MOODY'S ASSIGNS B1 TO LODGENET ENTERTAINMENT'S SENIOR NOTES AND Ba2 TO SECURED BANK FACILITY
NEW YORK, 12-09-96 -- Moody's assigned a B1 rating to the proposed $125 million of senior notes of LodgeNet Entertainment and a Ba2 rating to its proposed $100 million secured revolving credit facility. LodgeNet is the second-largest U.S. provider of video-on-demand and video games to the hotel industry. It also owns 95% of ResNet, a new company providing cable services to multiple dwelling units (MDUs). TCI Satellite, which was recently spun off from TCI, owns the remaining 5%, with options to increase its ownership to 50%; GE Capital-Rescom (GE-Rescom), a joint venture between GE Capital and R&B Realty Group, has an exclusive arrangement to offer ResNet's services to MDUs.
The ratings reflect the substantial capital investments and long payback periods for both the hotel and MDU businesses, which will likely render the company a net borrower over the medium term; the possible challenge against ResNet's exclusive contracts with MDU landlords, which are anti-competitive and thus counter to the deregulatory environment in the cable industry; and competition from On Command Video, which is the largest provider to the hotel industry by far and has considerable financial flexibility.
The ratings are supported by the strong growth and stability of the hotel business over the past three years; the long-term exclusive contracts in both businesses, which lock out competing services and dramatically increase the probability of positive returns toward the back end of the contract period; the initiation of capital expenditures only after acceptable contracts are signed, so that expenditures will be lower if the number of acceptable contracts are below expectations; and the strengthened equity base following two public offerings. In addition, TCI Satellite will contribute equipment in exchange for ResNet shares, which will offset a portion of ResNet's capital expenditures.
The senior notes rating reflects the weaker position relative to the secured bank facility and the presence of $30 million of notes which will rank pari passu to the new notes but which amortize sooner. Conversely, the bank debt rating reflects the significant value of the existing contracts and the fact that the facility will likely be drawn extensively only if contract growth is very strong.
Proceeds from the notes will be used to repay $22 million under the existing bank facility and prepay $29 million of existing senior notes plus a $3 million make-whole premium. The company will have nearly $81 million of cash on hand, primarily to be used toward capital expenditures of $100 to $140 million in 1997, after which the company will likely draw on the bank facility for additional liquidity. LodgeNet will downstream funds to build ResNet's business as senior debt, ranking those obligations ahead of the convertible sub debt to be held by TCI Satellite. If TCI Satellite increases its ownership to 50%, LodgeNet will still be owed the intercompany advances while retaining its own 50% stake.
LodgeNet's hotel business is well established. It enters into contracts that run 3-7 years to provide guest-pay services, free-to-guest services, or both, and then installs equipment for under $100,000 for a medium-sized hotel. Its guest pay service, where guests order movies on-demand for $7.95-$8.95 or Nintendo games for $5.95 per hour, generates nearly 80% of its hotel-based revenues on an installed base of about 370,000 rooms. Buy rates for movies are only 11% and each room only generates about $3 per month from video games. However, LodgeNet's primary operating costs are license fees to the movie studios and commissions to hotels, both of which are variable, so guest-pay margins are strong. Free-to-guest services, where hotels pay for the transmission of basic and premium cable channels and local broadcast stations, provide the rest of revenues. The average life of its current hotel contracts is close to 5 years, which should provide further stability. LodgeNet recently entered into an agreement with PrimeStar, a DBS provider, to transmit PrimeStar's feed free-to-guest services at a lower cost than using its C-band equipment. LodgeNet and PrimeStar will split cash flows as hotels are converted over to Ku-band equipment.
The MDU business, on the other hand, is early-stage. ResNet's agreement allows GE-Rescom to exclusively promote ResNet's video services to MDUs with which it has relationships. At a cost of around $200,000 on a 750 MHz bandwidth platform, ResNet enters into exclusive agreements of 7-10 years with the MDU. ResNet offers the property managers an incentive commission based on MDU's penetration levels. The channel line-up includes over 50 basic and premium cable channels plus capacity for video-on-demand and video games. GE-Rescom must deliver at least 200,000 units by January 1998 for a one-time marketing fee based on contract length and penetration levels. Assuming ResNet can achieve penetration levels in line with those experienced by residential cable operators, which Moody's believes is reasonable, the contracts will pay off prior to expiration. In Moody's view, the most critical issue is customers inability to choose from alternative technologies -- it must either accept ResNet's service or go without pay television.
LodgeNet's position in the lodging market is strengthening. However, if On Command can turn around SpectraVision's operations, LodgeNet could face significant competition as its contracts come up for renewal. With respect to the MDU business, Moody's believes property managers may face pressure from tenants to enter into long-term contracts that limit the tenant's choice to one pay television vendor. However, so long as ResNet's contracts are not legally challenged, Moody's believes the company's existing book of business and the nature of its contracts should allow it to service its obligations.
LodgeNet provides cable and video-on-demand services to the lodging industry. Its subsidiary, ResNet provides similar services to multiple dwelling units. The company is headquartered in Sioux Falls, South Dakota.
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