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Rating Action:

Moody's assigns a B2 CFR to DNEG; stable outlook

29 Sep 2020

London, 29 September 2020 -- Moody's Investors Service, ("Moody's") has today assigned a B2 corporate family rating (CFR) and B2-PD probability of default rating (PDR) to Prime Focus World N.V. (DNEG). Concurrently, Moody's has assigned a B2 instrument rating to the new USD375 million senior secured notes due 2025 to be issued by DNEG plc, as subsidiary of Prime Focus World N.V. The outlook on the ratings is stable.

DNEG will use the net proceeds from the senior secured notes (i) to repay amounts outstanding under its existing term loan facility, its existing revolving loan facility and its Indian financing facilities, (ii) to extend the shareholder loan to one or more subsidiaries of Prime Focus Limited, the parent of Prime Focus World N.V., (iii) to pay related fees and expenses and (vi) for general corporate purposes.

RATINGS RATIONALE

DNEG's B2 CFR reflects (1) the company's position and track record as a leading provider of visual special effects (VFX) services globally, (2) the strong demand momentum for TV content utilizing VFX arising from the emergence of new platforms, (3) the predictability of revenue with the company engaged on a number of large franchise projects, (4) the expectation of improvements in free cash flow (FCF) generation supported by reduced working capital cash outflows and limited capex needs, and (5) healthy EBITDA margin which should further improve.

However, the rating is constrained by the company's (1) small scale in terms of revenue compared to broader media peers with revenue concentration on the large Hollywood studios, (2) need to adapt and remain responsive to consumer needs and trends, (3) foreign exchange risk from its exposure in Indian Rupees, (4) high pro forma Moody's adjusted gross leverage at 6.8x as of the last twelve months (LTM) period to 30 June 2020 (or 5.5x excluding material stock based compensation expense related to the planned initial public offering of the company amounting to USD17.8 million in the LTM period to 30 June 2020), and (5) risk of contract delays and termination by content producers which could impact earnings, although the company has not seen any cancellations due to COVID-19 to date.

DNEG benefits from the growth of the VFX services and its strong position in the global VFX market -- the company provided VFX services to approximately half of the top 100 global box office films in the past ten years. The company also benefits from its global presence near the largest filming centres in the United States, the United Kingdom, and Canada as well as in cost-advantaged locations in India. DNEG delivered strong total income growth at a 15% compound annual growth rate (CAGR) from fiscal year ending 31 March 2018 to 2020 ahead of market growth estimated at a 9% CAGR over the same period (based on data from FTI Consulting LLP). Moody's also considers that the company has potential to further expand its offering of VFX services to emerging content production media, such as augmented reality (AR) and virtual reality (VR), and location-based and experiential entertainment, such as theme parks, as well as new geographies thanks to strong growth of locally-produced movies in India and China.

DNEG's revenue will remain concentrated around the leading content producers, including major Hollywood studios, over-the-top (OTT) video service providers, and other content producers and distributors. DNEG's top seven customers accounted for approximately 76% of total revenues in fiscal years 2018 to 2020.

DNEG has been impacted by the coronavirus outbreak as the company is significantly reliant on the physical production of films, television and OTT programming, which has been disrupted due to the temporary suspension of physical production since the outbreak of the pandemic. Revenues decreased by 10.7% to USD71 million in the three months period to 30 June 2020 primarily due to the significant curtailment of employees available to work due to governmental restrictions and projects that were extended over longer periods and/or postponed to future periods. During the same period, Moody's positively notes that adjusted EBITDA (as reported by the company) increased by 35.1% to USD20 million thanks to the combined impact of significant cost reduction efforts and USD12 million of subsidies received under various government relief programs, which more than offset the decline in revenues.

Moody's projects that DNEG's adjusted leverage (as adjusted by the rating agency for pension deficit, deferred considerations, and preferred shares) will decrease significantly to around 5.5x by the end of fiscal year ending 31 March 2021 from an elevated level of 6.8x pro forma for the transaction as of 30 June 2020. Deleveraging will be mainly driven by the phasing off of non-cash stock compensation expense which amounted to USD17.8 million in the LTM period to 30 June 2020 and included a one-time equity grant in connection with the common share listing process. Moody's projects moderate de-leveraging after fiscal year 2021 supported by EBITDA growth as operations normalize post COVID-19 disruptions.

The rating also takes into account the following environmental, social and governance (ESG) considerations. From a corporate governance perspective, Moody's notes DNEG's leverage which is expected to remain high beyond 2021. Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.

DNEG has an adequate liquidity position supported by USD74.5 million of cash pro forma for the transaction as of 30 June 2020 and a USD100 million 4.5-year revolving credit facility (RCF) of which USD25 million may be used towards letters of credit and guarantees. As of June 30, 2020, on an as adjusted basis for the transactions and after giving effect to approximately USD9.5 million of guarantees outstanding, approximately USD90.5 million was available under the RCF. The RCF will be subject to a financial maintenance covenant that will be tested each financial quarter.

DNEG's PDR of B2-PD is at the same level as the company's CFR reflecting the expected recovery rate of 50%, which Moody's typically assumes for capital structures that consist of a mix of bank debt and bonds. The senior secured notes will be guaranteed by subsidiaries which accounted for 98.9% of total revenue in the LTM period to 30 June 2020 and for 87.2% of total assets as of 30 June 2020. The senior secured notes will be secured by a first-ranking security interest in substantially all of the property and assets of the DNEG plc and the guarantors, including pledges of shares of certain subsidiaries thereof. The B2 instrument rating of the senior secured notes, in line with the CFR, reflects their pari passu ranking with the RCF which shares the same guarantee and security package.

RATING OUTLOOK

The stable outlook reflects Moody's expectation of significant improvement in leverage over fiscal year 2021 supported by the normalization of operations post COVID-19.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Upward rating pressure could arise if (1) DNEG maintains a strong order book, (2) DNEG's Moody's-adjusted gross leverage declines below 5.0x, and (3) retained cash flow/net debt (as adjusted by Moody's) increases above 15%, both on a sustained basis. Negative pressure on the rating could develop if (1) DNEG is negatively impacted by disruptions related to coronavirus for a longer-than-expected period of time as reflected, among others through a continued weakening of its order book, (2) DNEG's Moody's-adjusted gross leverage is maintained at above 6.0x, and (3) DNEG's liquidity position deteriorates.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Business and Consumer Service Industry published in October 2016 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1037985. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

COMPANY PROFILE

DNEG is an independent provider of computer-generated visual special effects services. DNEG has operations in the United Kingdom, Canada, India and the United States. For the LTM period to 30 June 2020, DNEG generated revenue of USD346.3 million and adjusted EBITDA (as reported by the company) of USD86.0 million.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Gunjan Dixit
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Peter Firth
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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