Fitch Affirms Viacom's IDR at 'BBB '; Outlook Revised to Negative
Approximately \\$12.9 billion of debt (face value - including commercial paper) outstanding as of Dec. 31, 2015 is affected by Fitch's action. A full list of ratings follows at the end of this release.
The Negative Rating Outlook reflects Viacom's weakened operating profile and eroding financial and credit protection metrics as the company struggles to adapt its operating strategies, distribution platforms and programming investments amid enduring shifts of media consumption patterns within its key viewing demographics that have led to increased volatility within the company's key cable network business.
Viacom's historically aggressive capital allocation posture, which has long favored share repurchases in excess of free cash flow (FCF) generation, along with the weak operating results have combined to produce a credit profile that is not consistent with Fitch's expectations for the 'BBB+' rating. Viacom's leverage has increased to 3.2x during the latest 12 month (LTM) period ended Dec. 31, 2015, which is outside the company's 2.75x to 3.0x leverage target as well as Fitch's threshold for the rating category.
Fitch notes that volatility within Viacom's operating profile is incorporated into the ratings given the exposure to cyclical advertising revenues and the hit-driven nature of its cable networks and film studio; however, there is minimal tolerance within the current ratings for further weakening of Viacom's operating profile.
Fitch believes the changes to Viacom's capital allocation policy, namely the suspension of its share repurchase program and the reallocation of free cash flow to reduce debt and changing its strategic programming focus and investment towards more original scripted programming, are appropriate given the current operating environment as the company attempts to recapture operating momentum and position the company to better monetize the changing viewing habits of its target audience. Viacom's decision to adopt a more conservative financial posture is in line with Fitch's expectations that the company would place a greater priority on managing its balance sheet and curtail share repurchases in the event the macroeconomic environment weakens or its operating profile begins to deteriorate.
While the company's credit profile is weak for the current rating, Fitch anticipates the company's actions will return Viacom's credit protection metrics to a level more appropriate for the current rating by the end of calendar year 2016.
KEY RATING DRIVERS
Financial Policy Addresses Operating Environment: Viacom intends to shift its capital allocation strategy over the near term to focus on debt reduction and increase investment in programming while minimizing share repurchases. Fitch views the company's decision positively given current operational headwinds and is in line with Fitch's expectations.
Limited Capacity at Current Ratings: Viacom's capital structure and credit protection metrics are at the high end of Fitch's expectations for the current rating and is weakly positioned within the 'BBB+' rating category after considering the sup-par operating trends.
Free Cash Flow Generation Provides Flexibility: Viacom has noteworthy financial flexibility as its operating profile positions the company to generate meaningful levels of FCF during the rating horizon. However, Fitch expects incrementally higher cash tax payments together with ongoing investments in original programming and production will pressure FCF generation.
Robust Cable Network Portfolio: The dual stream, recurring, high-margin revenue base of the cable networks remains the foundation for Viacom's ratings. While recognizing a level of viewership ratings volatility at any given cable network is factored into the current ratings, Fitch has concerns around weakened TV ratings at Viacom's cable networks. Fitch does not expect Viacom to lose any distribution deals, but continued ratings softness could weaken its negotiating position. Fitch believes that the higher level of investment in original programming has begun to improve ratings at key networks and expects that continued investment will lead to further improvements and will contribute to the strengthening of the company's operating profile.
Growing Secular Risks Present: The ongoing secular threats presented by changing media consumption, emerging distribution platforms and technology evolution and adoption have negatively affected Viacom's operating performance. Fitch recognizes the risks inherent in the company's strategies to address the secular threats and adapt to changing industry dynamics, monetize changing viewing habits, and recapture their target audience that continues to shift away from viewing media in a linear, measured environment.
Advertising Revenue Exposure Highlight Risks: Rating concerns include exposure to cyclical advertising revenues (at 36% of revenues, moderate relative to peer group) and the company's capacity to adapt to ever-changing media consumption patterns and technology platforms. Fitch's ratings recognize the volatility within Viacom's operating profile given the exposure to cyclical advertising revenues and the hit-driven nature of its cable networks and film studio; however, there is minimal tolerance within the current ratings for further weakening of Viacom's operating profile.
While noting recent ratings improvements, viewership on many of Viacom's key cable networks including MTV and Comedy Central have been volatile and impacted by a number of issues including on-air talent and management departures, programming issues and the ongoing shift to digital video consumption by younger viewing audiences. The lower ratings on certain key networks and changing media consumption patterns pressure advertising revenues as domestic advertising revenue within the company's Media Networks segment declined 4% during the December ended quarter and the company's performance continues to lag behind its peers.
