Earnings And Cash Flow Improvements Expected in the next Months, But Planned Deleveraging Remains Critical

Transcription

1 Bertelsmann SE & Co. KGaA - Diversified Media ISSUER IN-DEPTH Earnings And Cash Flow Improvements Expected in the next Months, But Planned Deleveraging Remains Critical RATINGS Bertelsmann SE & Co. KGaA Long Term Rating Baa1 Outlook Stable Summary KEY METRICS: x 2.8x 3.3x FCF / EBITDA 29.7% 19.6% 23.3% Total Revenue (USD Billion) $20.7 $21.7 $22.4 RCF / Net Debt 22.5% 23.6% 16.9% FCF / Net Debt 13.4% 11.5% 1.7% Debt / EBITDA 2014 ANALYST CONTACTS Gunjan Dixit VP-Senior Analyst gunjan.dixit@moodys.com Sofia Ferrer-Vidal Associate Analyst sofia.ferrer-vidal@moodys.com Michael J. Mulvaney MD-Corporate Finance michael.mulvaney@moodys.com Leverage, revenues and EBITDA improvement expected for Bertelsmann SE & Co. KGaA (Baa1 stable) in the next months. Acquisitions and restructuring efforts pressured profitability and cash flows in 2014, but we expect profitability and cash flows to improve in The company's commitment to deleveraging remains an important driver behind the current rating and outlook. Bertelsmann's restructuring initiatives and contribution from recent acquisitions to strengthen 2015 EBITDA and margins. Bertelsmann launched a profit improvement program in 2014 and expects to generate 500 million of additional profits within the next three to five years. We also expect improvement in 2015 EBITDA from restructuring initiatives and acquisitions completed in Recent acquisitions to support continued modest reported revenue growth. Although we anticipate largely flat organic revenues in 2015, we expect continued modest growth in reported revenues, helped by the contribution of fast growing small-sized businesses acquired in 2014 including Netrada and Relias Learning. Aggressive pursuit of expensive acquisitions could put pressure on leverage. This is because the businesses Bertelsmann is acquiring generally trade at high EBITDA multiples, and their immediate contribution to Bertelsmann's EBITDA is not particularly high. If the proceeds from its recently issued 1.25 billion of hybrid bond were used for acquisitions rather than debt reduction there could be negative pressure on Bertelsmann's ratings. Potential recapitalisation of Penguin Random House (PRH) would be credit negative. From October 2015, Pearson Plc will have the option to sell its entire shareholding in joint venture PRH. If a buyer can't be found Pearson could require a recapitalisation by raising debt at the JV of up to 3.5x EBITDA. If this happened it would be credit negative for Bertelsmann because it will lead to a significant increase in consolidated debt and would probably increase Bertelsmann's structural subordination to any external debt raised at PRH. If Bertelsmann bought the 47% stake and materially increased its leverage to do so, this would also put negative pressure on its rating.

