OREANDA-NEWS. S&P Global Ratings today affirmed its 'B' long-term corporate credit rating on U. K.-based cinema operator Vougeot Bidco PLC (Vue). The outlook remains stable.

At the same time, we affirmed our issue rating on the upsized super senior secured ?60 million revolving credit facility (RCF) at 'BB' and the recovery rating at '1+', indicating our expectation of a very high recovery (above 100%) in the event of a payment default. We also affirmed the 'B' issue rating on the ?300 million fixed rate senior secured notes and on the €290 million floating rate senior secured notes. The '4' recovery rating on these notes indicates our expectation of average (30%-50%) recovery in the event of a default, in the higher half of the range.

We also assigned our 'B' issue rating to the proposed €120 million term loan B with the '4' recovery rating on these notes. This indicates our expectation of average (30%-50%) recovery in the event of a default, in the higher half of the range.

The issue and recovery ratings on the proposed term loan B are based on preliminary information and are subject to the successful issuance of this loan and our satisfactory review of the final documentation.

The affirmation reflects our assessment of the company's fair business risk profile, and its highly leveraged financial risk profile, underpinned by our Financial Sponsor-6 assessment of Vue's financial policy.

The company is in the process of refinancing the one-year term loan facility it raised a year ago to fund the acquisition of Dutch cinema operator JT Bioscopen (JTB). That facility was raised by Vougeot Midco outside of Vue's restricted group perimeter, however, we have already included this loan in our adjusted debt calculation. The new €120 million term loan B will rank pari passu with existing senior secured notes and be borrowed within the restricted group. The loan will mature in seven years. As a result of refinancing JTB will be consolidated into the restricted group. The new term loan is €25 million higher than the existing one-year loan, which does not have a significant impact on credit metrics, with the reported EBITDA cash interest cover ratio remaining comfortably above 2x. The excess proceeds will be used for general group purposes and will support the group's liquidity.

We estimate that at the end of financial 2016 (ending Nov. 30), Vue's debt will mainly comprise about ?600 million senior secured fixed and floating rate notes, ?100 million of senior secured term loan B, and about ?660 million of the shareholder instruments provided by the company's shareholders. Our adjusted debt estimate, in addition to the aforementioned instruments, includes about ?1.1 billion of obligations under operating leases pro forma for JTB.

Due to our assumption of Vue generating a limited amount of reported free cash flow over the medium term, we believe that S&P Global Ratings-adjusted credit metrics for the company are likely to remain in our highly leveraged financial risk profile category in the next two to three years.

We continue to assess Vue's business risk profile as fair, at the stronger end of the category. In our opinion, the limiting factors are the company's exposure to customers' assessments of the film slate and to adverse weather conditions, and competition from other entertainment providers (such as sport events and theme parks)--all of which can have a strong impact on the group's operating performance. We also think that the sector is highly competitive and exposed to technology advances that are spawning new entertainment alternatives, such as video-on-demand and over-the-top television.

These weaknesses are partly offset by the industry's limited correlation with economic cycles and typically low levels of maintenance capital expenditure (capex), which are largely discretionary, in our view. Vue's modern and technologically advanced portfolio of theaters compares well with those of its peers. In addition, its operating efficiency is the highest among peers with an adjusted EBITDA margin of above 35%, over the forecast period through 2018. We see Vue's geographic diversification and increasing scale as another supporting factor.

On an S&P Global Ratings-adjusted basis, we estimate that Vue's debt-to-EBITDA ratio will be 9.5x-10.0x for 2016 while EBITDA to interest will be about 1.3x. These ratios would be 7.0x-7.2x and over 5x, respectively, excluding the shareholder instruments. We also anticipate that, excluding the effect of operating leases, Vue's EBITDA will cover cash interest by 2.0x-2.5x underpinned by reported EBITDA forecast of ?120 million-?130 million.

Under our base case, we assume: Broadly flat admissions in 2016 due to a somewhat weaker film slate compared with 2015 and Euro 2016 Football Championships in June and July. Annual revenue growth of about 5% in the period of fiscal 2016–fiscal 2017, in line with the trend demonstrated over the six months ended on May 26, 2016.Full consolidation of JTB. EBITDA margin growth by about 100–140 basis points due to cost control measures and tight management of rent costs and higher film rental costs. Capex of ?40 million-?50 million in 2016-2017.No further acquisitions. Based on these assumptions, we arrive at the following credit measures: Adjusted debt to EBITDA of about 10.0x in 2016-2017 (about 7.2x and 7.1x, respectively, excluding shareholder instruments).Cash pay and overall leverage moderately reducing over the next few years due to an increase in consolidated EBITDA. Reported EBITDA cash interest coverage (excluding the effect from the operating lease obligations and shareholder instruments) remaining above 2.0x in the wake of EBITDA growth. Reported free operating cash flow (FOCF) of about ?10 million-?15 million in 2016, increasing to about ?10 million-?20 million thereafter. The stable outlook for the next 12 months reflects our expectation that Vue's operating performance will continue to benefit from the sound film slate in 2016, supported by contribution from local content in Vue's international markets. We consider our forecast of ?120 million-?130 million EBITDA in 2016, on a reported basis, and more than ?120 million in the next 12 months, to be commensurate with the 'B' rating. Our outlook further assumes that the company will generate positive FOCF and maintain its adequate liquidity.

We could lower the rating if, over the next 12 months, Vue were unable to generate at least ?100 million EBITDA excluding the effect of our adjustments. This could stem from the company's aggressive pursuit of growth via debt-funded acquisitions or a shortfall in earnings caused by an unexpectedly weak film slate, accompanied by an inability to cut costs or unfavorable foreign currency effect. Vue's inability to generate FOCF on a reported basis or a weakening of its liquidity position could also trigger a downgrade. A significant increase in leverage resulting from the company's aggressive pursuit of growth via debt-funded acquisitions could also put pressure on the ratings.

We see limited upside potential for the rating because of the relatively high leverage over the next 12 months and our view of the aggressive financial policy of its financial sponsor-owners. However, we could raise the rating on Vue if strong operating performance led to an adjusted debt-to-EBITDA ratio approaching 5x. Any upgrade would depend on the tangible evidence of the company exercising a less aggressive financial policy, sustainably generating material FOCF, and maintaining a liquidity position at least adequate.