Fitch Affirms Cogeco at 'BB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the Issuer Default Rating (IDR) for Cogeco Cable Inc. (Cogeco) at 'BB+'. A full list of ratings is at the end of this release. The Rating Outlook is Stable.

KEY RATING DRIVERS

Increased Diversity Provides Growth Offset

Cogeco has diversified its asset mix through acquisitions as a result of maturing Canadian cable services that has experienced increased competitive intensity and structural substitution. Consequently, Canadian cable growth rates have declined to the low single-digits. Consolidated revenue for the first six months of fiscal 2015 grew 5% driven primarily by growth in its U.S. Cable and enterprise data segments including foreign exchange benefits. The Canadian cable segment generates approximately 70% of EBITDA compared to roughly 90% two years ago.

Rate Increases, Upgraded Offering

Cogeco expects to mitigate revenue pressure through rate increases, an upgraded service offering with the TiVo platform, targeted marketing initiatives to improve broadband and telephony business additions, which have become an increasingly important offset and growing its market position in its business footprint. In the U.S., the TiVo launch has moderately improved video loss trends and increased broadband service take-up rates.

Expectations for Stable Core

Fitch believes Cogeco's good business profile is primarily supported by the Canadian cable operations that generate strong profitability. Cogeco's competitive position is anchored by its robust high-speed internet and triple-play offering. While the cable segment has experienced increasing risks, Cogeco's cable systems are clustered in less concentrated and generally less competitive suburban regions as compared to large urban areas.

Competition will continue to increase through IPTV footprint expansion mainly with fiber-to-the-home overbuilds in a growing portion of Cogeco's regions as Bell covers roughly one-third of Cogeco's territories with an IPTV offering. However, the relatively slow pace of IPTV deployment has given Cogeco time to enhance its competitive position through the TiVo platform and upgraded bandwidth offerings to improve its ability to blunt these attacks.

Good Margins

Margins should remain relatively stable as price increases, continued mix shift to broadband and strong cost controls offset higher costs due to TiVo launch and programming increases. Longer-term risks include greater than expected pressure from IPTV competition, wireless substitution and cord cutting/cord shaving. Cogeco views over-the-top services as complementary with its cable offering and will negotiate to make these services, like Netflix, available on its TiVo platform. Fitch also believes Cogeco has sufficient capability to manage recent regulatory mandates without a material negative effect to EBITDA.

Acquisition Risk

Fitch expects Cogeco will opportunistically pursue additional acquisitions. Bolt-on sized acquisitions are more likely for its U.S. cable operations that would further diversify Cogeco's business profile. Over the long term, Fitch expects the U.S. operations could begin to approach the size of its Canadian cable operations. The higher investment rate including data center expansion, salesforce integration and process reengineering in the enterprise segment make a near-to-medium term acquisition less probable.

Stable Liquidity/Debt Structure

Cogeco's main sources of liquidity are its credit facilities, cash position and free cash flow (FCF). As of Feb. 28, 2015, Cogeco had approximately CAD588 million available under its term revolving facility of CAD800 million that matures in January 2020. In addition, two subsidiaries of Cogeco benefit from a revolving facility of US$150 million of which US$30 million was borrowed. Consolidated cash was CAD18 million.

Cogeco's FCF guidance for fiscal year 2015 (FY15), after dividend payments, is approximately CAD220 million. Fitch expects Cogeco will use excess liquidity generated by FCF to pay down bank credit facility borrowings. Debt maturities over the next several years are very manageable with US$190 million in FY16 and CAD100 million in FY18 which the company may refinance through revolver availability.

Cogeco's credit metrics have improved following the acquisitions in 2012 and 2013 as total leverage (total debt to operating EBITDA) was 3.2x at the end of the second quarter of fiscal 2015. Fitch expects leverage of approximately 3x by the end of 2015. Longer term, absent material acquisitions, leverage should continue to reduce to the mid 2x range.

Dividend Growth Expected

Cogeco's objective is to generate shareholder returns through capital appreciation and dividend growth. Cogeco historically has not generally engaged in share repurchase activity. The quarterly dividend is $0.35 per share, an increase of $0.05 per share, or 17% from a year ago. Dividend payments for FY14 were CAD59 million, compared to CAD51 million in FY13.

Expectations are that Cogeco will continue to manage its dividend policy consistent with its current ratings. Fitch's long range forecast assumes the company will increase the dividend in the mid-teens range the next couple years as a result of growth in excess cash flows. Thus, while Cogeco does not have a formal dividend policy at this time, Fitch expects the company will target a dividend payout in the range of 25%-30% of EPS. Fitch estimates FY15 dividend payout at 26%. Cogeco's current payout ratio is materially lower than its larger cable and telecom peers.

As a result, Fitch expects FCF (defined as cash from operations less capital spending less dividends) will remain in the CAD200 million range plus/minus 10% during the forecast period.

KEY ASSUMPTIONS

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

--Canadian cable revenue growth in the low-single digits;

--U.S. cable growth in the mid-single digit range;

--Enterprise revenue growth in the mid-to-high single digits;

--FY15 leverage of approximately 3x, reducing to the mid 2x range absent any material acquisitions;

--Dividend increases in the mid-teens range;

--Relatively stable profitability with consolidated EBITDA margins in the 44% to 45% range;

--FCF over the forecast period in the range of CAD200 million plus/minus 10%.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a positive rating action include:

--A change in financial policy and long-term commitment to maintain consolidated leverage at mid 2x range or below;

--Stable and/or growing operating trends across its three business segments;

--Increased operational diversification;

--Pre-dividend FCF to sales of greater than 10%.

Future developments that may, individually or collectively, lead to a negative rating include:

--A large transaction that increases consolidated leverage in excess of 3.5x for an extended period of time;

--Greater than expected competition, substitution or cord cutting/cord shaving in Cogeco Cable territories that adversely affects operating trends and cash flow growth;

--A change in financial policy resulting in higher leverage due to increased dividends or aggressive share repurchases;

--Negative operating trends in the Atlantic Broadband operations that requires Cogeco Cable to infuse additional funding;

--Reduced consolidated FCF prospects as a result of competitive factors.

Fitch has taken the following actions, including assigning recovery ratings as follows. The Rating Outlook for all of Cogeco's ratings remains Stable.

--IDR at 'BB';

--Senior unsecured notes at 'BB+/RR4';

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

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014);

--'Telecommunications - Ratings Navigator Companion (Nov. 17, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Telecommunications: Ratings Navigator Companion

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=809869

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982864

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Contacts

Fitch Ratings, New York
Media Relations
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Senior Director
William Densmore, +1-312-368-3125
or
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Associate Director
Constance McKay, +1-312-368-3148
or
Committee Chairperson
Senior Director
John Culver, +1-312-368-3216

Contacts

Fitch Ratings, New York
Media Relations
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Senior Director
William Densmore, +1-312-368-3125
or
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Associate Director
Constance McKay, +1-312-368-3148
or
Committee Chairperson
Senior Director
John Culver, +1-312-368-3216