NEW YORK--(BUSINESS WIRE)--According to Fitch Ratings, Cox Enterprises, Inc. (CEI) and its wholly owned subsidiary Cox Communications, Inc.'s (CCI) ratings are not affected by CCI's announced strategic investment in Unite Private Networks (UPN). CCI will be co-investing with a financial partner and UPN's management team. Neither financial terms nor timing were disclosed.
The acquisition is in line with Fitch's parameters for the ratings, which include the expectation that CCI would continue to invest in growth opportunities in its Cox Business segment. The acquisition allows CCI to leverage its existing infrastructure and address the overall growing demand for high capacity fiber. It also allows the Cox Business segment to expand its addressable market footprint.
UPN provides fiber-based networks to schools, government, carriers, data centers, hospitals and enterprise business customers, and operates a 6,200 route mile fiber network across 20 states primarily in central U.S.
KEY RATING DRIVERS
NextGear Debt Treatment: Fitch measures CEI's core leverage, excluding NextGear Capital Inc.'s (NextGear) debt and EBITDA. NextGear sources funding for its floor plan financing using cash from operations and debt, which was $3.2 billion at March 31, 2016. Fitch's rationale to exclude NextGear's debt and EBITDA is driven by its belief that NextGear is not critical to Cox Auto's business model: although Fitch recognizes NextGear is complementary to Cox Auto's other businesses given the cross selling opportunities, most of Cox Auto's businesses function autonomously. Fitch's treatment is also supported by the alternative financing options that have always been available to dealers, which results in Manheim's business model not being dependent on NextGear financing. Manheim has been the world's largest auto auction since 1959.
Cable Business Anchors Ratings: Ratings reflect CCI's size and strong competitive position. CCI is the company's largest business segment and fifth largest multichannel video programming distributor (MVPD) in the U.S. The operating leverage inherent in CCI's cable business along with stable capital intensity enable the company to generate consistent levels of free cash flow (FCF) before dividends to CEI, thereby providing CEI with significant financial flexibility.
Consistent Capital Allocation Policy: CEI's capital allocation strategy places a high priority on investment in its core businesses (CCI, Cox Automotive and Cox Media Group). The absence of a formal dividend policy creates uncertainty and elevates event risk and there is limited flexibility within the current ratings to accommodate a shift in the company's capital allocation policy. Future dividend payments will likely be made within the context of the company's leverage target, current ratings, anticipated FCF generation, and the scale and scope of internal or external investment opportunities.
Cable Competition a Concern: Rating concerns center on CCI's ability to adapt to changing competitive dynamics and maintain its relative market position given the challenging competitive environment. In addition, the mature video service product, along with the tepid economic and housing recovery and, to a lesser extent, competition from alternative distribution platforms, may continue to hinder CCI's ability to grow its subscriber base. This, together with continued programming cost inflation, may thwart margin expansion. CCI is working to overcome these challenges by converting its cable infrastructure to 100% digital by year-end 2016 and increasing its rollout of "Contour", based on Comcast's highly successful X-1 platform, to expand and enhance its video product.
Diverse Businesses, but Challenges Remain: The ratings recognize the diversification and market-leading positions of CEI's businesses, while acknowledging that some of these businesses remain exposed to moderate cyclical and secular pressures. Fitch expects Cox Media Group's organic growth to remain challenged as television stability and increasing retransmission revenue is offset by pressures on newspapers, Valpak and, to a lesser extent, radio. The company's ongoing efforts to streamline and consolidate the business, and its recent efforts to focus on larger markets, could drive moderate margin improvement.
Ratings are Linked: Fitch links the Issuer Default Ratings (IDRs) of CCI and CEI in accordance with its criteria. While no cross defaults or cross guarantees exist between the entities, Fitch believes that CCI's probability of default would be understated (i.e. rated higher) if it did not consider CEI's businesses and weaker credit profile. At the same time, it would overstate CEI's probability of default if the rating only incorporated the CEI businesses on a standalone basis and did not consider potential upstream cash flows CEI could access in distress.
Fitch's key assumptions within our rating case for the issuer include:
--Revenue growth in the high single digits in 2016 as a result of the Dealertrack acquisition completed in October 2015;
--EBITDA margin expansion over the forecast benefitting from the positive operating leverage in these businesses, following the full integration of Cox Auto's segments;
--FCF generation above $1 billion annually;
--Core leverage remains on track to delever to below 2.5x within 24 months of the close of the Dealertrack acquisition.
Positive: Fitch does not anticipate further ratings upside at this time. An upgrade would only come with a commitment to, and a credible rationale for, a substantially tighter leverage target, which is not expected.
Negative: Such an action could occur if CEI does not reduce total core leverage below 2.5x over a 12-18 month timeframe. In addition, Fitch could consider a negative action if NextGear adopted a more aggressive financial profile or the credit quality of NextGear's portfolio erodes due to market conditions or other issues.
CEI's liquidity position was supported by $334.2 million of cash on hand as of March 31, 2016, anticipated FCF generation, and the borrowing capacity under the company's $3.5 billion revolver maturing March 28, 2019, of which $2.3 billion was available as of March 31, 2016. CEI's revolver serves as the liquidity back-stop for its commercial paper program ($1.2 billion outstanding as of March 31, 2016). Either CEI or CCI may borrow up to $3.5 billion, provided that the aggregate amount outstanding under the facility does not exceed $3.5 billion. CEI and CCI are each severally, but not jointly, liable for their respective borrowing.
Overall, CEI's liquidity position is solid considering its ability to generate consistent levels of FCF. Fitch expects that CCI will generate the majority of CEI's consolidated revenues and cash flow. However, Fitch notes that each of CEI's segments is positioned to generate positive FCF over Fitch's ratings horizon. CEI generated approximately $1.1 billion of FCF during the latest 12 months (LTM) period ended March 31, 2016. Going forward, Fitch expects that modest revenue growth and margin expansion will position the company to generate FCF in excess of $1 billion annually.
CEI has the ability to access the cash flows from all of its restricted and unrestricted subsidiaries. CEI's credit agreement does not limit dividends from its unrestricted subsidiaries (primarily CCI) as long as leverage (calculated in accordance with covenants) is below 5.0x. Financial flexibility is further enhanced by CCI's stable and recurring pre-dividend FCF (net cash from operating activities less capital spending), which totalled approximately $751 million during the LTM period ended March 31, 2016.
CEI's maturity schedule is manageable. As such, Fitch believes that CEI has sufficient financial flexibility through expected FCF generation, available borrowing capacity from the revolver, and capital market access to address near-term maturities. Excluding securitized debt and $1.2 billion of commercial paper, CEI's maturity schedule includes approximately $600 million during 2016, $104 million during 2017 and $2.9 billion during 2018. CEI also has $425 million of demand notes listed as current liabilities.
Fitch currently rates CEI and CCI as follows:
Cox Enterprises, Inc.
--Long-Term Issuer Default Rating (IDR) 'BBB+';
--Short-Term IDR 'F2';
--Senior unsecured debt 'BBB+';
--Commercial paper 'F2'.
Cox Communications, Inc.
--Long-Term IDR 'BBB+';
--Short-Term IDR 'F2';
--Senior unsecured debt 'BBB+';
--Commercial paper 'F2'.
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:
--Fitch's calculation of CEI's core leverage excludes NextGear's debt and EBITDA.