CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded Viacom, Inc.'s (Viacom) Issuer Default Rating (IDR) to 'BBB' from 'BBB+'. In addition, Fitch has also downgraded the specific issue ratings assigned to the company's senior unsecured notes and debentures to 'BBB' from 'BBB+'. Fitch has affirmed the 'F2' short-term IDR and commercial paper ratings. The Rating Outlook remains Negative.
Approximately $12.8 billion of debt (face value - including commercial paper) outstanding as of June 30, 2016 is affected by Fitch's action. A full list of ratings follows at the end of this release.
The downgrade reflects the persistent weakening of Viacom's operating profile and the absence of tangible evidence that the strategies implemented by the company are recapturing positive operating momentum and reducing volatility with the company's key cable network businesses. The expected rebound of Viacom's operating profile has taken longer than Fitch previously anticipated. The company plans to increase its programming investment and focus on developing more original programming across its cable network portfolio, including scripted content and event programming, while becoming more selective in acquiring programming. Fitch believes this continues to be an appropriate strategy given the current operating environment as Viacom attempts to recapture operating momentum and position itself to better monetize the changing viewing habits of its target audience.
The ratings also recognize the overhang created by the ongoing discord among Viacom's controlling shareholders, National Amusements, Inc. and NAI Entertainment Holdings LLC and Viacom's board of directors and senior management. The situation has elevated event risks attributable to Viacom's credit profile and created uncertainty about management's ability to execute on strategic initiatives necessary to strengthen the company's competitive position and operating profile. It has also heightened uncertainty surrounding the company's strategic direction and transition of ownership control. The dispute has impaired Viacom's ability to sell rights to its content to subscription video on demand (SVOD) and OTT service providers and has delayed efforts to seek strategic alternatives pertaining to Viacom's Paramount Pictures Corporation subsidiary.
Viacom's historically aggressive capital allocation posture, which has long favored share repurchases in excess of free cash flow (FCF) generation, along with the weak operating results have combined to reduce Viacom's financial flexibility and yields a credit profile that is not consistent with Fitch's expectations for the 'BBB+' rating. Viacom's leverage increased to 3.6x during the latest 12 month (LTM) period ended June 30, 2016, which is outside the company's 2.75x to 3.0x leverage target. Fitch anticipates that leverage will improve during fiscal 2017 but will remain above 3x through Viacom's fiscal 2017 year-end before trending below 3x during fiscal 2018. Importantly, Fitch does not anticipate any meaningful debt reduction during the remainder of calendar year 2016 and expects scheduled maturities during 2017 to be refinanced.
The Negative Outlook incorporates the uncertainty related to Viacom's ability to stabilize and strengthen its operating profile amid the persistent secular challenges to its business model as well as the overhang created by the corporate governance issues and pending litigation.
KEY RATING DRIVERS
Appropriate Financial Strategy: The changes to Viacom's capital allocation policy, namely the suspension of its share repurchase program and the reallocation of free cash flow to reduce debt and changing its strategic programming focus and investment towards more original scripted programming, are appropriate given the current operating environment
Corporate Governance Overhang: The dysfunction among Viacom's board of directors and controlling shareholder calls into question the board's overall effectiveness and its ability to establish and execute the company's strategic objectives.
Limited Financial Flexibility: Viacom's operational headwinds, elevated leverage combined with incrementally higher cash tax payments and ongoing investment in original programming and production will constrain free cash flow (FCF) generation and limit the company's overall financial flexibility.
Cable Network Portfolio Anchors Ratings: The dual stream, recurring, high-margin revenue base of the cable networks remains the foundation for Viacom's ratings. While recognizing a level of viewership ratings volatility at any given cable network is factored into the current ratings, Fitch has concerns around weakened TV ratings at Viacom's cable networks. Fitch does not expect Viacom to lose any distribution deals, but continued ratings softness could weaken its negotiating position. Fitch believes that the higher level of investment in original programming has begun to improve ratings at key networks and expects that continued investment will lead to further improvements and will contribute to the strengthening of the company's operating profile.
Growing Secular Risks Present: The ongoing secular threats presented by changing media consumption, emerging distribution platforms and technology evolution and adoption have negatively affected Viacom's operating performance. Fitch recognizes the risks inherent in the company's strategies to address the secular threats and adapt to changing industry dynamics, monetize changing viewing habits, and recapture their target audience that continues to shift away from viewing media in a linear, measured environment.
Advertising Revenue Exposure Highlights Risks: Rating concerns include exposure to cyclical advertising revenues (at 38% of revenues, moderate relative to peer group) and the company's capacity to adapt to ever-changing media consumption patterns and technology platforms. Fitch's ratings recognize the volatility within Viacom's operating profile given the exposure to cyclical advertising revenues and the hit-driven nature of its cable networks and film studio; however, there is minimal tolerance within the current ratings for further weakening of Viacom's operating profile.
The lower ratings on certain key networks and changing media consumption patterns pressure advertising revenues as domestic advertising revenue within the company's Media Networks segment declined 4% during the June 2016 ended quarter and the company's performance continues to lag behind its peers. Fitch expects domestic advertising revenue to decline approximately 4% during fiscal 2016 and be flat during fiscal 2017. While noting recent ratings improvements, viewership on many of Viacom's key cable networks including MTV and Comedy Central have been volatile and impacted by a number of issues including on-air talent and management departures, programming issues and the ongoing shift to digital video consumption by younger viewing audiences.
Viacom is one of the few cable network groups that generate more of its revenues from advertising than from affiliate fee revenues, adding a degree of volatility to the performance of the company's Media Networks operating segment. The higher advertising revenue concentration (relative to peers) makes the company more susceptible to hit driven volatility of cable network programming ratings and share of viewing audience.
