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Global Credit Research - 20 Oct 2010
New York, October 20, 2010 -- Moody's Investors Service has upgraded CCGI Holding Corporation's
(CCGI) senior secured facilities to B2 from B3 due to a change in the
company's capital structure, which now will include about
$93 million of subordinated notes at CCGI. These subordinated
notes are the remaining portion of the $149 million amount held
by the company's primary sponsor, following the exchange of
a portion of the subordinated notes into equity in the company's
restructuring and merger of Covad Communications Group, Inc.
("Covad") with MegaPath, Inc. ("MegaPath"), and acquisition
of Speakeasy Broadband Services LLP.
CCGI has also changed the terms of the senior secured term loan and revolving
credit facilities that are jointly held by Covad and MegaPath, Inc.,
wholly-owned subsidiaries of CCGI, by lowering the previously
contemplated $250 million senior secured term loan to $150
million, and reducing the tenor of the term loan from six years
to five years. The tenor of the $25 million revolver remains
five years. The company expects the revolver to remain undrawn
at closing. As a result, under Moody's Loss Given Default
methodology the ratings of the senior secured credit facilities have been
upgraded due to structural seniority and the recovery cushion provided
by the subordinated debt at CCGI. The senior and subordinated term
loans, along with a portion of the approximately $45 million
of existing cash, will be used to repay existing debt at the predecessor
entities, with the combined company doing business as MegaPath.
As part of the rating action, Moody's affirmed CCGI's B3 corporate
family rating and the B3 probability of default rating. The outlook
Moody's has taken the following rating actions:
..Issuer: Covad Communications Group, Inc.
and MegaPath, Inc.
.$25Mln Senior Secured Revolving Credit Facility,
B2 (LGD3-33%), from B3 (LGD4-50%)
..$150Mln Senior Secured Term Loan, B2 (LGD3-33%),
from B3 (LGD4-50%)
CCGI's B3 corporate family rating partly reflects Moody's concerns
about the Company's fundamental business model and the increased
execution risk associated with the simultaneous integration of three companies.
In addition, high competition in CCGI's markets and the Company's
reliance on accessing incumbent telcos' networks are also major
considerations in CCGI's rating assignment. The ratings are supported
by the company's good liquidity and expected free cash flow generation.
Moody's expects CCGI's Moody's adjusted EBITDA margin for
2010 to be about 14.5% (incorporating pro-forma merged
operations and year one cost savings from the merger transaction).
Moody's expects CCGI's pro-forma adjusted Debt/EBITDA leverage
to be under 4.0x at closing (Moody's adjusted, post-synergies),
potentially improving over the next several years driven by EBITDA growth
and debt reduction due to mandatory amortization and excess cash sweep
in the credit facility. This de-leveraging is however dependent
on the successful integration of the three companies and success of the
revamped sales force to grow revenues.
Over the long term, Moody's believes that CCGI will face increasing
financial risk due to its challenging business model. Moody's
views this model, centered on serving small business customers over
a primarily leased network from the local telecom incumbents, to
generate significantly lower margins when compared to services offered
over owned facilities.
Moody's expects CCGI's EBITDA margins in 2011 to be in the mid-teens,
largely reflecting realization of the annualized cost savings initiated
in 2010 and some modest improvements in operating margins. CCGI
expects to generate about $40 million in run-rate cost savings
from the merger by mid-2011, primarily through network and
G&A consolidation. At the same time, CCGI continues to
face the intense competitive dynamics of its industry as it fends of better
capitalized and much-larger incumbent telcos and cablecos,
while attempting to increase sales in a weak economy requiring tighter
credit policies. Moody's remains cautious as to the ability
of the company to realize the full benefit of these savings in light of
the complexity of the transaction and the tough operating environment.
Moody's expects CCGI will have "good" liquidity over
the next twelve months. Pro forma for FYE 2010, Moody's
projects the company to have approximately $35 million in cash
or equivalents and an undrawn $25 million revolving credit facility.
CCGI's projected free cash flow is sufficient to meet its modest capex
obligations. In the event of business weakness, capex would
likely be lower as the majority of projected spending is success based
and the network's footprint is essentially complete.
The ratings for the debt instruments reflect both the overall probability
of default for CCGI, to which Moody's has assigned a B3 PDR,
and an average mean family loss given default assessment of 50%,
in line with Moody's LGD Methodology. The term loan is secured
by a first priority interest in and lien on substantially all CCGI's assets.
The term loan, which comprises the bulk of the company's debt capital
structure, is rated B2 (LGD3-33%), one notch
above the B3 CFR. This rating is one notch lower than the LGD methodology-implied
modeling template suggests, being on the cusp of a B2 instrument
rating, due to Moody's subjective adjustments to the LGD framework
in order to more appropriately reflect the perceived collateral coverage
of these debt obligations relative to the overall waterfall of debts.
The stable outlook reflects Moody's view that CCGI will retain a disciplined
capital structure and that merger synergies will drive adjusted debt/EBITDA
leverage below 4.0x range by the end of 2011.
What Could Change the Rating - Up
Upward rating pressure could build if the Company maintains adjusted leverage
in the low 3.0x range, which would likely result from the
Company succeeding in growing its revenues through greater product expansion
and maintaining solid cost controls at the combined entity. Maintenance
of a good liquidity profile and strong free cash flow-to-debt
are also assumed to be prerequisites to prospective positive rating action(s).
What Could Change the Rating - Down
Downward rating pressure could develop if adjusted leverage remains above
4.0x on a sustainable basis, or if free cash flow-to-debt
falls below 5%, which may result from revenue declines or
the inability to merge the three entities in the transaction. The
ratings could also come under pressure if heightened competition or churn
further threatens the Company's sales growth.
The principal methodologies used in rating CCGI, Inc were Global
Telecommunications Industry published in December 2007, Loss Given
Default for Speculative-Grade Non-Financial Companies in
the U.S., Canada and EMEA published in June 2009,
and Moody's Approach to Global Standard Adjustments in the Analysis of
Financial Statements for Non-Financial Corporations - Part
I published in February 2006. Other methodologies and factors that
may have been considered in the process of rating this issuer can also
be found on Moody's website.
San Jose, CA, based CCGI is a competitive local exchange carrier.
Information sources used to prepare the credit rating are the following:
parties involved in the ratings, parties not involved in the ratings,
public information, confidential and proprietary Moody's Investors
Service's information, confidential and proprietary Moody's
Moody's Investors Service considers the quality of information available
on the issuer or obligation satisfactory for the purposes of maintaining
a credit rating.
MOODY'S adopts all necessary measures so that the information it uses
in assigning a credit rating is of sufficient quality and from sources
MOODY'S considers to be reliable including, when appropriate,
independent third-party sources. However, MOODY'S
is not an auditor and cannot in every instance independently verify or
validate information received in the rating process.
Please see ratings tab on the issuer/entity page on Moodys.com
for the last rating action and the rating history.
The date on which some Credit Ratings were first released goes back to
a time before Moody's Investors Service's Credit Ratings were fully digitized
and accurate data may not be available. Consequently, Moody's
Investors Service provides a date that it believes is the most reliable
and accurate based on the information that is available to it.
Please see the ratings disclosure page on our website www.moodys.com
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Please see the Credit Policy page on Moodys.com for the methodologies
used in determining ratings, further information on the meaning
of each rating category and the definition of default and recovery.
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
Andris G. Kalnins
Senior Vice President
Corporate Finance Group
Moody's Investors Service
Moody's Investors Service
Moody's Upgrades CCGI Holding Corporation Senior Secured Facilities
250 Greenwich Street
New York, NY 10007
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