2 Leverage to improve in We expect Bertelsmann's credit metrics to improve in 2015, helped by it prioritising deleveraging, lower restructuring-related cash outflows and lower spending on acquisitions. Its rating and outlook could come under pressure if it fails to maintain adjusted RCF/net debt in the mid 20s and free cash flow/net debt of at least around 10% on a sustained basis, or Moody's adjusted gross debt/ebitda exceeded 3.0x on a sustained basis (with a lower cash balance). Restructuring initiatives and contribution from recent acquisitions to strengthen 2015 EBITDA and margins While acquisitions and restructuring efforts pressured profitability and cashflows in 2014, we expect Bertelsmann SE & Co. KGaA's (Baa1 stable) reported operating EBITDA to grow at a higher rate in 2015 than the 2.7% growth achieved in Principal drivers will be the benefits of the 2014 restructuring actions, the scaling back of declining businesses, and the contributions from Bertelsmann's investments in growth platforms. In 2014, Bertelsmann launched a plan targeting profit improvements of 500 million over three to five years. However it came at a cost: the company incurred 340 million of exceptional restructuring and other costs. Of the total, 22.1% or 75 million was related to the one-off integration costs associated with Bertelsmann and Pearson Plc (Baa1 negative) combining their respective trade book publishing businesses in the joint venture Penguin Random House, or PRH. It also included restructuring and severance payments at its managed services and integrated outsourcing services and solutions division Arvato ( 52 million, 15.3%), its magazine publishing division Gruner + Jahr ( 29 million, 8.5%) and in its corporate investments division ( 16 million, 4.7%). The costs also included non-cash one-off impairment charges of 88 million (25.9%) related to its printing business Be Printers, and a value adjustment to its Hungarian television business, and other one-off charges of 80 million (23.5%). These restructuring charges should lay the groundwork for Bertelsmann's improved performance in 2015 and beyond. A second but less material benefit to 2015 operating EBITDA will come from Bertelsmann s acquisition of growth platform such as Relias Learning (education) and Netrada (e-commerce) also made in Given the expected improvements in Bertelsmann's profitability, we forecast an improvement in group operating EBITDA margin in While the 2015 operating EBITDA margin will likely be more closer to the company's 15% target for 2020, we believe that the company will need to rely on contributions from high margin acquired businesses to achieve its objective. Exhibit 1 EBITDA Margin To Improve In 2015 Source: Moody's Investor Service This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. 2

3 Recent acquisitions to support modest revenue growth While Bertelsmann's organic revenue growth was flat in 2014, its reported revenues grew 3.1% to 16.7 billion, reaching a seven-year high. This was the result of the full-year inclusion of PRH for the first time and the acquisitions of BMG music rights group and Gothia, a service provider for the invoice process chain. Given the low growth potential of its legacy businesses, we expect Bertelsmann s organic revenue growth development to be largely flat in 2015, as Exhibit 2 shows, However, we anticipate continued modest growth in reported revenues (including acquisitions), helped by the contribution of fast growing small-sized businesses acquired in 2014 including Netrada and Relias Learning. Exhibit 2 Reported Revenue To Improve While Organic Revenue Flat In 2015 Footnotes: 1) Reported and organic revenue growth for is in line with Bertelsmann's audited accounts projections for reported and organic revenue growth are based on Moody's estimates. 2) In July 2013 Bertelsmann and Pearson Plc (Pearson) combined their respective trade book publishing businesses, Random House and Penguin, in a joint venture, PRH. Prior to 2013 Bertelsmann only reported Random House. Bertelsmann started to report the combined entity in 2H Organic revenues at PRH declined in 2013 (by 10.5%) as the previous year (2012) was largely characterized by the bestseller performance of the Fifty Shades trilogy. In 2014 revenues at Penguin were boosted due to the 100% consolidation of this entity for the first time. 3) As of January 1, 2012, Arvato s European gravure printing activities and its offset printers in Southern Europe, the US and Colombia were combined into the independent division Be Printers. Revenue decline in 2014 was mainly due to the sale of the Italian print business and the continuing structural decline of print businesses in general. 4) Organic revenue growth as reported and calculated by Bertelsmann. Adjusted for portfolio and exchange rate effects projections for organic revenue growth are based on Moody's estimates. Source: Moody's Investor Service and company data RTL, which accounts for 34.1% of Bertelsmann's total reported consolidated revenues, has guided towards flat organic revenue growth in 2015 following a decline of 1.1% in We expect the print-heavy businesses, Gruner + Jahr and BE Printers which comprise 3

