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18 Feb 2004
MOODY'S ASSIGNS Ba3 RATING TO READER'S DIGEST ASSOCIATION, INC.'S PROPOSED SENIOR UNSECURED NOTES; OUTLOOK REMAINS NEGATIVE
Approximately $800 million in long-term debt securities affected
New York, February 18, 2004 -- Moody's Investors Service has assigned a Ba3 rating to Reader's Digest
Association, Inc.'s proposed senior unsecured notes due 2011.
At this time, Moody's has also affirmed the company's
Ba1 senior secured and senior implied ratings and Ba3 issuer rating.
The rating outlook remains negative.
The company's ratings reflect Reader's Digest's position as
one of the best-known brands in the world with more than 100 million
people using the company's products. Management is currently focused
on a strategic turnaround plan to increase revenue and cut costs that
has yet to evidence more than marginal progress in some of the company's
U.S. magazine and books businesses. However,
as management endeavors to stop revenue declines and increase profitability,
the company continues to generate over $150 million in free cash
flow for debt reduction, which offsets some of the considerable
business risk associated with the struggling business. As well,
the company is increasingly diversified, both in its geographic
operations and in its line of products, with international businesses
accounting for 40% of revenues and 25% of its revenues from
new non-traditional core products, such as QSP and Books
Are Fun (BAF).
The negative outlook reflects Moody's expectations that revenues and profitability
will remain under pressure and could cause credit metrics to deteriorate
over the next 12-18 months. While the company continues
to generate more than $150 million in annual free cash flow and
has publicly expressed its desire to conserve capital for debt reduction,
Moody's believes the uncertain economic and operating environment
could adversely impact the company's operating results putting pressure
on the ratings. The company still faces considerable business and
financial risk associated with high overall financial leverage,
declining revenues and profitability, and limited success to date
in rebuilding profitability at its flagship magazine and integrating and
expanding new business offerings, like Reiman, QSP and BAF.
Over the last couple of years, Reader's has experienced operating
pressure due to the economic and geopolitical climate and increasing competition.
Moody's believes that management's attempts to rationalize the company's
cost structure have not kept pace with the pressure on revenue growth
in most of its business segments, except in some of the North American
magazine businesses, reducing the company's overall operating
margin to 6%. Operating pressures have also complicated
the company's strategy for rebuilding profitability around its flagship
magazine, driving revenue growth from QSP and Books Are Fun,
successfully integrating the new Reiman properties, and stabilizing
operating performance in the international businesses.
In the first half of 2004, the business segments with the weakest
operating performance were QSP, BAF, Reiman and Europe,
all of which experienced flat to mid-single digit revenue declines
year over year. While the U.S. magazines and U.S.
Books and Home Entertainment (B&HE) segments experienced revenue declines,
they expanded their operating margins and increased profitability as the
company began to see some reduction in operating and marketing costs associated
with its strategy of reducing the rate base for the Reader's Digest
magazine to 10 million subscribers. Over this same time period,
the international businesses saw mid-single digit revenue declines
with operating profit down in Europe but up in Asia. QSP and BAF
did not perform well in their strongest quarter with the holiday season,
which accounts for at least half of their annual revenue. QSP revenue
and profits were down versus prior year due to lower same account sales
and lost events from competition. BAF revenue and profits were
lower than prior year due to rep turnover and lower same event sales.
While these two business segments might see some improvement in the latter
half of the year, they will be unable to make up revenue and cash
flow shortfalls from the 2nd quarter and will experience both revenue
and operating profit declines year over year.
In 2002 and 2003, Reader's acquisition of Reiman Holding Company
for $760 million, and its purchase of the Wallace Funds stake
for $100 million, which together gave rise to the bulk of
the debt on its balance sheet, resulted in high financial leverage
of 3.8x debt-to-EBITDA and more than 5.0x
debt-to-free cash flow (as of 2nd quarter 2004 trailing
twelve months). Moody's believes financial leverage ratios will
not improve significantly until the middle of fiscal 2005.
Moody's believes the company's liquidity profile is fairly
stable following the amendment of its bank covenants at the end of fiscal
2003. Historically, in its 1st fiscal quarter (3rd calendar
quarter), the company requires between $90 million -
$100 million in working capital as it builds inventories at a number
of its businesses. In order to meet these working capital needs,
the company borrows from its $192.5 million 5-year
revolver, which the company begins to repay in the 2nd fiscal quarter
when it generates approximately two-thirds of its total EBITDA
for the year, with a substantial portion of this being generated
at QSP, Books are Fun, and Reiman. While those businesses
did not perform well this fiscal year, the company has extremely
low capital expenditure requirements and some working capital gains that
will help the company generate more than $150 million in free cash
flow (after dividends), which represents a high 50% to 60%
conversion of EBITDA to free cash flow. In addition, this
year, the company intends to engage in a sale-leaseback of
its headquarters in Westchester County, New York in order to pay
down additional debt. Moody's believes that while the sale
will improve after-tax cash flows, due to lower operating
and interest costs, it will not have a significant effect on overall
leverage since the company will lease back a significant portion of the
facility that Moody's capitalizes on the balance sheet. The
company only has $32 million in required debt amortization in fiscal
2004 and $57 million in fiscal 2005.
The company intends to use the proceeds of this notes issuance to repay
bank debt. The senior unsecured notes, which do not enjoy
a guarantee from the company's subsidiaries, are effectively
and structurally subordinated to the company's senior secured bank
term loans due 2007 and 2008. Those bank loans are collateralized
by substantially all of the company's assets. While the bond
indenture provides for a springing guarantee, should the company
choose to issue senior unsecured debt with subsidiary guarantees,
and a limitation on subsidiary indebtedness of $50 million,
Moody's believes the preponderance of debt, currently,
remains secured. However, the secured debt holders'
security is limited to largely intangible assets with their values derived
from the strength of the company's brands. As a result,
the senior secured ratings remain at the senior implied level while the
senior unsecured debt remains two notches below to reflect both effective
and structural subordination.
The Reader's Digest Association, Inc. is a global publisher
and direct marketer of products that inform, enrich, entertain
and inspire people of all ages and cultures around the world. Products
include Readers Digest magazine, the most widely read magazine in
the world, published in 19 languages, 48 editions and more
than 60 countries. Global headquarters are located at Pleasantville,
Media & Telecom Group
Moody's Investors Service
Media & Telecom Group
Moody's Investors Service
No Related Data.
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