OREANDA-NEWS. S&P Global Ratings said today that it has revised its outlook on Italian gaming operator Gamenet to stable from negative. At the same time we affirmed the issuer credit rating at 'B'.

We assigned a 'B' issue and '3' recovery rating to the proposed €200 million senior secured notes maturing in 2021. The recovery rating indicates our expectation of meaningful recovery prospects in the higher half of the 50%-70% range in the event of a payment default.

We affirmed the 'B' issue and '3' recovery ratings on the existing €200 million senior secured notes. We will withdraw the ratings on these notes on repayment of the debt.

We also assigned an issuer credit rating of 'B' to the vehicle issuing the proposed notes, Gamenet Group SpA. The outlook is stable.

The outlook revision and affirmation reflect our opinion that Gamenet has managed to stabilize operating performance and will have an improved liquidity profile once it completes the refinancing transaction it announced on July 15, 2016. The rating action also takes into account our view that the regulatory framework is more favorable this year as Italy's 2016 Stability Law repealed the €500 million tax on the industry that was put in place last year. Taxes have been increased on amusement with prizes (AWPs) machines and video lottery terminals (VLTs), but Gamenet will be able to adjust payouts downward to compensate.

The company launched the opportunistic refinancing of the €200 million senior secured notes due 2018 by announcing that it will issue €200 million of senior secured notes maturing in 2021 and add a €30 million RCF aimed at supporting its liquidity position. We assume that the transaction will close on Aug. 1, 2016. We view this as a favorable development for Gamenet, as the bullet maturity will get pushed out by an additional three years and liquidity will be boosted by the RCF. This has led us to revise our liquidity assessment to adequate from less than adequate.

Gamenet is one of the leading players in the gaming machine segment in Italy, where it is the second concessionaire after GTECH SpA. The group is a licensed gaming operator for betting and online products, and boosted its market share further following the close of its merger with Intralot Italia last month. This addition will reduce Gamenet's dependency on machines, especially VLTs, while significantly increasing earnings from the betting and online segments. We view the betting gaming segment as more volatile and payouts less predictable because odds can end up being unfavorable for betting companies, which was the case in Italy last year as industry players saw some of the highest payout levels in history. However, we believe that the 2016 Stability Law will make Gamenet's betting earnings more stable as taxation is shifting from total bet to net payout.

We continue to assess Gamenet's business risk profile as weak, reflecting its lack of geographic diversification outside Italy and its profitability, which we assess as below average for the leisure industry. The merger with Intralot Italia will increase Gamenet's earnings diversification by strengthening its betting and online activities, but will also result in lower profitability since betting and online activities are lower margin than gaming machines.

We've revised our assessment of Gamenet's financial risk profile upward to aggressive from highly leveraged as a result of the improved liquidity profile following the transaction and the expected reduction in adjusted leverage as Intralot Italia will add to the group's earnings base. We currently cap the financial risk profile at aggressive because the company is owned by a financial sponsor, Trilantic Capital Partners.

The rating incorporates a downward adjustment of one notch to reflect potential integration risks with Intralot and the fact that Gamenet is merging with a business that we view as weaker, as indicated by the lower combined group margin once Intralot Italia's operations are fully merged with Gamenet's. The sizable increase in exposure to the betting segment is likely to add further volatility to the earnings base, though we hope that this will be limited given the change to the betting tax calculation.

In our base case, we assume: Revenues will nearly double in 2016 to about €1 billion pro forma for the addition of Intralot Italia's operations. We forecast revenue growth of about 1%-2% in 2017.Adjusted EBITDA margin will decline to about 7%-8% in 2016 and 2017 from about 12% at the end of 2015 due to Intralot Italia's lower margins. Capital expenditure (capex) of about €5 million-€10 million in 2016 and 2017, to which we add about €25 million-€30 million for investment in the betting licence. Based on these assumptions, our S&P Global Ratings base case forecast arrives at the following credit measures: Adjusted debt to EBITDA of about 2.5-2.7x in 2016 and 2017. Modest positive free operating cash flow (FOCF) in 2016, turning slightly negative in 2017 as a result of betting license renewal fees. Adjusted EBITDA interest coverage of around 5.5x-6x in 2016 and 2017.The stable outlook reflects Gamenet's improved liquidity position with the addition of the proposed RCF. While the combined Gamenet-Intralot EBITDA margin will be lower than Gamenet's stand-alone margin, we anticipate that the combined entity will deliver stable operating performance, supported by the Italian government's repeal of the €500 million tax on the gaming industry in 2016 and the generally more stable regulatory environment. We acknowledge that Gamenet will have to make sizable capital investments over the next 12 months to renew betting licenses, but expect that the company will be able to finance these with FOCF and cash on its balance sheet.

We could consider raising the rating if the company's operating performance substantially improves and we can see clearly the benefits of the Intralot Italia acquisition and the regulatory and tax changes. Specifically, we would look for substantial positive FOCF, reported margins returning to above 10%, and adjusted leverage remaining sustainably below 4x. An upgrade is also contingent on a consistent track record of adequate liquidity and Trilantic maintaining their relatively conservative financial policy.

We could lower the ratings if Gamenet were not able to successfully integrate Intralot's operations and if this proved to be a significant drag on profitability, eroding headroom in financial ratios. We expect FOCF to turn modestly negative in 2017 because of spending on betting license renewals, but if combined group operation performance were to turn sluggish and the period of negative FOCF were prolonged, we would lower the ratings. Additionally, we could downgrade Gamenet if its liquidity deteriorated significantly.