017, the median and average first-lien recoveries were 77% and 73%, respectively. For additional details and a comparison with actual recovery performance for other sectors, see "A 10-Year Lookback At Actual Recoveries And Recovery Ratings," Feb. 4, 2019.

High Leverage Underscores The Sector's Relatively Low Credit Quality

Media companies' overall debt leverage has remained high over the last few years, largely due to significant LBO transactions and aggressive debt-financed acquisitions. A majority of transactions have included firms in the data and information, local TV broadcasting, and miscellaneous media services companies segments, with relatively high purchase multiples. These have resulted in high relative leverage despite sizable equity contributions. In addition, first-time-rated issuers in recent years have tended to result from sponsor purchases of either carve-outs from larger companies or small niche players, with high initial leverage. Transactions among print and publishing companies (which are trading at historically low multiples) have been scarce, largely due to failed M&A bids stemming from regulatory and funding challenges.

Media and entertainment companies top the charts among corporate sectors for EBITDA addbacks based on our review of about 260 M&A and LBO transactions that originated between 2015 and 2018. We believe EBITDA addbacks are a way to artificially inflate earnings and deflate leverage. The average addbacks for media, entertainment, and leisure companies was 34% of company pro forma adjusted EBITDA at deal inception, with cost savings/synergies and restructuring costs constituting over 50% of the addbacks. This compares with an average of about 28% across all corporate sectors.

Table 1

Average Addbacks By Sector
Sector Numbner of companies Average of total addbacks/company pro forma adjusted EBITDA at inception (%) Average of total addbacks/reported last-12-month EBITDA at inception (%)
Media, entertainment, and leisure 27 34.2 42.0
Technology 55 33.0 62.0
Health care 39 32.1 64.6
Chemicals 9 31.4 66.1
Auto/trucks 6 29.1 42.1
Transportation 7 25.5 37.5
Capital goods/machinery and equipment 23 25.4 57.2
Consumer products 23 23.5 34.0
Restaurants/retailing 12 21.7 46.2
Aerospace/defense 10 20.7 42.1
Forest products/building materials/packaging 14 19.7 26.4
Business and consumer services 23 19.4 27.9
Others 9 19.0 24.6
Total 257 27.6 48.5

Our ratings are based on our projections of a company's growth and earnings as well as our view of issues like expected synergies or cost efficiencies. Marketing leverage and the language around addbacks as defined in debt agreements do not determine our view of credit risk. That said, we often do give some credit to addbacks or synergies that we view as achievable, especially when a company has demonstrated its ability to realize on similar items in past comparable transactions. However, we are almost always considerably less optimistic than management when it comes to certain elements pertaining to future growth, such as realizable revenue and cost synergies, and our projections reflect that. In addition, we exclude adjustments for items that are ultimately cash operating costs like management fees and restructuring costs. For more details on EBITDA addbacks and how companies have attempted to understate leverage, see "When The Cycle Turns: The Continued Attack Of The EBITDA Add-Back," Sept. 19, 2019.

Secured First-Lien Recovery Rating Distribution

As Chart 2 (which comprises all outstanding secured first-lien debt as of the end of July 1, 2019) shows, we have higher first-lien recovery expectations for media than for corporates as a whole.

Chart 2

image

Media companies' first-lien debt is more frequently rated '1' (indicating 90%-100% recovery) and '2' (70%-90%) than corporates overall. Indeed, 27% of media companies have a '1' first-lien senior secured recovery rating and 35% have '2' compared with 19% and 22%, respectively, for corporates. A majority of the remaining recovery ratings--about 32% for media versus over 50% for corporates--are rated '3', indicating 50%-70% recovery. The median and average first-lien recovery for media is 77% and 81%, respectively, compared with about 69% and 74% for corporates.

The higher recovery expectations for media versus corporates might appear somewhat counterintuitive given the high degree of debt leverage for companies within the media sector. And on top of that, print and publishing companies are facing secular declines. However, in the media sector a lower amount of priority debt--such as asset-based loans and first-out revolvers--is ahead of first-lien debt, which is a key factor in the higher first-lien recoveries. For example, priority debt constitutes only 1% of the capital structure for media companies versus about 4% for corporates outside of the media sector. While the variance in priority debt levels appears somewhat small, it improves first-lien recovery prospects for media companies by almost 5% on average.

