NEW YORK--(BUSINESS WIRE)--Fitch Ratings has placed the 'B+' Issuer Default Rating (IDR) assigned to DreamWorks Animation SKG, Inc. (DWA) on Rating Watch Positive. Fitch's action follows the announcement that DWA will be acquired by NBCUniversal, a division of Comcast Corporation (Comcast), for total consideration of $4.1 billion, including the assumption of DWA's debt. Approximately $360 million of DWA's debt outstanding as of Dec. 31, 2015 is affected by Fitch's action.
Fitch will remove the Rating Watch Positive and expects to upgrade DWA to 'A-' upon the transaction's completion. Fitch currently rates Comcast 'A-' with a Stable Outlook. The transaction is subject to regulatory approvals and is expected to close by year end 2016. If the transaction does not receive regulatory approval, Comcast will pay DWA a $200 million breakup fee.
Fitch believes Comcast will repay DWA's outstanding senior secured bank debt ($60 million at Dec. 31, 2105) upon the transaction's closing. Fitch also believes Comcast will likely redeem DWA's $300 million of 6.875% senior unsecured notes due 2020, which become callable after Aug. 15, 2016 at 105.156% of principal plus accrued and unpaid interest, following the transaction's closing. If the bank debt is repaid, the senior secured rating will be withdrawn; if the bonds are redeemed, the senior unsecured rating will be withdrawn; if both occur, the IDR and all issue ratings will be withdrawn.
The Rating Watch Positive will also be removed if the transaction is not closed, and the ratings are expected to remain unchanged. However, if this were to occur, the company would remain on Positive Outlook given DWA's underlying strengths. The Positive Outlook reflects Fitch's comfort in management's ability to execute its plan to stabilize the film segment and the expected operational profile improvement resulting from DWA's diversification efforts. Fitch believes the film segment will continue to benefit from Jeffrey Katzenberg's return to a more active role in film production and from the revised annual film output mix (one sequel and one original). In addition, Fitch believes the TV and New Media segment will continue to grow due in part to the segment's contractual income sources thereby improving DWA's operating profile and diversification.
KEY RATING DRIVERS
The Rating Watch Positive is driven by DWA's acquisition by Comcast. Fitch will revisit the Watch and the ratings once the transaction's outcome has been finalized.
The existing ratings and Positive Outlook are driven by the following:
Inherent Volatility of Movie Studios: The film industry is characterized by meaningful operating volatility due to its hit-driven nature. This risk is magnified with standalone studios relative to studios housed in media conglomerates. Through 2012 DWA demonstrated an uncommon level of consistency, producing 17 consecutive 3D animation hit films and creating notable franchises despite low output. Since 2012, DWA has suffered from uneven film performance and increased production costs resulting in several impairments. Fitch believes recent leadership changes and reorganization efforts, coupled with a reduction in annual releases, should have a positive effect on DWA's future performance.
Recent Box Office Challenges: The underperformance of releases since 2012 demonstrated that DWA was not immune to the industry's volatility. Recent box office underperformance led to impairments for four of its last seven releases. Management has addressed the losses with a substantial restructuring effort.
Restructuring Initiative: In 2015, management restructured its core film business including the layoff of 500 employees (of 2,700), the closure of its Northern California facility and the sale-leaseback of its Glendale, CA headquarters. In addition, DWA made several senior management changes, with the most important being that Jeffrey Katzenberg returned to a more active, hands-on role with feature films. Mr. Katzenberg was the primary architect of DWA's successful animated film performance prior to 2012. Finally, the studio's annual film output strategy was revised from three to two films (one sequel and one original) with a reduced budget of $120 million per film starting with 'Trolls', which is scheduled for release in November 2016. In 2014, related pre-tax charges totalled $210 million (approximately $110 million in cash charges). The plan is expected to generate approximately $30 million in pre-tax run-rate savings in 2015, increasing to $60 million by 2017.