4 10.2% and 5.8% of Bertelsmann's reported consolidated revenues respectively, to continue to decline in 2015, following organic revenue declines of 3.1% and 4.4% in We anticipate Arvato and PRH (27.3% and 19.5% of total reported consolidated revenues respectively) will grow only moderately in During the next three to five years, we expect Bertelsmann to remain focused on growing its overall revenues organically as well as via add-on acquisitions. Bertelsmann aims to expand its revenues to around 20 billion (from 16.7 billion in 2014), as Exhibit 3 shows, and increase its group profit to more than 1 billion by around 2020, from 573 million in Exhibit 3 Strategic Objectives Focused On Restoring Growth Source: Company data Since the launch of its strategic plan, Bertelsmann has been making steady progress. In order to achieve its 2020 targets, Bertelsmann aims for its growth businesses to eventually make up around 40% of total revenues from 27% in 2014, while businesses in structural decline should ultimately account for only 5% of total revenues, versus 17% in Aggressive pursuit of acquisitions could put pressure on leverage Over the next three to five years, Bertelsmann plans to focus on building its presence in growth businesses including e-learning, medical education and services for universities, primarily via bolt-on acquisitions. However, the current outlook for higher education in the US remains generally challenging due to continued enrollment contractions. Bertelsmann s initiatives are also at a nascent stage and the long-term prospects for its business are difficult to predict as a result. Bertelsmann s retained cash flow (RCF)/net debt and gross debt/ebitda (ratios as adjusted by Moody's) in particular, could be negatively affected if it aggressively pursues its acquisition strategy during the next months. This is because, the fast growing small-sized businesses that Bertelsmann is acquiring generally trade at high EBITDA multiples, and their immediate contribution to EBITDA is not particularly high. Bertelsmann received gross proceeds of 1.5 billion from the 2013 sale of a 16% stake in its programming and television division RTL Group, but investments (including financial debt assumed) in high-growth businesses totaled 1.6 billion in 2014 and 2.0 billion in In order to restore its financial flexibility, the company issued 1.25 billion of hybrid debt in April 2015 for general corporate purposes, to support its strategy, and to diversify and strengthen its capital structure. This hybrid has received a 50% equity credit as per Moody s methodology. We would expect Bertelsmann to continue implementing its strategic plan while managing its discretionary cash outflows in 2015 and beyond such that it can achieve ratios that are more supportive of the Baa1 rating category. 4

5 The stable outlook on Bertelsmann's rating reflects our expectation that the company will prioritise reducing its leverage in However, if the proceeds from the hybrid were used primarily for add-on acquisitions rather than debt reduction, there could be negative pressure on Bertelsmann's ratings. Potential recapitalisation of Penguin Random House would be credit negative In July 2013, Pearson and Bertelsmann completed the transaction to combine PRH. Bertelsmann now owns 53% of the joint venture PRH. The partnership agreement stipulates that neither Pearson nor Bertelsmann may sell any part of their shareholding until the end of September From October 2015, Pearson may offer to sell its entire shareholding to either Bertelsmann which has first right of refusal or a third party buyer. If no buyer is found or offers are declined, Pearson can require a recapitalisation by raising debt at the joint venture to up to 3.5x EBITDA, with dividends distributed to shareholders. In addition either partner may require an IPO of the joint venture five years following financial close (i.e. from 2018). The recapitalisation mechanism is a potential credit negative for Bertelsmann because if it went ahead it could lead to a significant increase in consolidated debt. A recapitalisation would also probably increase Bertelsmann's structural subordination to any external debt raised at PRH. If Bertelsmann decided to buy the entire 47% stake from Pearson and funded it with debt, this would increase the company's leverage and put negative pressure on its rating. Leverage expected to improve in 2015 We expect Bertelsmann to prioritise reducing its leverage in Bertelsmann pursues a clearly defined set of financial goals, most notably what it calls the Leverage Factor ratio, which it defines as economic debt (i.e.: net financial debt plus provisions for pensions, profit participation capital and net present value of operating leases) in relation to operating EBITDA. In 2014, the ratio stood at 2.7x, compared with 2.0x in This is higher than the 2.5x ceiling Bertelsmann targets for this ratio. Moody s adjusted gross debt/ebitda stood at 3.3x at the end of We expect this to remain somewhat overstated until the company utilises its accumulated cash (cash balance of 1.3 billion on balance sheet at the end of 2014) and proceeds from its hybrid to execute its strategy and/or reduce debt. However we expect leverage to reduce in 2015, as Exhibit 4 shows. Exhibit 4 Leverage To Improve in 2015 Footnote: 1) Expected ratios for 2015 reflect Moody's ratio guidance for Bertelsmann for maintaining its Baa1 rating with a stable outlook. 2) Company Reported Leverage Factor ratio as defined by Bertelsmann = economic debt (i.e.: net financial debt plus provisions for pensions, profit participation capital and net present value of operating leases in relation to operating EBITDA). Source: Moody's Investor Service and company data 5

