Fitch Rates FDC's Proposed Secured Note Offering 'BB-/RR2'

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BB-/RR2' rating to First Data Corp.'s (FDC) proposed $500 million 10-year senior secured note offering.

In addition, Fitch has affirmed the following ratings for FDC:

--Long-term Issuer Default Rating (IDR) at 'B';

--$2 billion senior secured revolving credit facility (RCF) due 2013 at 'BB-/RR2';

--$12.4 billion senior secured term loan B due 2014 at 'BB-/RR2';

--$3.75 billion 9.875% senior unsecured notes due 2015 at 'CCC/RR6';

--$3.5 billion 10.55% senior unsecured notes with four-year mandatory paid-in-kind (PIK) interest due 2015 at 'CCC/RR6'; and

--$2.5 billion 11.25% senior subordinated notes due 2016 at 'CC/RR6'.

The Rating Outlook is Stable.

FDC is issuing $500 million in 10-year senior secured notes, the proceeds of which will be used to replace approximately $500 million of its $12.4 billion senior secured term loan due 2014 and thus begin the process of extending its substantial debt maturity schedule. FDC is also in the process of finalizing an amendment to its secured bank loan facility to enable it to issue $3.5 billion of second lien secured debt which Fitch expects it will use to refinance a portion of its unsecured debt. Fitch believes that the company is planning to incrementally extend a portion of its capital structure while growing EBITDA so that it is better positioned to extend the full amount of its secured term loan before 2014. It is worth noting that in order to truly extend the maturities of its secured term loan and RCF Fitch believes the company needs to extend the maturities of its unsecured notes due 2015 and subordinated notes due 2016 to avoid a springing maturity provision.

Fitch expects FDC's efforts to extend and refinance its capital structure to take up to several years at a significant cost in incremental interest expense as well as consent and underwriting fees. Based on current interest rates, Fitch estimates that incremental cash interest expense resulting from a complete refinancing of outstanding debt could amount to $200 million or more per year. Note that this figure may appear low but is partially reflective of the fact that FDC has fixed the majority of its floating rate term loan (roughly $7.5 billion of $12.4 billion outstanding) at significantly out-of-the-money LIBOR rates (approximately 5% versus the current rate of 0.5%). This is in addition to the approximately $400 million of incremental cash interest expense resulting from the conversion of PIK notes to cash pay at the end of 2011. Fitch estimates that underwriting and consent fees could amount to $300 million or more over time. FDC recently offered 10 basis points to amend its term loan which equates to a potential fee of up to $14 million.

The rating affirmations and Stable Outlook reflect the following considerations:

--Fitch expects revenue (excluding reimbursables) and EBITDA to increase in the high-single digits in 2010 driven by the resumption of global economic growth and continued secular trends favoring electronic payments. EBITDA including affiliates should increase to approximately $2.2 billion or above.

--Fitch expects cash flow from operation to be well in excess of $500 million, aided in part by cash generation from more efficient working capital management. In addition, this reflects FDC's relatively high conversion of EBITDA less $1.4 billion expected cash interest expense to operating cash flow. Free cash flow should be modestly positive.

--Fitch expects FDC to use any positive free cash flow to reduce debt beyond the approximately $128 million annual amortization of the company's secured term loan. Fitch notes that the potential exists for FDC to materially de-lever over the next few years if the global economic rebound continues and the company maintains its market position.

--Fitch estimates current leverage (total debt to operating EBITDA) at 10.2 times (x) and expects this figure to drop to approximately 10.0x by year end 2010 and 9.0x by year end 2011. Interest coverage (EBITDA to gross interest expense), currently at 1.2x, is expected to increase modestly to 1.3x and 1.5x by years end 2010 and 2011, respectively.

The ratings are reliant upon a resumption of low-single digit global economic growth and more normal consumer spending trends. Given FDC's highly levered balance sheet and refinancing needs beginning in 2013, Fitch does not believe the company could manage through another decline in economic activity.

Fitch's perspective on the company's future capital structure benchmarks and growth requirements to manage its refinancing risks is as follows:

--Beginning October 2011, FDC's 10.55% PIK senior unsecured notes due September 2015 (currently $3.5 billion outstanding) convert to cash pay. The first semi-annual cash interest payment on these notes of approximately $217 million will be due March 2012.

--In September 2013, FDC's $2.0 billion RCF expires. The company currently has no borrowings against this facility. The RCF charges interest expense on borrowings of Libor plus 275 basis points and a facility fee of 50 basis points.

