S&P: Netherlands-Based Ziggo Group 'BB-' Rating Affirmed On Announced Recapitalization; Outlook Stable
We also assigned our 'BB-' issue and '3' recovery ratings to Ziggo's new senior secured debt, while affirming our 'BB-' issue rating on Ziggo's existing senior secured debt. The recovery rating remains unchanged at '3', indicating our expectation of meaningful recovery, in the lower half of the 50%-70% range, in the event of a payment default.
Additionally, we assigned our 'B' issue and '6' recovery ratings to Ziggo's new senior unsecured debt, and affirmed the 'B' issue rating on Ziggo's existing senior unsecured notes. The recovery rating on these notes remains unchanged at '6', indicating our expectation of negligible recovery (0%-10%) in the event of a payment default.
The affirmation reflects our view that Ziggo is a core subsidiary of Liberty Global PLC (LGP), and after Ziggo is merged with Vodafone Netherlands into a 50/50 joint venture (JV), the parents LGP and Vodafone Group will maintain ownership and moderate support for the JV in the near term to protect their investments.
While neither party will be a controlling owner, consolidate Ziggo, or provide guarantees, we believe the JV is important to the strategies of both as it aligns with their quad-play ambitions in the significant Dutch market. There are also restrictions on an IPO for the JV until after the third anniversary of closing, other transfers of interests in the JV until the fourth anniversary of closing, and a first right of refusal to either parent in the event of sales to a third party after the fourth anniversary. After the merger, although we will no longer equalize the rating on Ziggo with that on its current owner LGP, we will view it as moderately strategic for LGP and Vodafone Group. The rating on Ziggo will still incorporate one notch of uplift to reflect the stronger credit quality of its owners and its moderately strategic group status.
We view the proposed merger between Ziggo and Vodafone Netherlands as moderately positive to Ziggo's business, making it a stronger competitor to the incumbent KPN N. V. The merged entity would have over 14.5 million revenue-generating units, including 4.5 million Vodafone Netherlands' mobile subscribers, as well as greater opportunities for cross-selling and converged quadruple-play growth. The JV targets revenue synergies with a net present value of approximately €1.0 billion. However, the ratings remain constrained by Ziggo's limited geographical diversification and fierce competition in the Dutch market. In our view, there are also integration risks that limit the potential for a positive rating action.
We assume the JV will generate annual costs and capital expenditure (capex) synergies of €280 million by the fifth full year after closing, partly offset by €350 million in integration costs. Integration costs will mostly be incurred in the first three years after closing. Vodafone Netherlands' S&P Global Ratings-adjusted EBITDA margin of approximately 33% is lower than Ziggo's margin of 54%. However, we expect the combined entity to generate above-industry average profitability.
We anticipate that the JV will target covenant leverage of 4.5x-5.0x, excluding shareholder loans, and we expect adjusted debt-to-EBITDA sustainably between 5.0x-5.5x. We expect the JV to generate adjusted free operating cash flow (FOCF) to debt of 3%-4% in the first two-to-three years of operation. Both ratios are in line with our current expectations for Ziggo. Over time, we expect the JV to raise additional financing, maintaining the current financial risk profile even if EBITDA grows. We assume that the proceeds from the financing and FOCF will be distributed to the owners.
The stable outlook reflects our view that Ziggo's stabilizing performance continues to be supported by LGP, and that the modestly stronger stand-alone creditworthiness of the proposed JV would also likely benefit from moderate support from the two owners, LGP and Vodafone.
We are unlikely to lower the ratings on Ziggo given our view of parent support. Prior to the merger, we could downgrade Ziggo if we downgraded LGP. After the merger closes, we could lower the ratings on Ziggo if the combined parent ownership were to decline, or if we otherwise came to believe parent support had become less likely.
We could revise down Ziggo or the JV's stand-alone credit profile (SACP) if its operating performance deteriorated materially. This could happen if the Dutch market becomes even more competitive and the JV continues to lose customers.
We could raise the ratings on Ziggo after the merger closes if we expected stronger support than we currently assume from the two owners of the JV. We are currently unlikely to revise upward Ziggo or the JV's SACP owing to strong market competition and the highly leveraged capital structure.