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Fitch Affirms Cogeco's IDR at 'BB+'; Outlook Stable

Published 2019-01-16, 11:08 a/m
Updated 2019-01-16, 11:10 a/m
© Reuters.  Fitch Affirms Cogeco's IDR at 'BB+'; Outlook Stable

© Reuters. Fitch Affirms Cogeco's IDR at 'BB+'; Outlook Stable

(The following statement was released by the rating agency)

Fitch Ratings-Chicago-January 16: Fitch Ratings has affirmed the Issuer Default Rating (IDR) for Cogeco Communications Inc. (Cogeco) at 'BB+'. The Rating Outlook is Stable. A full list of affirmed ratings follows at the end of this release.

KEY RATING DRIVERS Enhanced Geographic Diversity: Cogeco has materially increased cash flow diversification primarily through several acquisitions of U.S. cable assets. Pro forma for the recent MetroCast acquisition, the U.S. (Atlantic Broadband) and Canadian (Cogeco Connexion) broadband operations generate approximately 37% and 57% of consolidated EBITDA, respectively. This compares with six years ago when the Canadian broadband segment generated 90% of consolidated EBITDA.

Over the longer term, the American broadband assets should demonstrate stronger growth than the more mature Canadian operations, supported by broadband, TiVo/bundling and business market share gains. Deleveraging Expected: The MetroCast transaction, which was valued at USD1.4 billion, increased pro forma gross leverage at close (January 2018) to approximately 3.7x on a consolidated basis compared to 2.6x at the end of fiscal 2017. Fitch believes Cogeco remains on target with reducing leverage back to the low 3x range by the end of fiscal 2019 (August).

Stable Core Expectations: Fitch believes Cogeco's good business profile is primarily supported by the relatively stable, high-margin Canadian broadband operations, with a competitive position anchored by its high-speed internet and triple-play offering. Cogeco's broadband systems are clustered in less competitive, lower density suburban regions. Nevertheless, ongoing cord cutting, wireless substitution and promotional activity have pressured the operating profile. Challenges with the implementation of the new customer management system have also affected both the top line and EBITDA profile in fiscal year (FY) 2018. Fitch's forecast assumes a return to more normalized operating trends in the Canadian broadband services segment for the remainder of FY2019 following steps taken to address customer management system issues.

Opportunistic Bolt-Ons: Cogeco has continued to seek opportunistic bolt-on U.S. cable acquisitions. Fitch does not expect Cogeco to engage in material M&A until leverage is reduced back within the expected range. Over the long term, Fitch expects U.S. operations will approach at least the size of the Canadian broadband operations. During the first half of 2018, Cogeco acquired approximately CAD32 million of paired and unpaired wireless spectrum licenses within Cogeco's footprint in the 2,300MHz and 2,500MHz bands that increase its flexibility to explore wireless service alternatives. In October 2018, the Company completed the second phase of its FiberLight acquisition in Florida for $43.8 million.

DERIVATION SUMMARY Cogeco's business profile is weaker than larger investment-grade telecom/cable peers like Rogers Communications (BBB+/Stable) and Telus Inc. (BBB+/Stable) due to smaller scale and less service diversification (no wireless) combined with higher financial leverage. However, Fitch believes Cogeco has a strong business profile, supported by the stable, high-margin Canadian broadband operations, with a competitive position anchored by its high-speed internet and triple-play offering that leverages the TiVO platform. The solid growth characteristics of the Atlantic Broadband business also position Cogeco well relative to its peers. Cogeco's operating results have benefitted from 100% of its territories offering 120Mbps service. Cogeco will continue to further increase broadband speeds (1 Gbps launches) across a significant portion of its networks (60% in Canada and 85% for Atlantic Broadband) by the end of fiscal 2019.