Another factor that drives the higher recovery outcomes for media is the higher average valuation multiple of 6x versus 5.2x for corporates overall. The higher EBITDA multiples for the media sector are based on the sector's higher historical enterprise valuation multiples and the presence of a combination of fast-growing, highly valued subsectors, such as data publishers, outdoor companies, local TV broadcasters, and Internet companies. Furthermore, certain subsectors in media own assets that are in limited supply, such as billboards for outdoor advertisers and spectrum for TV and radio companies. The valuations for these subsectors is supported by the inherent scarcity of these underlying assets and the potential that they could be owned and operated more productively by another provider. Indeed, the number of companies with multiples of 6x or higher in the media sector outnumber those with multiples of 5x or lower. We typically assign lower multiples to companies operating in subsectors such as print and publishing, which we believe are in secular decline.

However, our recovery enterprise value is computed based on a combination of our estimate of an EBITDA multiple and the emergence EBITDA for companies. A key factor influencing our estimate of emergence EBITDA is the level of fixed charges a company needs to cover to avoid a default. Given the relatively low capital intensity of most companies in the media sector, fixed charges may need to fall further for many media companies compared to other more capital-intensive sectors, which generally lowers our estimated emergence EBITDA and offsets some of the benefits derived from a higher multiple.

New-Issue First-Lien Recovery Rating Distribution

Recovery ratings on first-lien debt newly issued by media companies and by all corporates in the last 12 months (see Chart 3) show a similar trend to that of recovery ratings for all of media and for corporates (see Chart 2).

Chart 3

image

However, median first-lien recovery for media and for corporates have diverged somewhat. Over the last 12 months, the median first-lien recovery for debt issued by corporates overall was about 66%, slightly lower than for all of corporates. The median first-lien recovery for first-lien debt issued by media companies was about 78%, slightly higher than for all media companies.

A key driver for this trend and the decline in median recoveries for corporates is an increasing use of first debt in the capital structure. Indeed, the junior debt cushion for corporates was 21% for debt issued over the last 12 months compared with 32% for all corporate issuers. However, we have not seen a similar trend for media. In the media sector, the junior debt cushion is about 32%--both for the debt issued over the last 12 months and across all of the media companies.

First-Lien-Only Capital Structures Are Slightly Less Common In The Media Sector

Only two (7%) of the 27 media companies that issued debt over the last 12 months (Allen Media and SurveyMonkey) had an all-first-lien capital structure compared with almost 65 (13%) of the 485 companies across all corporates. However, the media sector on the whole has only a slightly lower percentage (about 13%) of all-first-lien capital structures than corporates (about 16%).

Table 2

First-Lien Recovery
--First-lien recovery-- --Average % company debt-- --Number of ratings--
Media subsectors Median Average Priority debt First lien Junior debt Average multiple Ratings 'B-' or lower Total % of ratings that are 'B-' or lower
Data publishers 76.6 83.8 0.0 61.5 38.5 6.5 3 7 42.9
Internet 63.7 70.4 0.0 67.0 33.0 6.3 1 10 10.0
Broadcasters\local TV 100.0 95.3 1.0 43.1 55.8 6.6 0 10 0.0
Cable\national TV 67.9 74.4 0.4 85.3 14.3 6.5 0 5 0.0
Print and publishing 77.3 77.9 2.5 63.0 34.4 5.0 9 17 52.9
Radio\outdoor 89.3 86.2 2.3 68.7 29.0 6.4 4 12 33.3
Miscellaneous 75.1 79.4 0.3 74.4 25.3 5.9 10 28 35.7
Overall media 77.2 80.6 1.0 66.7 32.3 6.0 27 89 30.3
Other corporates 68.7 73.4 4.2 64.0 31.8 5.2 485 1,644 29.5
All corporates 69.3 73.8 4.0 64.1 31.8 5.3 512 1,733 29.5

Despite the relatively high overall first-lien recovery levels for the media sector, we see meaningful variations within the recovery expectations across subsectors. For example, median first-lien recoveries are highest for the broadcasters\local TV and radio\outdoor in the media subsectors and lowest for Internet and cable\national TV.

