OREANDA-NEWS. Fitch Ratings has assigned IDH Finance plc's proposed super senior revolving credit facility an expected rating of 'BB(EXP)' with a Recovery Rating of RR1, We also have assigned an expected rating of 'B+(EXP)' to the GBP425m senior secured notes with a Recovery Rating of 'RR3'.

At the same time, Fitch has placed Turnstone Midco 2's (Turnstone) Long-Term Issuer Default Rating of 'B+' on Rating Watch Negative (RWN) as we expect to downgrade Turnstone's IDR by one notch to 'B' with a Stable Outlook on completion of the proposed debt issues.

The proceeds from the planned issues, together with cash on balance sheet, will be used to refinance the group's existing GBP539m debt (senior and second lien notes, as well as drawings under the senior secured revolving credit facility) and associated transaction costs. The assignment of the final ratings is contingent on the receipt of final documents materially conforming to information already reviewed.

The RWN on Turnstone's IDR reflects Fitch's expectation that debt service and coverage ratios will weaken to levels more commensurate with the 'B' rating level once the debt issues are completed. We expect FFO-adjusted net leverage to increase to 6.7x and FFO fixed-charge cover to structurally weaken to below 2.0x, due to the larger amount of debt and higher cost of debt.

The rating, however, remains underpinned by the strengths of its brand, IDH, rebranded to Mydentist. IDH has a leading market position in the UK's National Health Service (NHS) dental sector. This gives it a stable cash flow driven by long-term evergreen contracts accounting for around 59% of total revenue.

It also has a record of acquiring and successfully integrating small dental businesses; vertical integration into dental supply services; an expanding network, which delivers economies of scale and a close relationship with the NHS.

Fitch expects there to be significant rating headroom under the expected 'B' rating for Turnstone to deliver on IDH's growth strategy as consolidator in the still fragmented dental services market in the UK and assigns a Stable Outlook.

KEY RATING DRIVERS

Increased Leverage, Improved Financial Flexibility

Fitch expects debt protection ratios to weaken as the result of the announced refinancing with pro-forma FFO adjusted net financial leverage to increase to 6.7x in the financial year ending 31 March 2017 (FY17) from 6.4x a year earlier and FFO fixed charge cover to weaken to below 2.0x from 2.1x per our previous expectations. This will be driven by the larger amount and higher cost of debt. The metrics would be commensurate with a 'B' rating, although the debt issues would lengthen Turnstone's maturity profile and the increased liquidity would offer sufficient financial flexibility to continue the group's growth strategy.

Above-Average Business Risk

Fitch views IDH's business profile as stronger than its financial metrics for the rating category. The business is supported by growing scale in its operations, vertical integration and brand investments. IDH benefits from its leading market position in the UK NHS dental sector, and it enjoys stable cash flows, which are underpinned by long-term evergreen contracts. IDH is also well-placed to tap a structurally growing private dental market. As a result, we project sustainable free cash flow margin of 2%-4% for the business over the four-year rating horizon, with the exception of FY17, where free cash flow will be negative due to exceptional costs, which are mostly associated with the debt refinancing. IDH's business risk, however, is constrained by its scale and limited diversification, compared to healthcare peers rated by Fitch.

NHS Contracts 'Sticky', But Focus on Value Increasing

The rating reflects a 92.4% decrease in units of dental activity (UDA) in FY16 from 95.8% in FY15 and compared with a target of 96%. The decline was a result of fewer exempt patients due to an improving economy, a change in band mix, and increased NHS scrutiny around delivery, claims and performance benchmarks, which we view as an industry-wide trend to improve value generated in the system. As a result IDH's productivity suffered and the management is taking active measures to recover UDA performance towards the long-term target of 96%, which include actively managing dentist productivity, simplifying administration and achieving an improved patient and appointment mix, in addition to increasing the share of private treatments.

Fitch projects a long-term average EBITDA margin of 15% (against historic margins of closer to 19% and FY16 margin at 14.5%) based on the expected improvement in UDA performance, greater value focus in NHS contracts, the shifting patient mix to private dental services as well as the integration of the dental supply operations, which both have structurally lower margins.

Further Acquisitions to Add Scale, Diversify

Fitch expects IDH to continue its targeted and carefully executed acquisition strategy as the fragmented UK dental sector consolidates further. Our rating assumes IDH will spend GBP40m a year to acquire targets in both businesses - practice services and patient services - which will add scale and diversification to the business. We assume acquisition multiples of around 6.0x and hence a continued deleveraging path despite these debt-funded transactions. We view the integration and execution risk as manageable based on IDH's good track record and will treat larger acquisitions outside our defined parameters as event risk.

KEY RATING DRIVERS FOR THE NOTES

Fitch believes that expected recoveries would be maximised in a going-concern scenario rather than a liquidation given the scale benefits, vertical integration and increasing investment in the brand, which we believe are key value drivers for the business. The 'RR3' Recovery Rating on the proposed senior secured notes indicates good recovery prospects, with securities historically recovering 51%-70% of current principal and related interest. We estimate a post-restructuring EBITDA of approximately GBP80m and a going-concern multiple of 6.0x EV/EBITDA.

LIQUIDITY AND DEBT STRUCTURE

Refinancing Improves Liquidity Profile

With no material debt maturity over the four-year rating horizon post-refinancing, we assess IDH's liquidity as adequate to implement its prudent growth strategy. After the refinancing, IDH's liquidity will comprise GBP9m readily available cash and an unutilised GBP100m Super Senior revolving credit facility (RCF).

KEY ASSUMPTIONS

Fitch's expectations are based on the agency's internally produced, conservative rating-case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions are listed below.

- Recovery in UDA delivery leading to an organic increase in NHS patient services revenues. This, combined with acquisitions will lead to annual growth of around 7.0% a year in 2017 and 2018.

- Continued strong like-for-like growth in private patient services as the rebalancing and rebranding strategies continue to take effect. This is projected to lead to revenue growth of just under 10% a year to 2018.

- Moderate growth in practice services (3.7% in 2017).

- Improved margins driven by a recovery in revenues as UDA delivery begins to normalise. This will lead to EBITDA margin trending above 14.5%.

- Continuance of acquisition strategy, aiming for GBP6m-8m additional EBITDA a year. Acquisition multiple projected to be less than 6.0x EV/EBITDA. This will lead to acquisition cash outflows of about GBP40m a year, which will be partly funded by drawings under the RCF.

RATING SENSITIVITIES

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

- Ability to increase diversification and scale via acquisitions without diluting profits or FCF, while maintaining FFO-adjusted net leverage below 6.0x (FYE16: 6.4x) on a sustained basis;

- FFO fixed-charge coverage above 2.0x (FYE16: 1.9x)

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

- Reduced profitability from failure to achieve UDA delivery, achieve cost synergies or to manage cost inflation, leading to EBITDA margin falling below 10%

- Negative FCF, for example, as a result of an unsuccessful acquisition strategy driving weaker credit metrics such as FFO-adjusted net leverage above 7.5x (pro forma for acquisitions)

- FFO fixed-charge coverage below 1.5x on a sustained basis