OREANDA-NEWS. Fitch Ratings has affirmed Germany-based Bertelsmann SE & Co KGaA's (Bertelsmann) Long-term Issuer Default Rating (IDR) and senior unsecured ratings at 'BBB+' and its Short-term IDR at 'F2'. The Outlook is Stable.

Bertelsmann's ratings are supported by a profitable core business portfolio generating growing operational cash flows and a conservative dividend policy that provides the group with significant financial flexibility for deleveraging and investments.

The company's significant exposure to traditional media represents a potential medium- to long-term risk, which Bertelsmann is seeking to mitigate by investing in digital platforms. It is also increasing its exposure to faster-growing markets and investing in new segments such as education. However, managing this process has led to a leverage spike as a combination of acquisitions, restructuring costs and one-off voluntary pension contributions has increased debt and removed any headroom the company otherwise had in its current 'BBB+' rating.

Fitch expects that Bertelsmann's funds from operations (FFO)-adjusted net leverage will peak in 2015 at 2.6x, a level that would not be consistent with its current rating if sustained. Bertelsmann has the capacity to reduce this to below 2.0x over the next 12 months, assuming minimal M&A and an unchanged dividend policy.

KEY RATING DRIVERS

Managing Leverage Spike
A combination of acquisitions, minority buyouts and extraordinary restructuring costs caused leverage to spike in 2014, increasing net debt by EUR1bn. Bertelsmann's ability to reduce leverage through its operating cash flows during 2015 has been constrained by further restructuring costs, one-off voluntary pension contributions in relation to minority buyouts and increases in working capital. Fitch expects Bertelsmann's free cash flow (FCF) to be a negative EUR502m in 2015, a reversal from EUR140m in 2014 and EUR380m in 2013. An issuance of EUR1.25bn hybrid debt has helped to partly offset these effects while the voluntary pension contributions should reduce pension payments in the future.

Fitch recognises that the company is going through a period of reorganisation of its business mix and has sufficient capacity through internal cashflow generation to return FFO adjusted net leverage to below 2.0x over the next 12 months. However, this assumes no further acquisitions in 2016 and the full use of retained FCF for reducing leverage. The spike in leverage is creating a short-term constraint on the company's capacity to sustain historical levels of acquisition spend within its 'BBB+' rating.

Moderate Dividend Policy
Bertelsmann targets a 20% to 25% dividend pay-out ratio, which currently equates to approximately EUR180m of dividends to its shareholders. For the size and stability of the business this is low. It is, however, key to Bertelsmann's credit profile and financial flexibility, leaving them with sufficient resources to reduce debt or to invest in new businesses.

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-1H15 accounted for 56% of group EBITDA. RTL benefits from fairly strong geographic diversification with market-leading channels in Germany, France, the Netherlands and Spain and from the ownership of content production arm, Fremantle. The diversification improves both the stability and visibility of revenues, which are driven predominantly by advertising and subject to cyclicality.

Bertelsmann's other principal businesses are a 53% stake in books publisher Penguin Random House (PRH), magazine publisher Gruner and Jahr and services provider Arvato.

Digital and Creative Challenge
The digitalisation of content is a medium-term risk, but Fitch recognises the company is addressing this risk with its restructuring efforts and repositioning of its business portfolio. RTL and PRH have deployed digital platforms, and the buyout of minorities at Gruner and 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 non-profit operating foundations (80.9%). The structure adds conservatism to the company's risk profile for investments, its financing strategy and dividend policy.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Revenue growth of 4.5% in 2015 and around 2% in 2016 and 2017, driven primarily by PRH and corporate investments
- EBITDA margin of 14.5% in 2015 and broadly stable in 2016 and 2017
- Capex-to-sales gradually declining to 3% by 2017 from 3.5% in 2014
- Exceptional EUR700m cash outflow in 2015 relating to restructuring and pension contributions
- Stable dividends at EUR180m per year
- Net M&A spend of EUR150m in 2015, EUR100m in 2016 and EUR600m per annum thereafter. The spending reflects Bertelsmann's leverage policy and digital transformation and expansion strategy.
- Conservative approach to financial policy in terms of capital structure and shareholder remuneration.

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- FFO adjusted net leverage (including profit participation certificates) above 2.0x (2014: 2.45x) on a sustained basis. M&A-induced leverage would be considered in the context of how accretive a deal is likely to be and the timeframe set by management to deleverage to more conservative levels.

- Erosion of the core media business (TV advertising, book and magazine publishing) as a result of adverse industry trends and operating performance.

- Underlying pre-dividend FCF margin in the low single digits

Positive rating action is unlikely given the company's operational profile despite rather conservative financial metrics.