First-Lien Debt Recoveries Are Highest For Local TV Broadcasters And Radio\Outdoor Companies

A significant junior debt cushion, little priority debt ahead of first-lien debt, and higher valuation multiples within media support very high recovery expectations for the first-lien debt for local TV broadcasters. On the other hand, the high median first-lien recoveries for radio and outdoor companies are primarily driven by the relatively high multiples in the subsector, with the outdoor companies in particular benefiting from high valuation multiples. Furthermore, six of the radio/outdoor companies (Entercom Communications Corp., Outfront Media Inc., Sirius XM Radio Inc., Townsquare Media Inc., Clear Channel Outdoor Holdings Inc., and Lamar Advertising Co.) have very high recoveries on their first-lien debt, in part due to their meaningful junior debt cushions.

First-Lien Debt Recoveries Are Lowest For Internet And Cable\National TV Companies, Mainly Due To First-Lien-Only Capital Structures

Internet and cable\national TV companies have the lowest median first-lien recoveries within the sector. Among the companies in the Internet subsector, the median recovery is skewed by four of the nine companies having substantially all of their debt structured as first-lien debt with a median recovery of 63%, which effectively lowers the overall median recovery for the subsector. Consequently, we believe the average first-lien recovery of approximately 70% is a more reflective metric for the Internet subsector. Similarly, four out of the five cable\national media companies have all-first-lien capital structures that lack a cushion of junior debt to absorb losses before first-lien creditors. We note that there is ample research showing that first-lien recoveries are strongly and positively correlated with the extent that there is a cushion from more junior debt.

First-Lien Debt Recoveries For Printers And Publishers Benefit From A Junior Debt Cushion

The average and median first-lien recoveries of almost 77% for the print and publishing subsector at first glance appear surprisingly high, especially given the low multiple attributed to the subsector compared with those of other subsectors within media. Indeed, three out of the 10 companies with first-lien recovery of over 75% had EBITDA multiples of 4x, and six of the 17 companies in the subsector had a 4x EBITDA multiple. Nevertheless, the average junior debt cushion for printers with first-lien recoveries of over 75% is almost 50%. Furthermore, some of these companies--such as R.R. Donnelley & Sons Co. and The McClatchy Co.--have legacy unsecured debt providing substantial junior debt cushion and supporting higher first-lien recovery. Their debt is currently trading below par, and the companies would likely need to provide collateral when issuing new debt to fund operating needs, refinancing, or growth initiatives. Debt maturities are less of a concern for McClatchy because its nearest debt maturity is in 2026. Furthermore, several of the companies that have recently secured first-lien financing have higher than the typical 1% first-lien debt amortization, supporting a higher level of fixed charges and resulting emergence EBITDA estimates and a somewhat lower level of debt outstanding in a hypothetical default scenario. Valuations in the subsector are also supported by custom and specialty printers such as Cimpress N.V., Digital Room Holdings Inc., and check printer Harland Clarke Holdings Corp. (which we typically value at 5x-6x) and textbook publishers such as Houghton Mifflin Harcourt Co., McGraw-Hill Education Inc., and Cengage Learning Holdings II Inc. (6x). While all of these businesses face some level of secular pressure, we believe their niche positions in the respective markets afford them some level of competitive reprieve compared with commercial printers.

Looking Ahead

Over 85% of media companies are rated in the speculative-grade category ('BB+' and lower), and a substantial number of them have high credit risk, with ratings of 'B-' or lower. A large proportion of revenues for the sector stem from advertising and are exposed to cyclicality, and an increasing number of subsectors are facing secular pressures and digital disruption. However, some companies within the sector are benefiting from robust growth from participating in the digital disruption through Internet and data and information services.

That said, a significant concentration of speculative grade companies in the sector and a large number of weakest links reflect that companies in the sector have limited margin for error in operating performance. Given the high relative leverage in the sector, when the cycle turns, we believe many companies in it will find it difficult to service and refinance debt. Nevertheless, first-lien media lenders are protected from significant priority claims, cushioned by reasonable levels of junior loss absorbing debt, and supported by above-average EBITDA valuation multiples. Furthermore, capital structures for media companies have fewer-than-average first-lien-only capital structures. Thus, we believe that the sector presents above-average recovery prospects for first-lien investors overall.

This report does not constitute a rating action.

Primary Credit Analyst:Vishal H Merani, CFA, New York (1) 212-438-2679;
vishal.merani@spglobal.com
Secondary Contacts:Naveen Sarma, New York (1) 212-438-7833;
naveen.sarma@spglobal.com
Steve H Wilkinson, CFA, New York (1) 212-438-5093;
steve.wilkinson@spglobal.com

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