--In September 2014, FDC's term loan B becomes due. Currently, there is $12.4 billion outstanding under this loan which carries an interest rate of Libor plus 275 basis points. The company used interest rate swaps to fix the interest expense of a substantial portion of this loan and currently pays an effective rate of approximately 6%. Fitch expects $2.5 billion of swaps to expire in September 2010 which will likely enable the company to reduce interest expense given current Libor rates.

--To manage the increased cash interest expense of approximately $400 million annually beginning 2012 when the PIK notes convert to cash pay, Fitch estimates that FDC will need to increase EBITDA by approximately 15% to 20% cumulatively over the next two years. Given the high fixed cost nature of the business and resulting positive operating leverage, Fitch estimates that this would necessitate mid- to high-single digital annual revenue growth during that period which is well within expectations for the business under normal economic conditions. The expiration of the $2.5 billion term loan swaps should also assist with the PIK cash pay conversion.

--To manage the refinancing risk of the term loan in 2014, Fitch estimates that the company would need to reduce leverage to below 8x in 2013 in order to demonstrate positive equity value and position the company for a potential IPO. Fitch estimates that this would require a minimum of 30% cumulative EBITDA growth over the next three years.

--The aforementioned EBITDA growth estimates are predicated upon FDC achieving its historically normal but relatively high rate of EBITDA conversion to cash. Over the past two years, Fitch estimates that FDC has converted approximately 100% of EBITDA less cash interest to cash from operations due in part to more efficient working capital management.

Fitch believes that there are reasonable expectations that FDC will continue to grow EBITDA and free cash flow sufficiently to manage the conversion of its PIK notes to cash pay at the end of 2011. However, the company's ability to manage its refinancing needs are less certain and dependent in part upon growth expectations for the company beyond the next three years as well as the interest of equity investors in a potential IPO of the company sometime before mid-2014.

While Fitch believes that FDC has sufficient runway to still grow out of its current capital structure, there is limited opportunity for negative surprises. In particular, FDC has been and could continue to be impacted by economic conditions affecting consumer credit and consumer spending in the U.S. and abroad. These issues include:

--FDC's Retail Services segment is correlated to consumer spending, partially offset by the secular shift to card-based transactions in lieu of cash. A further decline in consumer spending could pressure growth expectations inherent in the current rating.

--Conversely, FDC could be positively impacted by a normalization of consumer spending trends, in particular the mix shift between large discount retailers and local merchants. During the recent downturn, consumer spending was more than typically concentrated at discount retailers where FDC earns significantly less per transaction and dollar spent. A rebound in consumer spending that also leads to a reversing of this mix shift could add materially to growth expectations for revenue and EBITDA.

--Continued tightening of consumer credit could limit growth opportunities. A decline in consumer credit card availability is thought to have contributed to the recent surge in PIN debit card usage (although this is also impacted by the mix shift to large retailers where PIN debit is more widely accepted) for which FDC earns less money. In addition, declines in consumer credit card issuance and activity negatively impacted the Financial Services segment.

As a result, Fitch expects quarterly earnings results and future economic expectations to potentially impact FDC's ratings going forward. Aside from macro factors potentially impacting future results, Fitch believes that there are several operational risks which could impact the ratings in the near term including:

--FDC must demonstrate positive operating leverage in its international business where growth has lagged expectations.

--Competitive pressure in the merchant acquisition business, potentially from Chase Paymentech or other competitors targeting the local merchant market.

--Cost savings and control of variable operating expenses.

From an operational perspective, Fitch believes core credit strengths include:

--Stable end-market demand with below average susceptibility to economic cyclicality.

--A highly diversified, global and stable customer base consisting principally of millions of merchants and large financial institutions.

--A significant advantage in scale of operations and technological leadership positively impact the company's ability to maintain its leading market share and act as barriers to entry to potential future competitors. In addition, FDC's Financial Services business benefits from long-term customer contracts and generally high switching costs.

--Stable working capital requirements typically enable a high conversion of EBITDA less cash interest expense into cash from operations.

Fitch believes operational credit concerns include:

--Mix shift in the Retail Services segment, including a shift in consumer spending patterns favoring large discount retailers as well as higher growth in the usage of PIN debit cards, has negatively impacted profitability and revenue growth and could lead to greater than anticipated volatility in results.

--High fixed cost structure with significant operating leverage would typically drive volatility in profitability during business and economic cycles.

--Consolidation in the financial services industry and changes in regulations could continue to negatively impact results in the company's Financial Services segment.

--Potential for new competitive threats to emerge over the long term including new payment technology in the Retail Services segment, the potential for a competitor to consolidate market share in the Retail Services segment, and the potential for historically niche competitors in the Financial Services segment to move upstream and challenge FDC's relative dominance in card processing for large financial institutions.

