- We have lowered Arqiva Group Parent Ltd.'s business risk profile (BRP) to satisfactory from strong.
- Despite lowering the BRP, we have affirmed at 'BBB' our ratings on all classes of corporate securitization notes issued by Arqiva Financing and Arqiva PP Financing.
- Our ratings reflect our view of the borrower group's BRP, the assets' performance and cash flow generating potential, the structural protection features available to the noteholders, and our assessment of the counterparty exposures in the transaction.
- The transaction is a corporate securitization of the operating business of Arqiva Group Parent, which provides communications infrastructure and media services in the U.K.
LONDON (S&P Global Ratings) Dec. 22, 2020--S&P Global Ratings has today affirmed at 'BBB' its credit ratings on all classes of notes issued by Arqiva Financing PLC and Arqiva PP Financing PLC.
The transaction is a corporate securitization of the operating business of Arqiva Group Parent Ltd. (the Arqiva group), which provides communications infrastructure and media services in the U.K. The Arqiva group provides much of the infrastructure behind TV, radio, satellite, and wireless communications in the country. Its customers include major U.K. broadcasters such as the BBC, ITV, Channel 4, Five, Sky, Discovery, BT, and Sony; and the independent radio groups Global Radio and Bauer Radio.
The transaction would likely qualify for the appointment of an administrative receiver under the U.K. insolvency regime. An obligor default would allow the noteholders to gain substantial control over the charged assets prior to an administrator's appointment, without necessarily accelerating the secured debt.
We have applied our corporate securitization criteria as part of our rating analysis on the notes. As part of our analysis, we assess whether the operating cash flows generated by the borrower are sufficient to make the payments required under the notes' loan agreements by using a debt service coverage ratio (DSCR) analysis under a base-case and a downside scenario. Our view of the borrowing group's potential to generate cash flows is informed by our base-case operating cash flow projection and our assessment of its business risk profile (BRP), which is derived using our corporate methodology (see "Corporate Methodology," published on Nov. 19, 2013).
We have lowered the BRP of the Arqiva group to satisfactory from strong. It has the following strengths:
- Good predictability of revenue and cash flows, thanks to a high proportion of long-term contracted revenues, with contractual retail price inflation (RPI)-linked increases. Contract renewal rates are high. Notably, as of June 2020, the Arqiva group's order book amounted to about £3.8 billion.
- Its client base consists largely of investment-grade companies (rated 'BBB-' or higher), with a large share of revenues from state-owned broadcasters that have good standing in credit markets, in our view.
Weaknesses and mitigating factors:
- Limited geographic diversification, with operations principally focused on the U.K. market. This is partly offset by its strong market position and the monopoly-like characteristics of the TV broadcasting business.
- The regulatory environment for spectrum allocation among alternative uses is still evolving, which could result in changes to the revenue mix and profitability.
- The economic viability of competing technologies could improve over time, or new technology may emerge and erode the borrower's market position. Although this is a threat to the borrower's business, we view it as a long-term risk, at which point the borrower is likely to have reduced debt.
- Following sale of core Telecom Tower business to Cellnex we believe this weakens the group's overall competitive advantage and loss of telecom-site hosting weakens the group's medium- to long-term growth prospects.
The group applied the sale proceeds of its core Telecom Tower business toward debt and swap repayments as reflected in the annual report published on Sept. 22, 2020.
Our base-case EBITDA and operating cash flow projections for financial year (FY) 2021 and the company's satisfactory BRP rely on our corporate methodology.
We expect total revenues will decline by about 6% in FY2021, due to the completion of the "700MHz clearance program" during FY2020, more conservative market assumptions, average pricing for contract renewals in digital platforms, and continued exit from low-margin activities in the satellite and media business line. In FY2020, the actual revenue for the group declined reflecting expected declines due to the end of legacy contracts, decision to exit certain market areas and program completion along with some challenges in the markets in which the company operates including impacts from the COVID-19 pandemic.
We expect revenue performance in the media networks (terrestrial broadcast, digital platforms, and satellite and media) and M2M (smart metering) operating segments to be globally in line with management guidance, considering the Arqiva group's order book.
- Terrestrial broadcast: revenues generally grow globally with RPI as most contracts are RPI-linked. However, completion of the 700 MHz clearance project in FY2020 means we expect segment revenue to decline by close to 10% in FY2021 before stabilizing in FY2022. Over the longer-term, we expect Arqiva will benefit from dual revenue streams for analogue and digital as long as radio broadcasters maintain parallel setup, translating into annual low-single digit revenue growth.
- Digital platforms: we expect double-digit revenue contraction in FY2021, and single-digit revenue decline in FY2022 and FY2023 due to more conservative assumptions in terms of mux streams and average pricing to reflect a more conservative view of the advertising market.
- Satellite and media: we forecast high-single-digit revenue decline in FY2021 due to continued exit from low-margin business lines. From FY2022 we anticipate a rebound in the topline trend driven by over-the-top (OTT) services for video-on-demand (VoD) media processing and internet protocol (IP) streaming, and satellite data communications growing new IP broadband global access network (BGAN) services in the U.K. utility gas/electricity network operators.
- Smart metering: we assume single-digit revenue growth in FY2021, reflecting contracts linked to the continued rollout of specific existing projects, including Thames Water. In addition, the forecast considers an additional water contact win in FY2021.
