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31 Mar 2005
MOODY'S DOWNGRADES BLOCKBUSTER'S LONG TERM DEBT RATINGS (SENIOR IMPLIED TO Ba3); OUTLOOK NEGATIVE
Approximately $1.45 Billion of Rated Debt Affected.
New York, March 31, 2005 -- Moody's Investors Service downgraded the long term debt ratings
of Blockbuster Inc. (senior implied to Ba3) and affirmed the Speculative
Grade Liquidity Rating of SGL-2. The outlook is negative.
The downgrade is prompted by Blockbuster's weak fourth quarter results
which were significantly below Moody's expectations and resulted
in a deterioration of debt protection measures. In addition,
the downgrade reflects Moody's expectation that the lower debt protection
measures will be sustained over the next twelve to eighteen months as
management continues its current level of spending on new initiatives,
including the no late fee program and the ramp up of the online business.
This rating action concludes the review for possible downgrade announced
on February 9, 2005.
The downgrade primarily reflects Moody's expectation that the lower
level of earnings and cash flow reported in the company's fourth
quarter and year end results will be sustained over the next 12 to 18
months as it continues spending on new initiatives. EBITDA for
the fourth quarter of 2004 was $82.1 million versus Moody's
expectation of around $190 million. Adjusted EBITDA (which
adjusts for rental amortization and purchases) for the full fiscal year
was $450.5 million versus Moody's expectations of
some $570 million. Free cash flow before dividends for the
quarter was $87.7 million versus Moody's expectations
of $168 million; for the full year, free cash flow before
dividends was $128.6 million versus Moody's expectations
of $156 million. In addition, the company had $100
million outstanding under the revolver versus Moody's expectations
of $50 million. This resulted in adjusted debt/EBITDAR rising
to 5.7x and free cash flow to debt falling to 9.9%.
Moody's expects weaker free cash flow generation in fiscal year
2005 due to the additional spending required to roll out the no late fee
program, including advertising and increased rental library purchases,
as well as a quicker ramp up in spending on acquiring on line subscribers.
Blockbuster is running well ahead of plan in acquiring on line subscribers;
however, this has impacted its earnings as it incurs upfront subscriber
acquisition costs in advance of earning the monthly subscription fees.
The new rating category is supported by Blockbuster's clear leadership
and global presence in the area of video and game rentals, the continued
fragmented nature of the rental industry with only one other sizable player
(Movie Gallery post Hollywood Entertainment acquisition), high brand
value, and good liquidity. In addition, the ratings
reflect the discretionary nature of much of the company's additional
spending over the next twelve to eighteen months which provides some flexibility.
The ratings are constrained by the weakened debt protection measures,
the expectation that the online pricing war with Netflix will continue
over the next 12 months, as well as management's aggressive
business policies as evidenced by the hostile offer for Hollywood Entertainment
and the quick roll out of the no late fee policy.
The negative outlook reflects Moody's concern that credit metrics
could deteriorate further should Blockbuster not be able to make up the
lost extended viewing fees with additional rental and retail transactions.
While the elimination of extended viewing fees makes strategic sense in
order to compete effectively against retail sales, they were a sizable
portion of Blockbuster operating income -- approximately
$250 to $300 million. Extended viewing fees for the
fiscal year 2005 were approximately $622 million or approximately
10% of total revenues.
Given the negative outlook an upgrade is highly unlikely. The outlook
could stabilize once there is clarity around the sustainability of earnings
after the elimination of late fees, and should free cash flow/debt
rise above 14% and adjusted debt to EBITDAR fall below 5.5x.
Ratings could move downward should performance decline such that free
cash flow to debt should falls below 8% or adjusted debt to EBITDAR
is likely to remain above 6.0x.
The SGL-2 reflects good liquidity. Internally generated
cash flow and cash on hand will be sufficient to fund its working capital,
capital expenditures, term loan amortization, and dividend
requirement over the next twelve months. Blockbuster has a $500
million revolving credit agreement and, after deducting out the
Viacom letters of credit and outstanding borrowings, $250
million was available under the facility.
The following ratings are downgraded:
Senior implied to Ba3 from Ba2;
Issuer rating to B1 from Ba3;
Senior Secured Bank Credit Facilities to Ba3 from Ba2;
Senior Subordinated Notes to B2 from B1.
The following rating is affirmed:
Speculative Grade Liquidity Rating of SGL-2.
Blockbuster Inc., headquartered in Dallas, Texas,
is a leading global provider of in-home movie and game entertainment
with approximately 9,100 stores throughout the Americas, Europe,
Asia, and Australia. Total revenues for fiscal year 2004
were $6.1 billion.
Corporate Finance Group
Moody's Investors Service
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
No Related Data.
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