KEY ASSUMPTIONS Fitch's Key Assumptions within Our Rating Case for the Issuer --Consolidated revenue growth of approximately 6% in FY2019 with Cogeco Connexion remaining relatively flat and Atlantic Broadband increasing in the upper-teen range reflecting the full year of the recent acquisitions. In FY2020, consolidated revenue growth in the low single digits, with Cogeco Connexion increasing low-single digits and Atlantic Broadband increasing mid-single digits; --Relatively stable profitability with EBITDA margins of approximately 45%; --Dividend payouts of approximately 25% of cash flow; --Annual FCF (defined as cash from operations less capital spending less dividends) in excess of $250 million; --Leverage in the low 3x range in fiscal 2019 and the upper 2x range in fiscal 2020; --The ratings case assumes the Atlantic Broadband segment will make another debt-financed acquisition in FY2021 that is similar in scale to MetroCast.

RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action --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 primary business segments; --Increased operational diversification; --Pre-dividend FCF-to-sales of greater than 10%. Developments that May, Individually or Collectively, Lead to Negative Rating Action --A large transaction that increases consolidated leverage in excess of mid-3x range for an extended period of time; --Greater than expected competition, substitution or cord-cutting/cord-shaving in Cogeco Communications 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; --Reduced consolidated FCF prospects as a result of competitive factors.

LIQUIDITY Strong Liquidity: Cogeco's main sources of liquidity are its credit facilities, cash position and FCF. As of Nov. 30, 2018 Cogeco had approximately CAD242 million available under its term revolving facility of CAD800 million that matures in January 2024. In addition, two subsidiaries of Cogeco benefit from a revolving facility of USD150 million maturing January 2023, of which USD7.1 million was borrowed, leaving USD143 million of availability. Consolidated cash was CAD71 million. Expectations are that Cogeco will maintain a dividend policy consistent with its current ratings. Cogeco's objective is to generate shareholder returns through capital appreciation and dividend growth. Historically, Cogeco has not generally engaged in share repurchase activity, which Fitch does not see as changing at this time. The quarterly dividend has increased to CAD0.525 per share from CAD0.475 per share, an increase of approximately 11%, from a year ago. Fitch's forecast assumes Cogeco will increase dividends in a similar range over the next couple of years as a result of growth in excess cash flows. Thus, while Cogeco does not have a formal dividend policy, Fitch expects the company will target a dividend payout in the range of 25%-30% of FCF before dividends and working capital. Fitch anticipates FCF in excess of CAD250 million during the forecast period. Cogeco's current payout ratio is materially lower than its larger cable and telecom peers. The Company has no material maturities in fiscal 2019 or fiscal 2020. In fiscal 2021, Cogeco has CAD200 million of 5.15% notes maturing. First-lien credit facility debt at Cogeco's U.S. subsidiaries approximates 60% of Cogeco's capital structure. While the debt is nonrecourse to Cogeco, Fitch has consolidated the U.S. subsidiary debt given the strategic importance of the U.S. operations, which serve as the primary beachhead for M&A opportunities. Fitch does not expect Atlantic Broadband to issue dividends during the next several years given its growth focus. Cogeco's agreement with Caisse de depot et placement du Quebec, which has taken a 21% ownership interest in Atlantic Broadband, is long-term in nature with no put option for several years. Cogeco does not expect to pay meaningful cash taxes from its U.S. subsidiaries for the next couple of years due to a substantial tax shield. Cogeco also receives material tax benefits in Canada from deductibility related to Atlantic Broadband's interest payments.

FULL LIST OF RATING ACTIONS Fitch has affirmed Cogeco's rating as follows: Cogeco Communications Inc. -- Long-Term IDR at 'BB+'. The Rating Outlook is Stable.

Contact: Primary Analyst William Densmore Senior Director +1-312-368-3125 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst David Peterson Senior Director +1-312-368-3177 Committee Chairperson Jack Kranefuss Senior Director +1-212-908-0791 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. Media Relations: Elizabeth Fogerty, New York, Tel: +1 212 908 0526, Email: elizabeth.fogerty@thefitchgroup.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10023785 Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10024585 Sector Navigators (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10023790 Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/site/dodd-frank-disclosure/10059506 Solicitation Status https://www.fitchratings.com/site/pr/10059506#solicitation Endorsement Policy https://www.fitchratings.com/regulatory

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