Fitch Affirms Liberty Interactive and QVC IDR at 'BB'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'BB' Long-Term Issuer Default Rating (IDR) for Liberty Interactive LLC (Liberty) and its wholly owned subsidiary QVC Inc. (QVC). Additionally, Fitch has affirmed the issue ratings of Liberty and QVC as outlined at the end of the release. The Rating Outlook is Stable. As of Sept. 30, 2016, Liberty had approximately $8.5 billion of debt outstanding, including approximately $5.7 billion at QVC.

KEY RATING DRIVERS

Consolidated Profile Drives Ratings: Liberty's and QVC's ratings reflect the consolidated legal entity/obligor credit profile, rather than the tracking stock structure of Interactive (QVCA/B)/Ventures (LVNTA/B). Based on Fitch's interpretation of Liberty's indentures, Liberty could not spin out QVC without bondholder consent. Fitch believes QVC generates 81% and 95% of Liberty's last 12 months (LTM) ended Sept. 30, 2016 revenues and EBITDA, respectively; a spinoff would trigger the "substantially all" asset disposition restriction in the Liberty indentures.

Ratings Reflect Spinoff: Fitch's ratings materially rely on QVC with Liberty's other investments viewed as incremental support. The ratings incorporate LVNTA/B's spinoffs of CommerceHub, Inc. completed in July 2016 and Liberty Expedia Holdings, Inc. in November 2016. Pro forma for the spinoffs and $345 million of new borrowings under the QVC/zulily llc (zulily) revolver to fund Liberty's 1% HSNi exchangeable debentures put, Fitch calculates QVC's gross leverage at 2.8x and Liberty's gross leverage at 4.3x as of Sept. 30, 2016.

Broadband Investment: Liberty used cash on hand to invest $2.4 billion in Liberty Broadband Corporation (Broadband) for a 24% ownership position in Broadband in May 2016. Broadband used the proceeds to fund its $5 billion stock purchase for 25% ownership in a new entity (New Charter) created by Charter Communications Inc.'s merger with Time Warner Cable Inc. and acquisition of Bright House Networks. Liberty also exchanged its TWC ownership into a 2% ownership position in New Charter.

QVC Debt Ratings: Fitch rates both QVC's senior secured bank credit facility and the senior secured notes 'BBB-', two notches higher than QVC's IDR. The secured issue rating reflects what Fitch believes QVC's stand-alone ratings would be.

Recent Operating Weakness: Fitch recognizes QVC's ability to manage product mix and adapt to its customers' shopping preferences. However, QVC has been experiencing top line weakness across an increasing number of product categories including jewelry and electronics. and Fitch will pay close attention to QVC's operating performance over the next few quarters to determine the breadth, depth and tenor of this weakness.

EBITDA Margin: While EBITDA margin fluctuation is driven in part by product mix, Fitch believes QVC's margins will remain within its historical 18%-20% range over the next few years. One additional driver of this expectation is QVC's recent announcement regarding the elimination of 100 corporate positions as part of a broader effort to reduce SG&A expenses by $30 million to 35 million in 2017.

Cash Deployment: Fitch expects Liberty's free cash flow (FCF) to be dedicated to share repurchases and debt reduction. Although Fitch expects QVC to manage leverage down to its stated 2.5x leverage target within 12-15 months, recent operating performance weakness suggests that debt repayment may be necessary to accomplish this. Fitch also recognizes the risk remains that Liberty may acquire the 62% of HSN Inc. it does not own, but believes Liberty's $2.3 billion acquisition of zulily in October 2015 reduced this probability.

QVC experienced an increase in credit write-offs driven by issues with Easy-Pay, a broadly offered program designed to extend customer payment terms without credit checks. Bad debt expense began stepping up in 2Q16, significantly exceeding 1% for the first time in several years, driven primarily by a higher default rate among new and infrequent customers. QVC has since become more conservative in offering this program and will work to reduce write-offs to more normalized levels below 1%. While Fitch is mindful of this trend, it remains well below industry averages. Fitch also notes that QVC offers a credit card though Synchrony Bank which has not experienced any worsening credit trends.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--High single-digit revenue growth in FY2016 as a full year of zulily more than offsets QVC's weak second-half performance

--Mid-single-digit growth thereafter driven by mid-teen growth at zulily, low single-digit U.S. growth and mid-single-digit International growth.

--Consolidated EBITDA margins remain within their historical range between 18%-20%

--Annual FCF in the range of $1 billion-$1.2 billion.