The growth rates of Viacom's affiliate fee revenues also lag behind its peer group of large diversified media companies and present a new challenge to the company's operating model. The growth rate has slowed due to recent subscriber rate adjustments and the re-tiering of certain networks. Affiliate fee revenue growth will be further hampered during the remainder of Viacom's fiscal 2016 and possibly into fiscal 2017 due to the difficulty in signing previously expected SVOD agreements attributable to the ongoing corporate governance issues. Fitch's base case assumes that domestic affiliate fee revenues will decline at a mid-single digit rate during fiscal 2016 before rebounding to a low-single digit growth rate during fiscal 2017.
Fitch believes reversing these negative operating trends will be difficult in the current operating environment. Competition for viewing audience within Viacom's targeted demographic will remain fierce as these younger demographics are migrating away from traditional linear video programming. Moreover, given Viacom's reliance on the kids and teen demographic segments, the company is more dependent on advertising categories which target kids and teens relative to its peer group. To combat these issues, Viacom has increased its investment in programming expense focusing on producing more original programming across its cable network portfolio, adding more scripted shows and event programming and becoming more selective in acquiring programming. In addition to the programming investment, Viacom has created products to improve the monetization of both linear and non-linear viewership and improve the yield on its advertising inventory, including its Viacom Vantage, Velocity and Echo offerings. In addition the company is reducing unit loads to improve viewer experience and thereby strengthen its domestic advertising business.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case include:
--Global advertising revenues decline to low single digits during fiscal 2016 followed by flat revenue growth during fiscal 2017. Domestic advertising revenues are expected to decline 4% during fiscal 2016 and flat during fiscal 2017.
--Affiliate fee revenue is expected to decline mid-single digits during fiscal 2016 due primarily to timing of content distribution agreements with SVOD providers. Going forward, affiliate fee revenues are expected to grow to low single digits. Fitch does not expect Viacom to lose any meaningful distribution deals.
--Higher programming and production costs pressure EBITDA margins within the company's Media Networks segment. Fitch anticipates fiscal 2016 margins to range between 37% and 38%, and expanding modestly to approximately 40% during fiscal 2017.
--Fitch assumes typical volatility and continued weakness within in the Filmed Entertainment segment over the ratings horizon.
--Suspension of share repurchases in light of weakening operational profile and minimal merger and acquisition activity.
--All maturing debt is expected to be refinanced during the ratings horizon.
RATING SENSITIVITIES
Positive: Upward ratings momentum is unlikely during the current ratings horizon. Stabilization of the Outlook at the current rating is predicated on the company successfully executing on its strategies to address persistent secular threats to its business, and recapturing positive operating momentum, as evidenced by sustainable positive domestic advertising and affiliate fee revenue growth and expanding operating margins. In addition Fitch needs to observe a rationale resolution to the pending litigation related to the company's ongoing corporate governance issues and a clear articulation of a strategy to strengthen the company's operating profile.
Negative: Negative rating actions are more likely to coincide with the company's inability to strengthen its operating profile and reduce leverage below 3.5x. Resumption of share repurchase activity or other aggressive financial policy decisions that delay the anticipated improvement of Viacom's credit profile would also result in negative rating action. Moreover an unfavourable resolution to the corporate governance issues and pending litigation can lead to negative rating action.
LIQUIDITY
Viacom's weakening operating profile is diminishing its financial flexibility. In step with the company's weakened operating results, FCF generation, margin and FCF leverage metrics have also deteriorated. Led by Viacom's Media Networks segment, the company generated approximately $866 million of FCF (defined as cash flow from operations less capital expenditures and dividends) during the LTM period ended June 30, 2016, reflecting a 46% decline relative to company's reported FCF generation during its fiscal year end 2015. Operational headwinds, higher cash taxes and interest costs along with higher programming and production costs are expected to continue hindering FCF generation. Fitch expects FCF generation after dividends during fiscal 2016 to range between $550 million and $650 million before improving to approximately $1 billion during fiscal 2017.
In Fitch's view, Viacom's liquidity is adequate and supported by expected FCF generation. Additional financial flexibility is provided by the company's $2.5 billion revolving credit facility (fully available as of June 30, 2016 but with $453 million of outstanding commercial paper as of June 30, 2016) and $192 million of cash on hand as of June 30, 2016. Viacom has deemed substantially all of the cash held by its foreign subsidiaries as permanently reinvested in its foreign operations and does not intend or foresee a need to repatriate the cash held by foreign subsidiaries. Commitments under Viacom's revolver expire on Nov. 18, 2019. The credit facility contains an interest coverage covenant requiring coverage for the most recent LTM period to be at least 3.0x.
Viacom repaid the remaining $367.3 million outstanding under its 6.25% notes due April 2016 with cash upon maturity. However higher commercial paper balance has largely offset the debt reduction. Approximately $900 million of debt is scheduled to mature during fiscal 2017, including $400 million of 2.5% senior unsecured notes due December 2016, which is followed by $1 billion of maturities due in fiscal 2018. The maturities are well-laddered and manageable considering expected FCF generation, reliable market access and back-up liquidity. Fitch expects the near-term maturities will be refinanced upon maturity.
FULL LIST OF RATING ACTIONS
Fitch downgrades Viacom's ratings as follows:
--Long-term IDR to 'BBB' from 'BBB+';
--Senior unsecured notes and debentures to 'BBB' from 'BBB+';
--Senior unsecured bank facility due 2019 to 'BBB' from 'BBB+';
The Rating Outlook remains Negative.
Fitch affirms Viacom's ratings as follows:
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook remains Negative.
Date of Relevant Rating Committee: Aug. 4, 2016.
Additional information is available on www.fitchratings.com.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--No material adjustments have been made that have not been disclosed in public fillings of this issuer.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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