6 We will continue to be somewhat tolerant Bertelsmann's weak gross debt/ebitda (as adjusted by Moody's) ratio, because it is driven by lower discount rate assumptions used in the current low interest rate scenario. These assumptions also increased its IAS19 pension deficit by 30% in Ratings could come under pressure if, amongst other factors, Bertelsmann loosened its financial comfort parameters (Bertelsmann leverage factor limit is below 2.5x) and/or Moody's adjusted gross debt/ebitda exceeded 3.0x on a sustained basis (with a lower cash balance). As we said earlier, given that most of Bertelsmann's restructuring initiatives were executed in 2014, we expect restructuring cash outflows to be much lower in This should help improve its adjusted RCF/net debt to closer to 25% versus 16.9% in 2014, as Exhibit 5 shows. Exhibit 5 Cash Flow Ratio To Improve In 2015 Moody's adjusted RCF/net debt Footnote: Expected ratios for 2015 reflect Moody's ratio guidance for Bertelsmann for maintaining its Baa1 rating with a stable outlook. Source: Moody's Investor Service We also expect acquisition expenditure to be lower in 2015 after two years of heavy spending in 2014 and We anticipate that Bertelsmann will manage its discretionary cash outflows in 2015 and beyond in such a way that our target ratios for the rating and Bertelsmann s own comfort parameters are respected. However its rating could come under pressure if it fails to maintain adjusted RCF/net debt in the mid 20s and free cash flow/net debt of at least around 10% on a sustained basis. 6

7 2015 Moody s Corporation, Moody s Investors Service, Inc., Moody s Analytics, Inc. and/or their licensors and affiliates (collectively, MOODY S ). All rights reserved. CREDIT RATINGS ISSUED BY, INC. AND ITS RATINGS AFFILIATES ( MIS ) ARE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY S ( MOODY S PUBLICATIONS ) MAY INCLUDE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBTLIKE SECURITIES. MOODY S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY S OPINIONS INCLUDED IN MOODY S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY S ANALYTICS, INC. CREDIT RATINGS AND MOODY S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. MOODY S CREDIT RATINGS AND MOODY S PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS FOR RETAIL INVESTORS TO CONSIDER MOODY S CREDIT RATINGS OR MOODY S PUBLICATIONS IN MAKING ANY INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided AS IS without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY S is not an auditor and cannot in every instance independently verify or validate information received in the rating process or in preparing the Moody s Publications. To the extent permitted by law, MOODY S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY S. To the extent permitted by law, MOODY S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY S IN ANY FORM OR MANNER WHATSOEVER. Moody s Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody s Corporation ( MCO ), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by Moody s Investors Service, Inc. have, prior to assignment of any rating, agreed to pay to Moody s Investors Service, Inc. for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at under the heading Investor Relations Corporate Governance Director and Shareholder Affiliation Policy. For Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY S affiliate, Moody s Investors Service Pty Limited ABN AFSL and/or Moody s Analytics Australia Pty Ltd ABN AFSL (as applicable). This document is intended to be provided only to wholesale clients within the meaning of section 761G of the Corporations Act By continuing to access this document from within Australia, you represent to MOODY S that you are, or are accessing the document as a representative of, a wholesale client and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to retail clients within the meaning of section 761G of the Corporations Act MOODY S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for retail clients to make any investment decision based on MOODY S credit rating. If in doubt you should contact your financial or other professional adviser. For Japan only: Moody's Japan K.K. ( MJKK ) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody s SF Japan K.K. ( MSFJ ) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization ( NRSRO ). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively. MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000. MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements. 7

8 AUTHORS Gunjan Dixit Sofia Ferrer-Vidal EDITOR Tania Hall 8