NEW YORK--(BUSINESS WIRE)--Fitch Ratings is providing the following observations on various strategic options for Warner Music Group Corp. (WMG), including a potential 1) acquisition of EMI; 2) sale of WMG Music Publishing; 3) sale of 50% or more of WMG; or 4) sale of less than 50% of WMG with an acquisition of EMI.
The private equity sponsors (which include Thomas H. Lee, Bain Capital and Providence Equity Partners) and Edgar Bronfman own approximately 68% of WMG; 30% of WMG is owned publicly and the remaining 2% is owned by executives and officers. Fitch estimates an enterprise value of $2.2 billion, equating to an EBITDA to enterprise value market multiple of approximately 5.4 times (x) as of Jan. 20, 2011. The following discussion regarding Fitch's conclusions are based on Fitch's interpretation of the current loan documents across WMG Acquisition Corp (WMG Acquisition) and WMG Holding Corp. (WMG Holding).
WMG ACQUIRES EMI:
If WMG were to acquire EMI, it is likely that certain publishing and/or recorded music assets would have to be sold due to the significant market share. Management would have some flexibility in deciding which assets to hold on to and which ones to sell, maximizing their market share. Fitch also believes that the timing of any acquisition of EMI would be impacted by EMI's current capital structure issues, which may or may not be settled in the near term. Based on available information, Fitch values EMI in a range of $2.0 to $2.8 billion, with EMI's Recorded Music business ranging from $300 million to $700 million.
Based on Fitch's analysis of the existing governing indentures, Fitch believes it is possible to finance an acquisition of EMI without violating any covenants. Fitch believes this transaction could be financed using a combination of non-recourse acquisition financing (a debt limitation covenant carve out under the indentures), additional debt under the Fixed Charge Coverage incurrence test of 2.0x (Fitch estimates that there is approximately $300 million in capacity under this carve out) and proceeds from asset sales. A downgrade of the rating could occur depending on the level and/or structure of debt incurred to finance an acquisition of EMI. Cost synergies could potentially provide an offset.
Fitch does not believe that this scenario would have a material impact for the existing senior secured bond holders at the WMG Acquisition level, given that their seniority and security package remain unchanged. However, Fitch does believe that this could be detrimental to the current Subordinated note holders at WMG acquisition and the current note holders at WMG Holdings, given that any new debt at WMG Acquisitions would likely rank ahead or pari passu with the WMG Acquisition subordinated notes and may reduce any potential recovery prospect for these series of notes. It is possible that even if the structure of the transaction did not lead to the downgrade of the Issuer Default Rating (IDR), the issue ratings on the subordinated notes and notes at WMG Holding could be downgraded.
SALE OF WMG MUSIC PUBLISHING:
If WMG were to sell its Music Publishing business, an explicit change of control (CoC) would be triggered under the 9.5% senior secured notes, in addition, there are covenant restrictions on the sale of WMG's Music Publishing business, including a requirement that the acquirer assume all the obligations under the senior secured notes (this is only relevant if any of the bond holders do not accept the 101% CoC offer). WMG also has the option to redeem the senior secured notes prior to June 15, 2013 under the 'Major Music/Media Transaction' provision at a price of 104.75%. Fitch would expect the company to use this provision if 1) the acquirer was a Major, 2) the CoC offer was not taken up by the bondholders, and 3) the sale of the Music Publishing business would not meet the Music Publishing Business sale covenant requirements (including if the acquirer decides not to assume the senior secured bond). The indenture defines a Major as any significant competitor or participant in any business or service that is similar or a reasonable extension/expansion of such business or service.
Fitch notes that the Subordinated notes at WMG Acquisition and the notes at WMG Holding contain 'all or substantially all' CoC triggers, which may also be triggered by a sale of its Music Publishing business given its substantial value. If all of these CoC's were triggered it could be possible that the cash proceeds from the sale of the WMG's Music Publishing business would not be sufficient to cover all of the bond repurchases (if 100% of the bond holders accepted).
The ratings on the remaining Warner Music recording business would be dependent on the subsequent capital structure and financial policy. Fitch notes the business risk would be heightened without the stable publishing division in the business mix. As such there would be a lower leverage tolerance at the same rating level.
SALE OF 50% OR MORE OF WMG:
If 50% or more of WMG's equity (there is only one series of common stock) were bought by a third party, the CoC put across all bonds at WMG Acquisition and WMG Holding would be triggered at 101%. Rating implications would be dependent on the resulting capital structure; however, Fitch believes Sony Corporation (Sony: 'BBB'; Stable Outlook) is the only strategic buyer that could result in an upgrade to the ratings. A purchase by a financial buyer that used incremental leverage would likely result in a downgrade of the existing ratings, or possibly no change. Fitch does not believe that Sony would purchase all of WMG, but there could be certain publishing catalogs that may be attractive to Sony.
LESS THAN 50% OF WMG IS PURCHASED AND WMG ACQUIRES EMI:
Fitch believes that there could be a scenario where both less than 50% of WMG is acquired by a third party and EMI is acquired by WMG. Fitch believes this series of transactions can be structured in a manner that does not trigger any CoCs, and any additional debt incurred is done so within the existing debt and lien provisions. As previously mentioned timing of an acquisition of EMI would be unclear and there could be regulatory requirements to sell certain assets, due to the significant market share.
Depending on whether the proceeds of the sale of the WMG equity stake were used to finance a portion of the EMI acquisition, ratings could be affirmed. Any additional debt at WMG, WMG Acquisition or WMG Holdings, would likely result in a rating downgrade. As discussed above, the senior secured bond lenders may not be materially impacted by this transaction; however, the existing subordinated notes and the WMG Holding notes could see their recovery prospect decline.
LIQUIDITY AND LEVERAGE:
Fitch calculates WMG's metrics as follows as of Sept. 30, 2010:
--Cash interest coverage at 2.3x;
--Free cash flow (FCF; before dividend and acquisitions) of $99 million. Fitch expects WMG to generate FCF in the range of $100 million to $150 million range in 2011;
--Cash balances available at $263 million (Fitch excludes a portion of the cash held at WMG - consolidated cash balances were $439 million - when calculating liquidity);
--Gross leverage at approximately 4.7x and net leverage at approximately 4.1x. Fitch expects leverage to remain near these levels in 2011.
The FCF and leverage expectations do not take into account any transactions discussed above.
Fitch currently rates WMG and its subsidiaries as follows:
WMG
--IDR 'BB-'.
WMG Holdings
--IDR 'BB-';
--Unsecured notes 'B'.
WMG Acquisition
--IDR 'BB-';
--Secured notes 'BB';
--Subordinated notes 'B+'.
Additional information is available 'www.fitchratings.com'.
Applicable Criteria & Related Research:
--'Corporate Rating Methodology' Aug. 13, 2010;
--'Operating Leases: Updated Implications for Lessees' Credit' Aug.13, 2009;
--'Evaluating Corporate Governance' Dec. 12, 2007;
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' Nov. 24, 2009.
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646
Operating Leases: Updated Implications for Lessees' Credit
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=462222
Evaluating Corporate Governance
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=581405
Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=489006
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