On the cost side, we expect that costs will decline less than revenue in FY2021, resulting in adjusted EBITDA margin dilution to about 51% in FY2021. Thereafter we expect a gradual improvement of the adjusted EBITDA margin back toward about 54% in FY2023, largely due to continued implementation of the Future Fit Program.
We have kept management capital expenditure (capex) assumptions as, in our view, they are realistic and are tied to maintenance and specific projects. We have included maintenance capex and both committed and uncommitted capex (as we believe the uncommitted capex is likely to become committed in the indicated periods). The company expects a reduction in its capex in FY2021 compared to FY2020 and FY2019. This significant reduction over the medium term is due to a number of projects that are winding down, in particular smart metering change requests and clearance, which have significantly inflated current capex. Procurement savings will also contribute to lower capex over the near term. Finally, we note that over 90% of future growth capex relates to contracted growth projects, and this provides strong capex visibility.
Beyond FY2024, our base-case and downside EBITDA projections are based on our criteria for rating corporate securitizations, from which we then apply assumptions for capex and taxes to arrive at our projections for the cash flow available for debt service.
Our revenue assumptions are based on the contracted revenue and order book information that the Arqiva group provided to us as well as detailed information on the RPI linkage of contracts in each segment. We assume that it will maintain the contracts it has in place but that no new contracts will be signed. Our assumptions, indirectly, factor in cost increases in line with RPI by applying a constant revenues margin assumption. Corporate and technology cost assumptions are in line with management's plan, and we assume maintenance capex in line with the company's projections. Notably, since no revenues from new contracts are assumed from FY2021, we assume only the maintenance capex required to support the contracted portion of revenue. We assumed that growth capex required to sustain the revenues during FY2024 is spent and that forecast growth capex is included due to the technology investment needed to maintain the base-case cash flow level rather than for growth, with any assumptions for new contracts excluded from our cash flow projections. We have also assumed a material increase in growth capex in FY2030-FY2032 to account for the predicted renewal capex required when the digital terrestrial television (DTT) network equipment is due for the next major refurbishment.
We established an anchor of 'bbb-' for the class A notes based on:
- Our assessment of the Arqiva group's satisfactory BRP, which we associate with a business volatility score of 3; and
- In our base-case DSCR analysis, we do not give credit to the borrower liquidity facility (BLF) as the facility can be used to service borrower's bank debt which has reduced following the redemption and the respective maturities are closer.
Our downside DSCR analysis tests whether the issuer-level structural enhancements improve the resilience of the transaction under a stress scenario. After considering its satisfactory BRP, sizable order book of long-term RPI-linked contracts, and RPI-linked escalation fees that bring visibility in terms of prices, in our view a 17% decline in EBITDA from our base-case is appropriate for the Arqiva group. It reflects potential technological changes that could affect its margins.
Our downside DSCR analysis resulted in a strong resilience score for the class A notes. The combination of a strong resilience score and the 'bbb-' anchor derived in the base-case results in a resilience-adjusted anchor of 'bbb+' for the class A notes.
We also give credit to the BLF in our downside scenario since it is also available to the issuer directly upon an insolvency of the borrower, which would not be a draw-stop under the liquidity facility agreement. It is notable that drawings made by the issuer for an issuer liquidity shortfall amount would be repaid by the borrower under the borrower's pre-enforcement priority of payments, by way of the issuer/borrower facilities fees.
The £250 million liquidity facility balance represents a significant level of liquidity support, measured as a percentage of the current outstanding balance of the notes it supports. However, it is available to both the borrower and the issuer. We did not grant an additional notch of uplift to the class A notes despite the presence of liquidity support in excess of 10% of debt, including the pari passu European Investment Bank (EIB) loan, the institutional term loan, the tranche 1a term loan, and any amounts drawn on ancillary facilities.
None of the amortizing classes of rated notes has a profile longer than 20 years. The longest-dated amortizing class is the class 2013-1b notes with a legal final maturity in December 2032. However, the class 2014-1 notes have an expected repayment date (ERD) in June 2030, which is longer than the seven-year ERD window within which we would not adjust the resiliency-adjusted anchor. The ERD window is also longer than the 10-year ERD window stated in our criteria. However, there are mitigating factors that we considered, specifically:
- The Arqiva group's BRP is satisfactory;
- The majority of the Arqiva group's order book is linked to long-term contracts that are linked to RPI;
- Its competitive position is assessed as strong; and
- It owns long-lived assets that are infrastructure-like.
Therefore, we have applied a one-notch reduction in the resilience-adjusted anchor in our modifiers analysis, i.e. 'bbb'.
A change in our assessment of the company's BRP would likely lead to rating actions on the notes. We would require higher/lower DSCRs for a weaker/stronger BRP to achieve the same anchors.
We could also lower our ratings on the notes if we were to lower the BRP to adequate from satisfactory or if our minimum projected DSCRs fall below 1.4x for the class A notes in our base-case scenario. In addition, we would consider lowering our ratings on the notes if we revised our RPI forecasts, or if we believe the relative weight of the obligors' secured creditors--which, in our view, may have interests and views not aligned with those of the noteholders--could heighten the risk of acceleration.
The notes are currently capped by the counterparty rating on Commerzbank AG. As such, we would not rate the notes in the transaction above the minimum rating on the transaction's dependent counterparty.
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|Primary Credit Analyst:||Ganesh A Rajwadkar, London + 44 20 7176 7614;|
|Secondary Contacts:||Sebastian Sundvik, London + 44 20 7176 8600;|
|Joyce Kang, London + 44 20 7176 0621;|
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