Fitch Affirms Viacom's IDR at 'BBB'; Outlook Remains Negative

CHICAGO--()--Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) of Viacom, Inc. (Viacom) at 'BBB'. Fitch has also affirmed the specific issue ratings assigned to the company's senior unsecured notes and debentures at 'BBB'. The Rating Outlook remains Negative. A full list of Fitch's ratings on Viacom follows at the end of this release.

Approximately $12.8 billion of debt (face value - including commercial paper) outstanding as of June 30, 2016 is affected by Fitch's action.

Fitch's rating action follows a series of announcements by Viacom aimed at increasing its financial flexibility and solidifying its liquidity position. Specifically the company announced a 50% reduction to its dividend and announced its intent to access capital markets to fund near-term scheduled maturities. Fitch believes these actions are positive for the company's credit profile as they provide incremental financial flexibility given the company's weak operating profile.

Fitch's ratings continue to reflect Viacom's weakened operating profile and the absence of tangible evidence that the strategies implemented by the company are recapturing positive operating momentum and reducing volatility with the company's key cable network businesses. As previously indicated by Fitch, the expected rebound of Viacom's operating profile has taken longer than Fitch previously anticipated.

Fitch continues to believe the company is pursuing appropriate strategies to strengthen its operating profile given the current operating environment. Fitch expects to observe tangible improvement in Viacom's operating profile during the first half of its fiscal 2017 as evidenced by strengthening domestic affiliate fee revenues and recovering domestic advertising revenues in combination with stable operating margins.

The ratings incorporate the ongoing uncertainty related to the company's leadership transition and commitment to investment grade ratings. Viacom's board will finalize the succession plan for Viacom's president and CEO by mid-November 2016. Fitch recognizes that Viacom's financial and strategic plans will remain in flux until the board agrees on a new president and CEO and final plans are in place.

Viacom's decision to reduce its dividend confirms the company's intent to reduce debt and de-lever its balance sheet. However Fitch expects an operational rebound will have a more meaningful impact on improving the company's credit profile.

Viacom's historically aggressive capital allocation posture, which has long favored share repurchases in excess of free cash flow (FCF) generation, along with the weak operating results have combined to reduce Viacom's financial flexibility and weaken its credit profile. Viacom's leverage increased to 3.6x during the latest 12 month (LTM) period ended June 30, 2016, and Fitch expects leverage will range between 3.8x and 3.9x as of Viacom's fiscal year end 2016. Fitch anticipates that leverage will improve during fiscal 2017 and that leverage will approximate 3.5x as of Sept. 30, 2017 before approaching 3x by the end of fiscal 2018.

The Negative Outlook incorporates the uncertainty related to Viacom's ability to stabilize and strengthen its operating profile amid the persistent secular challenges to its business model. Viacom's new board of directors and management will face the challenge of strengthening the company's operating profile and competitive position. The strategies currently in place have struggled to produce tangible evidence that they are regaining positive operating momentum and reducing volatility in the company's key cable network businesses.

Fitch believes reversing these negative operating trends will be difficult in the current operating environment. Competition for viewing audience within Viacom's targeted demographic will remain fierce as these younger demographics are migrating away from traditional linear video programming. Moreover, given Viacom's reliance on the kids and teen demographic segments, the company is more dependent on advertising categories which target kids and teens relative to its peer group. To combat these issues, Viacom has increased its investment in programming focusing on producing more original programming across its cable network portfolio, adding more scripted shows and event programming and becoming more selective in acquiring programming. In addition to its programming investment, Viacom has created products to improve the monetization of both linear and non-linear viewership and improve the yield on its advertising inventory, including its Viacom Vantage, Velocity and Echo offerings. In addition the company is reducing unit loads to improve viewer experience and thereby strengthen its domestic advertising business.

KEY RATING DRIVERS

Appropriate Financial Strategy: The changes to Viacom's capital allocation policy, namely the reduction of its dividend, the suspension of its share repurchase program and the reallocation of free cash flow to reduce debt coupled with changing its strategic programming focus and investment towards more original scripted programming, are appropriate given the current operating environment.

Leadership Transition Underway: Fitch recognizes the resolution of litigation involving Viacom's controlling shareholder and its board of directors and the resultant orderly transition of Viacom's leadership and board is a positive development for Viacom's credit profile and reduces the event risks attributable to the overall credit profile. Fitch cautions, however, that the leadership changeover is a two-step process. Fitch anticipates a new CEO will be in place by mid-November and that Viacom's financial and strategic plans will remain in flux until the board agrees on a new president and CEO and final plans are in place.

Limited Financial Flexibility: Fitch recognizes the reduction of the dividend will improve overall financial flexibility, however operational headwinds, elevated leverage combined with ongoing investment in original programming and production is still expected to pressure FCF generation and limit the company's overall financial flexibility.

Cable Network Portfolio Anchors Ratings: The dual stream, recurring, high-margin revenue base of the cable networks remains the foundation for Viacom's ratings. While recognizing a level of viewership ratings volatility at any given cable network is factored into the current ratings, Fitch has concerns around weakened TV ratings at Viacom's cable networks. Fitch does not expect Viacom to lose any distribution deals, but continued ratings softness could weaken its negotiating position. Fitch believes that the higher level of investment in original programming has begun to improve ratings at key networks and expects that continued investment will lead to further improvements and will contribute to the strengthening of the company's operating profile.