In addition, Fitch believes the credit suffers from a general lack of transparency due to multiple segment accounting changes over the years as well as the varying reporting nature of numerous joint ventures. In addition, FDC has experienced significant management turnover the past few years including three different CFOs and two CEOs which includes the current interim CEO.

From a financial perspective, Fitch believes core credit strengths include expectations that the company will use excess free cash flow for debt reduction. Credit concerns include a highly levered balance sheet that results in minimal financial flexibility and reduces the company's ability to act strategically in a business that has historically benefited from consolidation opportunities. Expectations for modest growth in free cash flow over the next several years may not be sufficient to manage pending changes in the company's capital structure including the conversion of PIK notes to cash pay at the end of 2011 and the need to refinance the company's secured term loan in 2014. FDC's ability to manage this refinancing risk may in part be contingent upon its ability to attract equity capital in future years which could be impacted by future growth expectations for the company as well as future equity risk premiums. The multiple at which investors would be willing to invest in the company would determine the extent of deleveraging necessary over the next few years in order to realize an enterprise value in excess of existing debt obligations.

Negative rating action could occur if FDC can not demonstrate an ability to grow EBITDA by approximately 8% or more annually as estimated by Fitch to be required to manage higher cash interest expense and refinancing risks in the future. Fitch expects revenue growth in the Retail Services segment and International to materially exceed overall economic growth over the next 12 months, combined with positive operating leverage. If quarterly results lag these expectations or future economic expectations decline materially, negative ratings actions are likely. Conversely, positive rating action could occur if free cash flow was considered more than sufficient to manage the higher cash interest expense beginning in 2012 and if it were deemed likely that FDC could reduce leverage to below 8x before 2014.

Total liquidity as of June 30, 2010 was solid and consisted of $584 million in cash and $1.72 billion available under a $2 billion senior secured RCF that expires September 2013. The reduced availability under the RCF reflects approximately $230 million which was provided by an affiliate of Lehman Brothers and is no longer available to be borrowed upon in addition to letters of credit currently outstanding. Approximately $203 million of cash is held by Bank of America Merchant Services (BAMS) and IPS (a discontinued business segment) and is not available for general corporate purposes. In addition, FDC accrued approximately $160 million of cash interest expense in the June 2010 quarter which will be paid out in September 2010.

Total debt as of June 30, 2010 was approximately $22.6 billion and consisted primarily of the following: i) $12.4 billion outstanding under a secured term loan B maturing September 2014; ii) $3.75 billion in 9.875% senior unsecured notes maturing September 2015; iii) $3.5 billion in 10.55% notes maturing September 2015 with mandatory PIK interest through September 2011 and cash interest thereafter; and iv) $2.5 billion of 11.25% senior subordinated notes maturing September 2016. In addition, the parent company of FDC, First Data Holdings, Inc., has outstanding $1 billion original value senior unsecured PIK notes due 2016.

The Recovery Ratings (RRs) for FDC reflect Fitch's recovery expectations under a distressed scenario, as well as Fitch's expectation that the enterprise value of FDC, and hence recovery rates for its creditors, will be maximized in a restructuring scenario (as a going concern) rather than a liquidation scenario. In deriving a distressed enterprise value, Fitch applies a 10% discount to FDC's estimated operating EBITDA (adjusted for equity earnings in affiliates) of approximately $2.1 billion for the latest 12 months (LTM) ended Dec. 31, 2009 which is equivalent to Fitch's estimate of FDC's total interest expense and maintenance capital spending. Fitch then applies a 6x distressed EBITDA multiple, which considers FDC's prior public trading multiple and that a stress event would likely lead to multiple contraction. As is standard with Fitch's recovery analysis, the revolver is fully drawn and cash balances fully depleted to reflect a stress event. The 'RR2' for FDC's secured bank facility reflects Fitch's belief that 71%-90% recovery is realistic. The 'RR6' for FDC's senior and subordinated notes reflect Fitch's belief that 0%-10% recovery is realistic. The 'CC/RR6' rating for the subordinated notes reflects the minimal recovery prospects and inherent subordination in a recovery scenario.

These rating actions reflect the application of Fitch's current criteria which are available at www.fitchratings.com and specifically include the following reports:

--'Corporate Rating Methodology', dated Nov. 24, 2009;

--'Liquidity Considerations for Corporate Issuers', dated June 12, 2007;

--'Cash Flow Measures in Corporate Analysis', dated Oct. 12, 2005;

--'Evaluating Corporate Governance', dated Dec. 12, 2007.

Additional information is available at www.fitchratings.com.

Related Research:

Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=489018

Liquidity Considerations for Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666

Cash Flow Measures in Corporate Analysis
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=243758

Evaluating Corporate Governance
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=363502

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