OREANDA-NEWS. S&P Global Ratings today revised its outlook on South Africa-based media and e-commerce group Naspers Ltd. (Naspers) to negative from stable.

At the same time, we affirmed our 'BBB-' long-term corporate credit rating on Naspers and our 'BBB-' issue rating on its senior unsecured debt instruments.

The outlook revision reflects our view that Naspers' profitability will weaken in 2017 (fiscal year ending March 31) following its lackluster reported revenues and profitability in 2016. Slower organic growth in its cash-generative video entertainment operations and its limited ability to quickly adjust its cost base, which bears significant exposure to the U. S. dollar, are the main reasons behind the expected weaker performance.

The deteriorating economies in South Africa and Sub-Saharan Africa, coupled with the resulting devaluation of local currencies, have dragged down consumer confidence and demand for video entertainment, especially in Sub-Saharan Africa. Consequently, 288,000 of Naspers' direct-to-home subscribers in the region cancelled their subscriptions in 2016. The increased foreign exchange volatility in the same period prompted lower dollar-denominated profitability, due to lower dollar-denominated revenues and a substantial chunk of total costs incurred in dollars.

We understand that Naspers has taken measures to defend its subscriber base in the region and to reduce its cost base by changing its offering of pay-TV packages and shifting toward more local content. In our view, these steps, teamed with gradually declining development spending, will mitigate the slowing organic growth in the video entertainment business. Therefore, we expect the EBITDA margin will narrow to 8%-10% in 2017, versus the more than 10% margin we previously anticipated.

Naspers' fair business risk profile remains constrained by still-high but gradually reducing development spending in its e-commerce business. Naspers continues to fund and develop its e-commerce portfolio, and the number of its profitable assets increased to 21 in 2016 from 15 in 2015. However, the e-commerce division is still loss-making despite some profitable e-commerce assets, including Allegro, Avito, and OLX. We think this division is unlikely to turn profitable in the next 24 months. In addition, the company's profitability is constrained by the weaker contribution from video entertainment. Therefore, we continue to assess the company's profitability, measured by the EBITDA margin, as below average for the media industry.

Our assessment of the business risk profile benefits from Naspers' leading position in the video entertainment business and its strong subscription base in South Africa and Sub-Saharan Africa. Despite the current cyclical challenges in video entertainment, we think that this business is solid. Long-term underlying trends, such as low penetration of pay TV in Africa and positive growth prospects over the long run in the region, will in our view support the division's development.

The company's aggressive financial risk profile weakened in fiscal 2016, due to persistent but decreasing development spending and deteriorating EBITDA and cash flows from the video entertainment business. We expect that the financial risk profile will weaken further in 2017 because of the declining cash flows from video entertainment. We then anticipate this division will return to organic growth from 2018. S&P Global Ratings-adjusted leverage (debt to EBITDA) was 4.0x-4.5x in 2016, and we calculate an increase to significantly above 5.0x in 2017, and then a decrease to 5.0x-6.0x, due to declining e-commerce spending and recovery in video entertainment.

The combination of a fair business risk profile and aggressive financial risk profile leads to our anchor, or baseline assessment, of 'bb-' for Naspers. We then apply a very positive capital structure modifier to the anchor to reflect the high market value--exceeding $80 billion as of Aug. 24 2016--of Naspers' stakes in listed companies Tencent Holdings and Mail. ru. This results in a two-notch uplift from the anchor. In addition, we apply a further one-notch positive adjustment to the anchor based on our positive comparative ratings analysis modifier. The application of this modifier reflects our view that Naspers' financial risk profile doesn't incorporate the discretionary aspect of e-commerce development spending.

In our base case, we assume: Annual real GDP growth of 0.6%-1.5% in South Africa and 3.4%-4.0% in Nigeria in 2016-2017, with subdued consumer confidence in Sub-Saharan Africa. We forecast annual real GDP growth of 3.2%-3.5% in Poland for the same period, and a contraction in Russia's GDP of 1.3% in 2016 and growth of 1.0% in 2017. Naspers' revenues falling by about 15%-20% in 2017 owing to a drop in revenues in video entertainment and a negative foreign exchange impact, with a return to growth in 2018 in the 8%-14% range, owing to a recovery in video entertainment and growth in the e-commerce. A decline in the S&P Global Ratings-adjusted EBITDA margin to 8%-10% in 2017, due to slower organic growth in video entertainment and a negative foreign exchange impact, with a recovery to 12%-15% in 2018 on the back of renewed growth in video entertainment and declining development spending in e-commerce. Positive free operating cash flow from 2019. Based on these assumptions, we arrive at the following credit measures for Naspers in fiscal years 2017-2018: An S&P Global Ratings-adjusted debt-to-EBITDA ratio significantly above 5.0x in 2017 and a decline in the ratio to 5.0x-6.0x in 2018; and S&P Global Ratings-adjusted EBITDA interest coverage of 1.3x-1.8x in 2017 and between 2.0x and 2.5x in 2018. We apply our criteria for ratings above the sovereign to Naspers because it has material exposure to South Africa, its country of domicile. We believe that Naspers would still be able to service its debt and maintain liquidity sources over uses of more than 1x under a sovereign default of South Africa, even though it generates about 46% of its consolidated revenues in its home market. We assess the company's sensitivity to South Africa's country risk as moderate, because we consider that the media and e-commerce industry in which Naspers operates exhibits moderate sensitivity to country risk.

The negative outlook reflects our expectation that Naspers' earnings and margins will decline, due to the weak economic conditions in South Africa and the Sub-Saharan Africa region, and foreign exchange volatility, which are pulling down both demand for video entertainment and the company's operating margins. As a result, we expect the S&P Global Ratings-adjusted EBITDA margin will contract to 8%-10%, with an increase in S&P Global Ratings-adjusted leverage to significantly above 5.0x in fiscal 2017. The outlook also factors in our expectation that Naspers will maintain a prudent financial policy and not execute any material shareholder returns funded by sizable sales of its Tencent or Mail. ru stakes before any marked improvement in its financial risk profile.

We could downgrade Naspers if it doesn't post organic growth in its video entertainment business, improve its free cash flow generation, and restore adjusted leverage to about 5x or below within the next 24 months. Underperformance in Naspers' e-commerce business or a more aggressive financial policy than we currently anticipate could be additional obstacles to reduce adjusted leverage toward 5x or lower. We would also view negatively Naspers' disposal of its stake in Tencent or of other assets, and then not using the proceeds for debt reduction. Furthermore, we would likely review our ratings on Naspers if we lowered our foreign currency long-term sovereign rating on South Africa by more than one notch.

We could change the outlook to stable if Naspers' operational performance were stronger than our current base case, resulting in stabilized earnings, an improved S&P Global Ratings-adjusted EBITDA margin, and strengthening FOCF, which together would translate into adjusted leverage below 5.0x. In our upside scenario, we also take into account our expectations of the company's gradual increasing monetization of its e-commerce assets. A possible change to a stable outlook would also hinge on Naspers' maintenance of its prudent financial policy.