Fitch Expects to Rate Charter's New Senior Secured Notes 'BBB-'
CCO Holding LLC's (CCOH) and CCO's current 'BB-' Issuer Default Ratings (IDRs) remain on Rating Watch Positive following the announcement of the merger agreement by Charter and TWC. For clarification, the rating expected to be assigned to the new senior secured notes discussed in this press release are not on Rating Watch Positive. Fitch placed CCOH and CCO's 'BB-' IDRs on Rating Watch Positive following the April 2015 announcement of the acquisition of Bright House from Advance/Newhouse Partnership (A/N) for $10.4 billion. Following the announcement that Comcast Corporation and TWC had terminated their merger agreement, on May 18, 2015 Charter and A/N reaffirmed their commitment to complete this deal under the same economic and governance terms. CCOH and CCO are indirect wholly owned subsidiaries of Charter.
Safari was created to allow Charter to opportunistically pre-fund the transactions, with the proceeds placed into escrow in Safari until the transactions are completed. Prior to the consummation of the transactions, the notes will be secured by a first-priority interest in the cash held in Safari's escrow account. The cash will be released once the transactions are complete and all related conditions are met, at which time Safari will merge into CCO which will become the obligor of the notes. If the transactions are not completed, the notes will be subject to a mandatory redemption at 101% of the principal amount of the notes.
Once the notes become the obligations of CCO, they will rank pari passu in right of payment with all existing and future secured debt of CCO, including existing TWC debt, and will be secured by a first priority interest in all of the assets of CCO and the notes' guarantors. The notes will be guaranteed on a senior secured basis by all of CCO's subsidiaries, including those that will hold the assets of Charter, TWC and Bright House, and CCOH.
On May 23, 2015, Charter announced a merger with TWC for total consideration of $196.60 per share, providing a total valuation for TWC of $78.7 billion as of the announcement date. The offer consists of a combination of cash and Charter stock totaling $56.4 billion for all outstanding TWC shares. As part of the transaction, approximately $23.3 billion of existing TWC debt will be rolled into CCO and will have equal and ratable security with all first lien debt (existing Charter and TWC debt and newly issued debt). The TWC merger is not contingent on the acquisition of Bright House.
TWC's total consideration assumes that all TWC shareholders elect to receive $100.00 cash and 0.5409 shares of Charter common stock for each share of TWC common stock. However, TWC's shareholders have the option to receive $115.00 cash and 0.4562 shares of Charter common stock for each share of TWC common stock. If the latter occurs, Charter has committed financing for approximately $4.3 billion of additional unsecured debt to be issued by CCOH.
Fitch views both transactions positively and believes they will strengthen Charter's overall credit profile. Fitch anticipates that Charter's total leverage, pro forma for both the TWC merger as it is currently structured and the Bright House acquisition, would be under 5.0x at closing. Fitch notes that integration risks are elevated and Charter's ability to manage the integration process and limit disruption to the company's overall operations is key to the success of the transactions.
On a pro forma basis the combined company will serve 24 million customer relationships and become the second largest cable multiple system operator in the country. Pro forma revenues totalled approximately $36 billion during 2014 and EBITDA was approximately $13 billion. Charter's operating strategies are having a positive impact on the company's operating profile resulting in a strengthened competitive position. The market share-driven strategy, which is focused on enhancing the overall competitiveness of Charter's video service and leveraging its all-digital infrastructure, is improving subscriber metrics, growing revenue and ARPU trends, and stabilizing operating margins.
Resolution of the Rating Watch will largely be based on Fitch's review of Charter's ultimate capital structure including assignment of potential equity credit to the convertible preferred partnership units and an assessment of the risks associated with Charter's ability to integrate the new cable systems from TWC and Bright House.
KEY RATING DRIVERS
All three entities regularly produce strong levels of free cash flow (FCF) that provide the company with substantial financial flexibility. Charter management stated that, in the short term, they will use FCF to meet existing and planned amortization, which along with EBITDA improvement is expected to lower leverage by 0.6x annually. They also stated that there are no short term plans for shareholder friendly activities.
RATING SENSITIVITIES
Positive rating actions would be contemplated if the TWC merger and the Bright House acquisition go forward as total leverage is expected to be below 5.0x;
--If the company demonstrates progress in closing gaps relative to its industry peers on service penetration rates and strategic bandwidth initiatives;
--Operating profile strengthens as the company captures sustainable revenue and cash flow growth envisioned when implementing the current operating strategy;
--Fitch believes negative rating actions would likely coincide with a leveraging transaction or the adoption of a more aggressive financial strategy that increases leverage beyond 5.5x in the absence of a credible deleveraging plan;
--Adoption of a more aggressive financial strategy;
--A perceived weakening of Charter's competitive position or failure of the current operating strategy to produce sustainable revenue and cash flow growth along with strengthening operating margins.
LIQUIDITY AND DEBT STRUCTURE
Fitch regards Charter's liquidity position and overall financial flexibility as satisfactory given the rating category. Charter's financial flexibility will improve in step with the growth of free cash flow generation. Charter generated $277 million of free cash flow during the LTM period ended March 31, 2015 reflecting a 101% increase relative to free cash flow generated during the year ended Dec. 31, 2014. The increase is primarily due to a decrease in capital expenditures, driven by the completion of the completion of Charter's all-digital transition in 2014. The company's liquidity position is primarily supported by available borrowing capacity from its $1.3 revolver and anticipated free cash flow generation. Commitments under the company's revolver will expire in April 2018. As of March 31, 2015, approximately $875 million was available for borrowing.
Charter's leverage as of the LTM ended March 31, 2015 was 4.4x (excluding the debt issued by CCOH Safari, LLC and CCO Safari, LLC which was repaid following the termination of the Comcast TWC merger.) Charter's total leverage target remains unchanged ranging between 4x and 4.5x. Fitch recognizes that a large portion of the TWC transaction will involve senior secured debt, both existing at TWC and new issuance. Charter recently stated that it expects to maintain a senior leverage target of 3.5x following the completion of the TWC and Bright House transactions. Depending on the ultimate capital structure, a one or two notch upgrade of Charter's IDR and existing ratings could be possible provided that pro forma senior secured leverage is at or below 4.0x and total leverage does not exceed 5.0x.
FULL LIST OF RATINGS
Fitch maintains the following ratings on Rating Watch Positive:
CCO Holdings, LLC
--IDR 'BB-';
--Senior unsecured debt 'BB-'.
Charter Communications Operating, LLC
--IDR 'BB-';
--Senior secured credit facility 'BB+'.
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