OREANDA-NEWS. Fitch Ratings has assigned Bertelsmann SE & Co KGaA's (Bertelsmann) EUR650m and EUR600m callable subordinated securities (hybrids) final ratings of 'BBB-'. The agency has also affirmed the publishing/broadcasting group's Long-term Issuer Default Rating (IDR) at 'BBB+'/Stable. A full list of rating actions is available at the end of this commentary.

The issue of the hybrids reduces Bertelsmann's net debt to approximately EUR1.5bn currently, from EUR2.1bn at end-2014. The company's leverage had spiked as a result of acquisitions and restructuring costs. Funds flow from operations (FFO) adjusted net leverage falls to 2.1x from 2.5x during the same period. This incorporates profit participation certificates, a 50% equity-credit for the hybrids, but excludes non-recurring cash items as estimated by Fitch. The new capital structure improves rating headroom significantly at the 'BBB+' rating, where Fitch's threshold is an FFO adjusted net leverage of 2.0x.

The ratings of the hybrids are two notches lower than Bertelsmann's IDR and carry 50% equity credit, in line with Fitch's rating methodology for hybrid securities. The securities have a formal maturity of 60 years. The documentation envisages a non-call 8 (NC8) and non-call 12 (NC12) note paying 3% and 3.5% p.a. during their respective non-call periods. The issuer has a call option to redeem the notes at par on the first call date (in 2023 for the NC8 and in 2027 for the NC12) and at any interest payment date thereafter.

There will be a coupon step-up of 25bp every five years starting from 2028 to 2043 for the NC8, increasing to 100bp step-up thereafter. For the NC 12 the step-up will be 25bp from the first call date in 2027 every five years, increasing to 100bp from 2047. According to Fitch's criteria, the effective maturity dates are when the cumulative amount of step-ups exceeds 1% throughout the life of the security. In the case of the NC8 and NC12, the effective maturity dates are therefore in 2048 and 2047 respectively. The instruments' equity-credit would switch to zero five years prior to this date (i.e. in 2043 for the NC8 and 2042 for the NC12).

KEY RATING DRIVERS

Managing Leverage Spike
M&A continues to be a major part of the company's strategy - the acquisition of e-learning business Relias as well as the buyout of a 25% minority stake at its magazines division Gruner+Jahr caused a spike in leverage at end-2014, which the company has addressed with the issue of the hybrid securities. Fitch recognises that the company is going through a period of reorganisation of its business mix and expects FFO adjusted net leverage to trend towards 1.5x in 2016 as restructuring costs fall.

Stable Cash Generation
The company's underlying operating cash flow has remained stable, while free cash flow (FCF) of EUR140m in 2014 (EUR380m in 2013) was impacted by restructuring costs and negative working capital changes. Bertelsmann targets a modest dividend policy, which should allow the company to deleverage in the next two years. Fitch expects low single-digit percentage growth in EBITDA in 2015 and 2016 as a result of acquisitions and efficiency gains, along with lower restructuring costs, to support increase in FCF.

RTL Underpins Profile
Bertelsmann's financial profile is underpinned by its 75% holding in RTL Group. RTL is Europe's largest free-to-air TV broadcaster and at end-2014 accounted for approximately 60% of group EBITDA. RTL runs leading TV channels in Germany, France, and the Netherlands and owns content production arm Fremantle. Bertelsmann's other principal businesses are a 53% stake in books publisher Penguin Random House (PRH), magazine publisher Gruner & Jahr and services provider Arvato.

Digital and Creative Challenge
The digitalisation of content is a medium- to long-term risk, but Fitch recognises the company is addressing this risk with its restructuring efforts and repositioning of its business portfolio. RTL and PRH are successfully running digital platforms, and the buyout of minorities at Gruner+Jahr should facilitate ongoing restructuring of this magazines business where EBITDA has declined at 16% CAGR over the past three years.

Shareholder-Driven Portfolio
Bertelsmann has an unusual mix of media-related businesses with no immediate synergies. The collective rationale of these assets is a reflection of Bertelsmann's ownership structure with shareholders using Bertelsmann as a portfolio manager of majority owned assets. The group is owned by the Mohn Family (19.1%) and by a non-profit operating foundation (80.9%). The structure adds conservatism to the company's risk profile for investments, its financing strategy and dividend policy.

KEY ASSUMPTIONS

-Low single-digit revenue growth on a group level, boosted by consolidation of the educational business Relias in 2015
-Flat EBITDA margin broadly in line with 2014
-M&A activity in the low hundred million EUR per year
-Flat parent dividends, slight minority dividend progression to RTL minorities (25%)

RATING SENSITIVITIES

Any upward movement in the rating is unlikely given the company's operational profile, despite conservative financial metrics.

Downgrade guidelines include FFO adjusted net leverage (including profit participation certificates) above 2.0x (2014 pro-forma for the hybrid issuance: 2.1x) on a sustained basis and an erosion of the core media business (TV advertising, book and magazine publishing) as a result of adverse industry trends and operating performance.

M&A-induced leverage would be considered in the context of how earnings-accretive a deal is likely to be and the timeframe set by management to deleverage to more conservative levels.
The rating actions are as follows:

Long-term IDR: affirmed at 'BBB+'; Stable Outlook
Senior unsecured rating: affirmed at 'BBB+'
Short-term IDR: affirmed at 'F2'
Subordinated hybrid securities: assigned final ratings of 'BBB-'.