Viacom is one of the few cable network groups that generate more of its revenues from advertising than from affiliate fee revenues, adding a degree of volatility to the performance of the company's Media Networks operating segment. The higher advertising revenue concentration (relative to peers) makes the company more susceptible to hit driven volatility of cable network programming ratings and share of viewing audience.
Fitch believes reversing these negative operating trends will be difficult in the current operating environment. Competition for viewing audience within Viacom's targeted demographic will remain fierce as these younger demographics are migrating away from traditional linear video programming. Moreover, given Viacom's reliance on the kids and teen demographic segments, the company is more dependent on advertising categories which target kids and teens relative to its peer group. To combat these issues, Viacom has increased its investment in programming expense focusing on producing more original programming across its cable network portfolio, adding more scripted shows and event programming and becoming more selective in acquiring programming. In addition to the programming investment, Viacom has created products to improve the monetization of both linear and non-linear viewership and improve the yield on its advertising inventory, including and its Viacom Vantage, Velocity and Echo offerings. In addition the company is reducing unit loads to improve viewer experience and thereby strengthen its domestic advertising business. .
Fitch does not expect any meaningful changes in Viacom's strategic direction stemming from the appointment of CEO Philippe Dauman as the company's new Chairman of its board of directors. Sumner Redstone has been elected Chairman Emeritus and retains his 80% voting control of the company.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case include:
--Flat advertising revenues in 2016.
--Mid-single digit affiliate fee revenue growth as a result of contractual rate increases. Fitch does not expect Viacom to lose any meaningful distribution deals.
--Fitch assumes typical volatility and continued weakness within in the Filmed Entertainment segment until 2017.
--Suspension of share repurchases in light of weakening operational profile.
--Debt reduction using cash on hand during fiscal 2016 to return within leverage target of 2.75x to 3.0x.
RATING SENSITIVITIES
Positive: Upward ratings momentum is unlikely during the current ratings horizon. Stabilization of the Rating Outlook at the current rating is predicated on the company successfully executing on its strategies to address persistent secular threats to its business, improving operating performance, including, but not limited to returning the performance of its domestic advertising business to a level consistent with its peers and demonstrating the sustainability of its operating profile amid ongoing competitive pressures, changing media consumption patterns and evolving technology platforms. Additionally, the company's credit profile will need to be more reflective of the current rating including reducing leverage to under 3.0x on a sustained basis.
Negative: Negative rating actions are more likely to coincide with the company's inability to strengthen its operating profile and reduce leverage below 3x by the end of 2016. Resumption of share repurchase activity or other aggressive financial policy decisions that delay the anticipated improvement of Viacom's credit profile would also result in negative rating action.
LIQUIDITY
Viacom's operating profile positions the company to generate meaningful levels of FCF providing the company noteworthy financial flexibility. However, in step with the company's weakened operating results, FCF generation, margin and FCF leverage metrics have also deteriorated. Fitch notes that Viacom's FCF metrics remain in line with the company's peer group. Led by Viacom's Media Networks segment, the company generated approximately \\$1.4 billion of FCF during the LTM period ended Dec. 31, 2015, reflecting a 27% decline relative to company's reported FCF generation during its fiscal year end 2014. Operational headwinds, higher cash taxes and interest costs hampered FCF generation. Fitch expects incrementally higher cash tax payments together with on-going investments in original programming and production will pressure FCF generation during fiscal 2016. Fitch expects FCF to range between \\$1.5 billion and \\$1.6 billion during fiscal 2016.
In Fitch's view, Viacom's liquidity is strong and supported by expected FCF generation. Additional financial flexibility is provided by the company's \\$2.5 billion revolving credit facility (fully available as of Dec. 31, 2015; however, Fitch notes \\$290 million of outstanding commercial paper as of Dec. 31, 2015) and \\$327 million of cash on hand as of Dec. 31, 2015. Viacom has deemed substantially all of the cash held by its foreign subsidiaries as permanently reinvested in its foreign operations and does not intend or forsee a need to repatriate the cash held by foreign subsidiaries. Commitments under Viacom's revolver expire on Nov. 18, 2019. The credit facility contains an interest coverage covenant requiring coverage for the most recent LTM period to be at least 3.0x.
Scheduled maturities include the remaining \\$367.3 million outstanding under its 6.25% notes due April 2016, approximately \\$900 million due in fiscal 2017 and \\$1 billion due in fiscal 2018. The maturities are well-laddered and manageable considering expected FCF generation, reliable market access and back-up liquidity. Fitch expects the near-term maturities will be repaid with available cash upon maturity.
FULL LIST OF RATING ACTIONS
Fitch affirms Viacom's ratings as follows:
--Long-term IDR at 'BBB+';
--Senior unsecured notes and debentures at 'BBB+';
--Senior unsecured bank facility due 2017 at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook has been revised to Negative from Stable.
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