NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed Expedia, Inc.'s (Expedia) 'BBB-' Issuer Default Rating (IDR) and senior unsecured issue-specific ratings at 'BBB-'. This action follows a review of Liberty Interactive Corp.'s (Liberty) planned spin-off of its Expedia holdings to a newly created entity, Liberty Expedia Holdings, Inc. (Spinco). The Rating Outlook is Stable.
KEY RATING DRIVERS
Liberty plans to spin-off of its Expedia holdings to a newly created Spinco entity. The transaction will not impact Expedia's financial policies, including its tendency to operate around 2.0x debt/EBITDA(leverage). However, Fitch believes the spin-off increases the likelihood that Expedia will repurchase the shares owned by Liberty (and controlled by Expedia Chairman and Senior Executive Barry Diller) through a combination with Spinco.
Liberty has highlighted the tax efficiency, reduced complexity and the long-term potential for combination with Expedia (possibly through a stock-for-stock deal) as key benefits for the transaction. Any transaction is unlikely occur to for at least 12 months to preserve the tax-free nature of the spin-off. Fitch has previously reflected the risk of Expedia undertaking a debt-funded purchase of Liberty's stake in its 'BBB-' IDR.
Expedia's funding strategy and the control premium required to purchase Spinco's super voting Expedia shares are key unknowns related to a possible Expedia/Spinco combination. A stock-for-stock transaction could provide Liberty with additional tax planning flexibility, assuming it wants to exit its Expedia stake. However, Fitch believes a cash funded (i.e. leveraging) transaction could be preferable if Liberty has an immediate use of proceeds. Fitch believes Expedia may also prefer a combination of stock-and-debt (rather than all equity) to help minimize the dilution relative to its cost of capital.
Fitch expects Expedia's leverage to return to below 2.0x by the end of 2017. Fitch's Expedia ratings have some tolerance for leverage temporarily exceeding 2.0x due to strategic acquisitions, provided there is a clear path for the company to return to below 2.0x during our one-to-two year Rating Outlook horizon. Fitch calculates Expedia's leverage at 2.1x at Dec. 31, 2015, pro forma for the annualized impact of its eLong sale and Orbitz and HomeAway acquisitions. As such, Fitch's Expedia ratings have little headroom for additional leveraging transactions, including material debt-funded acquisitions or return of capital to shareholders.
Fitch sees no immediate change to the corporate governance issues surrounding Mr. Diller's effective control of the company as a result of the Spinco transaction, which Expedia's ratings contemplate. Mr. Diller controlled approximately 54% of the outstanding total voting power of Expedia through his personal Expedia holdings and holdings of Liberty, which Mr. Diller has voting control through an irrevocable proxy granted by Liberty. Longer-term, combining with Spinco could remove the uncertainty regarding Mr. Diller's control of the company, as well concerns about pressure on the stock were Liberty to sell its position. Mr. Diller's personal Expedia stake is not impacted by the Spinco transaction - only his proxy over Expedia shares owned by Liberty.
Spinco will own Liberty's 16% economic interest (52% voting) in Expedia (approximately $2.5 billion market value based on current trading price) and 100% of Bodybuilding.com. The company plans to raise $350 million of floating rate margin debt that will fund a $300 million dividend to Liberty. Spinco will retain the remaining $50 million. Spinco will continue to receive annual dividend income from its Expedia stake that will cover its debt service with adequate cushion. When viewed on a consolidated basis with Spinco, Expedia's pro forma leverage increases by 0.2x to 2.3x as of Dec. 31, 2015.
Mr. Diller will retain effective control of Expedia through a proxy swap structure that will revert back to the current ownership structure after 12-to-18 months. The proxy swap is structured to allow Spinco to avoid '40 Act Investment Company classification at the time of the spin-off. Under the proxy swap terms, Mr. Diller will temporarily assign his proxy over Liberty's Expedia stake to Spinco and John Malone will concurrently give Diller a temporary proxy to vote Malone's Spinco shares.
Expedia had 137.5 million shares of common stock outstanding at Dec. 31, 2015 and 12.8 million shares of super voting Class B common stock. Common stockholders are entitled to one vote per share and 10 votes for each Class B share. Liberty controls 8% of Expedia's common stock and 100% of its outstanding Class B common stock through a wholly-owned subsidiary, representing an approximate 16% economic interest in Expedia assuming conversion of Class B stock into common stock.
KEY ASSUMPTIONS
--Strong revenue growth in the double-digit range driven by organic growth and recent strategic acquisitions.
--EBITDA margins hold steady in the 16%-17% range through leveraging of fixed costs on aggressive revenue growth offset by the levels of investments in sales and marketing expense that support a longer term view.
--No additional debt raised through the forecast period as future acquisitions are in the $400 million range and funded through cash flow from operations.
--Share repurchases are subdued due to recent acquisitions and anticipated elevated capital expenditures from 2016-2018 related to new headquarters construction (est. $1.2 billion through 2018).
--Steady dividend increases consistent with 2014 payout ratio.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
--Positive rating action will likely be forestalled for the foreseeable future due to minimal business considerations to support the company maintaining a rating above 'BBB-' and certain secular challenges. These include an intensifying competitive environment, shifting consumer behaviors, and technological shifts. However, a more conservative financial profile coupled with increased revenue diversification from the growth of the Egencia segment and Ad and Media revenues could have positive implications for the rating.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--An increase in expected volatility in profitability, potentially due to greater volatility in travel services demand or a higher fixed-cost component to Expedia's financial model;
--A secular decline in the OTA business model, potentially the result of a shift to direct bookings with travel providers;
--The potential for a substantial financial loss from any future conclusion of the occupancy tax lawsuits facing the company;
--A more aggressive financial policy, reflected through material debt-funded acquisition, share repurchase, or dividends that drive leverage sustainably above 2.0x.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Expedia, Inc.
--IDR 'BBB-', Outlook Stable;
--Senior unsecured bank credit facility 'BBB-';
--$500 million in 7.456% senior unsecured notes due 2018 'BBB-';
--$750 million in 5.95% senior unsecured notes due 2020 'BBB-';
--EUR650 million in 2.5% senior unsecured notes due 2022 'BBB-';
--$500 million in 4.5% senior unsecured notes due 2024 'BBB-';
--$750 million in 5% senior unsecured notes due 2026 'BBB-'.
Date of Relevant Rating Committee: March 28, 2016
Additional information is available on www.fitchratings.com.
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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