Diversification Improvements: Over the last several years, management has a made material progress in diversifying DWA's business operations. For the Fiscal Year Ended Dec. 31, 2015 (FY 2015), Feature Films contributed 57% of revenue compared to 78% for the fiscal year ended Dec. 31, 2011. Remaining revenues came from TV (25% of FY 2015 revenues), Consumer Products (9%), and New Media and Other (9%) segments. Within the TV segment, DWA benefits from long-term contractual agreements paying per-episode fees with Netflix in the U.S. (over 1,000 episodes pre-sold) and similar output arrangements with other distributors abroad. The TV segment generated $228 million in revenues for FY 2015, with Netflix accounting for the majority. Contract renewal risk is mitigated by strong demand from other Over-The-Top (OTT) players for first run original TV content. The New Media and Other segment (primarily AwesomenessTV) represent a promising growth area as it reaches the Gen Z demographic outside traditional distribution channels. Fitch believes growth in these new segments will continue to materially improve DWA's risk profile.
Emerging Distribution Opportunities: Fitch believes the new distribution platforms via OTT services create additional outlets and exploitation opportunities for DWA's content, intellectual properties and past libraries, while allowing the company to reduce its reliance on theatrical distribution. DWA is better positioned to take advantage of the emerging distribution platforms as the company is much less dependent on the traditional TV ecosystem relative to other studios. DWA also retained TV/SVOD distribution rights for its feature films in the Americas, which were carved out from its current distribution agreement with Twentieth Century Fox. However, Fitch believes acceleration in the decline of theater ticket sales or physical content sales could pose serious challenges before the company can get meaningful traction on emerging platforms.
Credit Metrics Pressured: DWA's leverage (Total Debt to Fitch-calculated EBITDA) can experience significant fluctuations due to the volatility of the underlying business and timing of film releases. As a result, Fitch believes FCF is a more appropriate measure of DWA's credit profile and therefore prioritizes FCF measures over EBITDA metrics. As of LTM Dec. 31, 2015, Fitch calculates LTM FCF at $29.8 million and adjusted gross leverage (adjusted for restructuring charges and film impairments) at 2.7x. Material debt reductions could be difficult in the short term due to incremental cash outlays required for content deliveries under the Netflix contract.
KEY ASSUMPTIONS
--Stabilization within the Feature Film segment due to the company's restructuring efforts, revised film mix, and leadership changes;
--Increase in working capital needs in 2016 due to ramp up for content deliveries, primarily to Netflix;
--Continued growth in the TV and New Media and Other segments due to favorable secular trends.
RATING SENSITIVITIES
Positive: A positive rating action would result in the removal of the Rating Watch Positive and an expected upgrade to 'A-' upon the transaction's closing. If the transaction does not close, a positive rating action would entail a combination of a return to positive FCF generation, continued diversification of revenue streams, and/or sustained leverage of 3.5x or below. The Positive Rating Outlook reflects Fitch's confidence that DWA can achieve these measure by end of 2017 or early 2018.
Negative: A negative rating action would result in the removal of the Rating Watch Positive if the transaction does not close, but the ratings and Positive Outlook are expected to remain unchanged. A further negative rating action would entail the removal of the Positive Outlook. Ratings may be pressured if Feature Films materially underperform at the box office and FCF continues to be pressured. In addition, any leveraging transaction including large acquisitions and material debt-funded share buyback activities without a clear plan to de-lever may pressure the rating.
LIQUIDITY
Liquidity is supported by cash on hand of $110.8 million and availability of $390 million under the $450 million revolver due 2020. The company has no debt maturities until 2020. Although DWA is expected to require incremental cash for film investments in the short-term, current liquidity should be sufficient to meet these expected cash needs.
FULL LIST OF RATING ACTIONS
Fitch has placed the following ratings on Rating Watch Positive:
DreamWorks Animation SKG, Inc.
--IDR 'B+';
--Senior secured credit facility 'BB+/RR1';
--Senior unsecured notes 'B+/RR4'.
Date of Relevant Rating Committee: April 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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