RIO DE JANEIRO--(BUSINESS WIRE)--Fitch Ratings has affirmed Cielo S.A. (Cielo) and its subsidiary Cielo USA Inc.'s ratings as follows:
--Foreign and local currency Issuer Default Ratings (IDR) at 'BBB+';
--Long-term national scale rating at 'AAA(bra)'.
Cielo USA Inc.
--Foreign currency IDR at 'BBB+';
--Senior unsecured notes at 'BBB+' due in 2022.
The Rating Outlook for the corporate ratings is Stable.
Cielo USA Inc. is a wholly owned subsidiary of Cielo. The aggregate amount of the senior unsecured notes units is USD875 million. It consists of USD470 million issued by Cielo and USD405 million issued by Cielo USA Inc., which is unconditionally and irrevocably guaranteed by Cielo. The senior unsecured notes cannot be sold independently. The credit quality of Cielo and Cielo USA Inc. has been linked according to Fitch's 'Parent and Subsidiary Rating Linkage' criteria report dated Aug. 5, 2013.
Cielo's investment grade ratings reflect the company's leading position in the Brazilian card payment industry and the strength and resilience of its business model, which is supported by the growing and predictable revenue stream from a diversified base of affiliated merchants. Cielo has a solid capital structure, liquidity position, and the ability to generate strong and resilient cash flow in its business.
Cielo's ratings also incorporate the low counterparty risks associated with the Brazilian banking system, as more than 95% of credit and debit transactions are settled with investment grade banks. The support and the strength of its controlling shareholders, Banco Bradesco S.A. (Bradesco) [rated 'AAA(bra)' National Scale; local currency IDR 'A-' and foreign currency IDR 'BBB+' by Fitch] and Banco do Brasil S.A. (Banco do Brasil) [rated 'AAA(bra)' National Scale; local and foreign currency IDR 'BBB' by Fitch] are also incorporated in the ratings. Cielo's ratings are not limited by the credit profile of one of its main shareholders, Banco do Brasil, as it divides the control of the company with Bradesco and its access to Cielo's cash flow is restricted to dividends.
KEY RATING DRIVERS
Leading Position in the Brazilian Card Payment Industry
Cielo is the leading company in the Brazil's merchant acquiring and payment processing industry with an estimated market share of 53.5%. The industry is extremely consolidated with the number two participant, Rede (formally known as Redecard), having around 40% of the market. Cielo has a strong competitive advantage, as the company relies on the strong relationship and distribution network of Banco do Brasil, Bradesco, HSBC and Caixa. Together these banks have about 13,957 branches. They account for about 62% of the Brazilian banking system. Cielo's affiliation with these leading banks gives it access to their broad customer base to acquire merchants accounts and creates high barriers to entry; approximately 60% of Cielo's merchant accounts are established through its affiliations with banks. The penetration of credit and debit cards in Brazil is low, which supports Cielo's long-term growth prospects. The company's strategy to preserve margins may result in a reduction of market share in the short term.
Strong Capital Structure
As of June 30, 2013, Cielo had BRL2.3 billion of total debt. This debt consists primarily of USD875 million of senior notes and BRL389 million FINAME loans used to finance the purchase of POS equipment. The company's net debt to adjusted EBITDA leverage ratio of 0.4x is low and is not expected to materially change over the next few years. Cielo's liquidity position is strong. As of June 30, 2013, Cielo had cash and marketable securities of BRL430 million, which compares favorably with BRL221 million of short-term debt. During the latest 12 months (LTM) ended June 2013, Cielo generated BRL4.2 billion of adjusted EBITDA, including financial income derived from the discounting and pre-payment of receivables to merchants, BRL2.8 billion in funds from operations (FFO) and BRL1.7 billion in cash flow from operations (CFFO).
Free Cash Flow Negative due to Dividends and Acquisitions
Cielo's free cash flow was negative BRL1.4 billion in the LTM. During this time, the company spent BRL1.5 billion on investments and distributed BRL1.6 billion of dividends. In September 2012, Cielo acquired a 100% participation in an American company, Merchant e-Solutions (MeS), for USD670 million (BRL1.365 billion), which was partially financed with debt. Cielo has a minimum dividend distribution policy of 50% of net income, but has historically distributed dividends of about 70% of net income.
Recurring and Growing Revenues, Shrinking Margins
Cielo's business model is stable, with a low correlation to economic cycles. The revenue growth is generally driven by the increasing migration to an electronic payment system from a cash system and increasing card payment penetration in Brazil. In the LTM ended June 2013, net revenues was BRL6.1 billion, compared to BRL5.4 billion in 2012. These figures do not include financial income from pre-payment of payables to merchants. Cielo processed BRL380 billion of credit and debit card transactions in 2012. This figure will grow in 2013, as the company already had processed BRL204 billion of transactions in the first half of the year. Revenues from the rental of POS equipment and financial income from pre-payment/discounting of payables to merchants also contributed to growth. Cielo's operating margins remain pressured by higher competition in the Brazilian card payment industry. In the LTM ended June 2013, adjusted EBITDA margin was 60.7%, compared to 62.5% in 2012 and 67.2% in 2010.
Low Risk of Credit Loss
Cielo currently has virtually no direct credit exposure to cardholders, as the card-issuing bank guarantees cardholder's payment. The company is, however, exposed to card-issuing bank defaults on a payment settlement for Visa transactions. The licensing agreement with Mastercard mitigates this risk, as it guarantees the settlement of all transactions. The risk associated to Visa transactions is mitigated by the fact that more than 95% of the volume of credit and debit transactions is concentrated with investment grade rated banks. For non-investment grade banks, Cielo's risk management policy requires the card-issuing bank to pledge collateral. Cielo is exposed to merchants that accept cards processed by Cielo in terms of their performance, payment of the rental of the equipment, fraud, and losses due to customer charge-backs. These losses have been historically low, representing less than 1% of net revenues.
Manageable Regulatory Risk
In October 2013, Brazil's Central Bank was named as the regulator of the payment processing industry, approved under the law 12865/2013. The Central Bank is expected to publish new regulatory requirements for the sector by the end of this year. Some of the key changes expected in the near term include the end of the exclusivity agreements of smaller brands like Elo, American Express, Hiper and food vouchers. As the participation of these brands in Cielo's volume of credit and debit transactions is low, the impact on the company's cash flow generation capacity should be limited.
Ratings upgrades are not likely in the short to medium term. Cielo's IDRs are already positioned at the same level of Brazil's country ceiling of 'BBB+'. Ratings downgrades would most likely be driven by a combination of the following factors: an increase in the volume of credit and debit transactions with non-investment grade banks without collateral being pledged by the card-issuing bank or not guaranteed by Mastercard; by a weakening credit profile of the main banks that operate with Cielo; and/or by a significant loss due to fraud and charge-backs. Factors that could lead to consideration of a Negative Outlook or downgrade also include effects on the business caused by the competitive environment and significant changes in the regulatory risk.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage