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Rating Action:

Moody's assigns first-time B2 ratings to GEMS; outlook stable

12 Jul 2019

London, 12 July 2019 -- Moody's Investors Service ("Moody's") has today assigned a B2 corporate family rating (CFR) to GEMS MENASA Cayman Ltd (GEMS), a provider of kindergarten to 12th grade (K-12) private-pay education in the Middle East. Concurrently, Moody's has also assigned a B2-PD probability of default rating, and B2 instrument ratings to the $200 million senior secured revolving credit facility due 2025 and the proposed $850 million equivalent senior secured term loan B and $800 million equivalent senior secured notes due 2026 that will be raised in USD and EUR tranches as part of the transaction. The outlook is stable. This is the first time Moody's has assigned ratings to GEMS.

RATINGS RATIONALE

GEMS' B2 CFR is supported by the company's (1) strong market position as the largest private-pay education provider in the UAE; (2) good revenue visibility from committed student enrolments; (3) good operational track record with a focus on organic growth and profitability; and (4) good liquidity.

The rating is constrained by (1) GEMS' geographical concentration to Dubai, especially given the emirate's soft macro-economic environment and restrictive and unpredictable regulations in the education sector; (2) competitive pressure in the premium segment, towards which GEMS has some concentration of earnings; (3) very high Moody's-adjusted leverage and (4) a lack of track record of free cash flow generation.

GEMS is the leading player in the Emirate of Dubai, with no other player being close in terms of scale. This advantage provides the company with strong operational benefits and a deep understanding of the market, but also highlights its geographic concentration to Dubai. The company is also particularly exposed to the more competitive premium segment, which represents a large share of the company's earnings, despite the company's growing presence at lower price points and its diversified curricula offering.

The K-12 private education sector benefits from strong demand dynamics in emerging markets, but remains highly fragmented and highly competitive despite high barriers to entry. GEMS benefits from a strong competitive position within its markets, thanks to its strong brand reputation and track record of academic quality. However, GEMS is exposed to reputational and regulatory risks. The regulatory environment in Dubai in particular is restrictive and unpredictable, as demonstrated by a freeze on school fees for academic year 2018/19 and stronger limitations on fee increases for academic year 2019/20.

GEMS benefits from strong revenue visibility from committed student enrolments and a demonstrated capacity to retain students. The company has a strong track record of revenue growth through a mix of enrolment growth and fee increases above inflation. Its balanced portfolio of mature, maturing and new schools, provide a stable operating base while allowing for additional revenue growth. The company's profitability was negatively affected by new school openings since 2014 and we expect it to decline further over the next 12-18 months because the acquisition of a portfolio of 15 private schools in the UK and Switzerland (the Bellevue schools) will dilute margins. However, GEMS' profitability will improve over time as it focuses on increasing the capacity utilization of its existing schools.

GEMS will start generating positive free cash flow following years of rapid expansion as it perceives the new regulatory framework in Dubai as less attractive for new school openings. However, FCF generation will at first be modest due to committed expansion projects until 2021. GEMS has a limited track record of capital spending discipline which creates uncertainties over more sustained FCF generation. The group has mostly grown organically since its foundation in 1968 and we view the risk of large acquisitions as limited.

GEMS will bear a very high level of leverage of around 7.5x Moody's adjusted debt/EBITDA at the closing of the transaction (pro forma for the Bellevue acquisition) which will decrease towards 7.0x within 12-18 months which is at the high end of the identified target range for GEMS' B2 CFR. The company's new Term Loan B will amortize at 1% per year and contain an excess cash flow sweep mechanism which should not be triggered in the next 12-18 months because of the limited free cash flow generation.

STRUCTURAL CONSIDERATIONS

The B2 ratings assigned to the term loan B, notes, and revolving credit facility are at the same level as the CFR of GEMS and reflect the all senior secured capital structure, with modest non-recourse local debt ($64 million) remaining in place after the closing of the transaction. The security package provided to the first lien lenders is relatively weak and mostly comprises share pledges. Guarantees from all material operating companies represent more than 80% of consolidated EBITDA. The documentation allows significant flexibility for corporate actions including dividends and acquisitions.

The proceeds from the senior secured term loan B and senior secured notes will be used to refinance most existing indebtedness of the company, issue a $115 million dividend to shareholders, purchase the Bellevue schools from the Varkey Group, one of GEMS' ultimate shareholder, and repurchase some buildings in Qatar that were previously sold and leased back. A new $200 million revolving credit facility due 2025 complements the new capital structure and will be undrawn at the closing of the transaction.

LIQUIDITY

GEMS has a good liquidity profile. We expect modest positive free cash flow generation of around $30 million over the next 12 months, as cash from operations of around $205 million more than cover around $125 million of capital investments and $50 million of planned dividend payments. There are only small near-term maturities of around $15 million following the refinancing. The company also benefits from $97 million of estimated cash and cash equivalents as of 28 February 2019 (pro forma for the transaction) and a $200 million revolving credit facility maturing in 2025 which should remain undrawn through the year.

OUTLOOK

The stable outlook reflects Moody's expectation of sustained operating performance in the next 12-18 months and a gradual deleveraging within the identified target range.

WHAT COULD CHANGE THE RATING UP/DOWN

The ratings could be upgraded if Moody's-adjusted debt/EBITDA declines and is sustained below 6x, and if free cash flow to debt is sustained above 5%, while maintaining an adequate liquidity profile.

Conversely, the ratings could be downgraded if Moody's-adjusted debt/EBITDA fails to decline below 7x, if free cash flow to debt reduces towards zero, or if liquidity weakens.

LIST OF AFFECTED RATINGS

Assignments:

..Issuer: GEMS MENASA Cayman Ltd

....Probability of Default Rating, Assigned B2-PD

....Corporate Family Rating, Assigned B2

....BACKED Senior Secured Bank Credit Facility, Assigned B2

....Senior Secured Regular Bond/Debenture, Assigned B2

Outlook Actions:

..Issuer: GEMS MENASA Cayman Ltd

....Outlook, Assigned Stable

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Business and Consumer Service Industry published in October 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

COMPANY PROFILE

GEMS MENASA Cayman Ltd (GEMS) is a provider of kindergarten to 12th grade (K-12) private-pay education in the Middle East. GEMS owns and operates 63 schools across the UAE (46), UK (14), Qatar (2), and Switzerland (1) teaching c. 125 thousand students. GEMS was founded in Dubai in 1968 by the Varkey family, who still owns 66% of the company. Its schools generated revenues of $1.0 billion and Moody's-adjusted EBITDA of $318 million for the year ended 31 August 2018.

The Local Market analyst for these ratings is Thomas Le Guay, +971 (423) 795-45.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt 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.

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

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.

Mikhail Shipilov
Asst Vice President - Analyst
Corporate Finance Group
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Mario Santangelo
Associate Managing Director
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Client Service: 44 20 7772 5454

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