Growing Secular Risks Present: The ongoing secular threats presented by changing media consumption, emerging distribution platforms and technology evolution and adoption have negatively affected Viacom's operating performance. Fitch recognizes the risks inherent in the company's strategies to address the secular threats and adapt to changing industry dynamics, monetize changing viewing habits, and recapture their target audience that continues to shift away from viewing media in a linear, measured environment.

Advertising Revenue Exposure Highlights Risks: Rating concerns include exposure to cyclical advertising revenues (at 38% of revenues, moderate relative to peer group) and the company's capacity to adapt to ever-changing media consumption patterns and technology platforms. Fitch's ratings recognize the volatility within Viacom's operating profile given the exposure to cyclical advertising revenues and the hit-driven nature of its cable networks and film studio; however, there is minimal tolerance within the current ratings for further weakening of Viacom's operating profile.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case include:

--Global advertising revenues decline to low single digits during fiscal 2016 followed by flat revenue growth during fiscal 2017. Domestic advertising revenues are expected to decline 4% during fiscal 2016 and flat during fiscal 2017.

--Affiliate fee revenue is expected to decline high-single digits during fiscal 2016 due primarily to timing of content distribution agreements with SVOD providers. Going forward, affiliate fee revenues are expected to grow to low single digits. Fitch does not expect Viacom to lose any meaningful distribution deals.

--Higher programming and production costs pressure EBITDA margins within the company's Media Networks segment. Fitch anticipates fiscal 2016 margins to range between 37% and 38%, and expanding modestly to approximately 39% during fiscal 2017.

--Fitch assumes typical volatility and continued weakness within in the Filmed Entertainment segment over the ratings horizon.

--Continued suspension of share repurchases in light of weakening operational profile and minimal merger and acquisition activity.

--All maturing debt is expected to be refinanced during the ratings horizon.

RATING SENSITIVITIES

Positive: Upward ratings momentum is unlikely during the current ratings horizon. Stabilization of the Outlook at the current rating is predicated on the company successfully executing on its strategies to address persistent secular threats to its business and recapturing positive operating momentum, as evidenced by sustainable positive domestic advertising and affiliate fee revenue growth and expanding operating margins. In addition Fitch needs to observe a rational resolution to the pending litigation related to the company's ongoing corporate governance issues and a clear articulation of a strategy to strengthen the company's operating profile.

Negative: Negative rating actions are more likely to coincide with the company's inability to strengthen its operating profile and reduce leverage below 3.5x. Resumption of share repurchase activity or other aggressive financial policy decisions that delay the anticipated improvement of Viacom's credit profile would also result in negative rating action. Moreover an unfavorable resolution to the corporate governance issues and pending litigation can lead to negative rating action.

LIQUIDITY

Viacom's weakening operating profile is diminishing its financial flexibility. In step with the company's weakened operating results, FCF generation, margin and FCF leverage metrics have also deteriorated. Led by Viacom's Media Networks segment, the company generated approximately $866 million of FCF (defined as cash flow from operations less capital expenditures and dividends) during the LTM period ended June 30, 2016, reflecting a 46% decline relative to company's reported FCF generation during its fiscal year end 2015. Operational headwinds, higher cash taxes and interest costs along with higher programming and production costs are expected to continue hindering FCF generation. Fitch expects FCF generation after dividends during fiscal 2016 to range between $500 million and $550 million before improving to approximately $1 billion during fiscal 2017.

In Fitch's view, Viacom's liquidity is adequate and supported by expected FCF generation. Additional financial flexibility is provided by the company's $2.5 billion revolving credit facility ($2.1 billion available as of June 30, 2016, with $453 million of outstanding commercial paper) and $192 million of cash on hand as of June 30, 2016. Viacom has deemed substantially all of the cash held by its foreign subsidiaries as permanently reinvested in its foreign operations and does not intend or foresee a need to repatriate any of this cash. Commitments under Viacom's revolver expire on Nov. 18, 2019. The credit facility contains an interest coverage covenant requiring coverage for the most recent LTM period to be at least 3.0x.

Approximately $900 million of debt is scheduled to mature during fiscal 2017, including $400 million of 2.5% senior unsecured notes due December 2016, which is followed by $1 billion of maturities due in fiscal 2018. Fitch expects the notes maturing in Dec. 2016 and April 2017 will be refinanced with proceeds of near-term capital market activity.

FULL LIST OF RATING ACTIONS

Fitch affirms Viacom's ratings as follows:

--Long-Term IDR at 'BBB';

--Senior unsecured notes and debentures at 'BBB';

--Senior unsecured bank facility due 2019 at 'BBB';

--Short-term IDR at 'F2';

--Commercial Paper at 'F2'.

The Rating Outlook remains Negative.

Date of Relevant Rating Committee: Sept. 22, 2016.

Additional information is available on www.fitchratings.com.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--No material adjustments have been made that have not been disclosed in public fillings of this issuer.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/site/re/869362

Short-Term Ratings Criteria for Non-Financial Corporates (pub. 13 Aug 2015)

https://www.fitchratings.com/site/re/869259

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1012108

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012108

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
David Peterson
Senior Director
+1-312-368-3177
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Rachael Shanker
Associate Director
+1-212-908-0649
or
Committee Chairperson
Jack Kranefuss
Senior Director
+1-212-908-0791
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
David Peterson
Senior Director
+1-312-368-3177
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Rachael Shanker
Associate Director
+1-212-908-0649
or
Committee Chairperson
Jack Kranefuss
Senior Director
+1-212-908-0791
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com