--QVC Inc. reduces total leverage below its 2.5x target in 2017, which is within Fitch's rating parameters, using a mix of EBITDA improvement and FCF. The EBITDA growth and debt repayment are also sufficient to reduce Liberty's total leverage below 4x.

RATING SENSITIVITIES

Positive Rating Actions: Fitch believes if Liberty were to manage to more conservative leverage targets, ratings could be upgraded. Liberty would need to demonstrate sustained gross unadjusted leverage below 3.5x and QVC's unadjusted gross leverage managed to below 2x.

Negative Rating Actions: Negative action could occur if QVC does not return leverage to below 2.5x within 12-15 months; if financial policy changes, including more aggressive leverage targets and asset mix changes weakening bondholder protection; or if there are unexpected revenue declines in excess of 10% that materially drive declines in EBITDA and FCF, and result in QVC's leverage exceeding 2.5x in the absence of a credible plan to reduce leverage.

LIQUIDITY

Fitch believes liquidity at QVC will be sufficient to support operations and its expansion into other markets. Fitch expects near-term debt repayment, acquisitions and share buybacks to be a primary use of FCF. Fitch also believes there is sufficient liquidity and cash generation (from investment dividends and tax sharing between the tracking stocks) to support debt service and disciplined investment at Liberty. Fitch recognizes that in the event of a liquidity strain at Liberty, QVC could provide funding to support debt service (via intercompany loans), or the tracking stock structure could be collapsed.

Fitch notes that cash can travel throughout all Liberty entities relatively easily. Although the tracking stock structure adds a layer of complexity, Liberty has in the past reattributed assets and liabilities. Fitch believes that resources at QVC would be used to support Liberty, and vice versa, if ever needed.

Liberty's consolidated liquidity as of Sept. 30, 2016 included $505 million in readily available cash, $680 million available under QVC's $2.65 billion revolving credit facility (RCF), the majority of which expires in June 2021 (see below) and $1.8 billion in available-for-sale investments. Fitch calculates FCF of approximately $1.04 billion. Fitch expects FCF to be in the $1.1 billion-$1.2 billion range in 2017 and 2018. Liberty's balance sheet includes public holdings with an estimated market value of $5.6 billion. Fitch believes the remaining assets could be liquidated in the event that Liberty needed additional liquidity.

Liberty has $1.2 billion of near-term maturities that are only classified as near term because Liberty does not own the underlying shares needed to redeem the debentures. However, Liberty has no intention or requirement to redeem them in the near term, and maturities range from 2029 to 2046. QVC's next maturity, other than its $2.7 billion RCF in 2021, is $400 million aggregate principal of 3.125% senior secured notes due in 2019. Fitch believes Liberty has sufficient liquidity to handle this maturity.

In June 2016, QVC amended its senior secured credit facility to include a $400 million revolver (Tranche 2) on which Liberty's subsidiary zulily is a co-borrower. Although pricing did not change, the maturity on Tranche 1 and Tranche 2 ($2.1 billion) was extended to June 23, 2021, with the remaining $140 million (Tranche 3) maintaining the existing June 30, 2016 maturity. QVC's maximum leverage ratio covenant under the new credit facility will be 3.5x, which is unchanged from the previous credit facility. Additionally, there is a combined zulily and QVC leverage covenant, which improves the overall interest rate under the new credit facility. Tranche 1 is secured by the stock of QVC and zulily while Tranches 2 and 3 continue to be secured by QVC stock only.

Fitch expects cash deployment to be dedicated toward debt repayment in the near term along with share buybacks and acquisitions. Fitch recognizes the risk that Liberty may acquire the 62% of HSN Inc. it does not already own, but believes the zulily acquisition reduced this probability. However, depending on how the transaction is structured and the company's commitment to returning QVC's and Liberty's leverage to 2.5x and 4x, respectively, ratings may remain unchanged. Fitch believes that Ventures cash deployment will be primarily toward acquisitions and investments.

FULL LIST OF RATING ACTIONS

Fitch affirms the following ratings:

Liberty Interactive LLC

--LT Issuer Default Rating (IDR) at 'BB';

--Senior unsecured at 'BB/RR4'.

QVC

--IDR at 'BB'.

--Senior secured debt at 'BBB-/RR1'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: Nov. 10, 2016

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014670

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Contacts

Fitch Ratings
Primary Analyst
Jack Kranefuss
Senior Director
+1-212-908-0791
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Rachael Shanker
Associate Director
+1-212-908-0649
or
Committee Chairperson
Steven Marks
Managing Director
+1-212-908-9161
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com