S&P: Global University Systems Holding 'B+' Rating Affirmed Following Tap Issuance; Outlook Remains Negative
We also affirmed our 'B+' issue rating on GUS' senior secured debt issued by its subsidiary Lake Bridge International PLC. The '3' recovery rating on this debt remains unchanged, reflecting meaningful recovery prospects for creditors in the higher half of the 50%-70% range in the event of a payment default.
We also affirmed our 'BB' issue rating, with a '1' recovery rating (90%-100% recovery in the event of a payment default), on the group's ?15 million super senior revolving credit facility (RCF).
The affirmation reflects that GUS' leverage is increasing in line with our previous expectation when we revised the outlook to negative in July 2016. The outlook factors in our opinion of a more aggressive financial policy than in previous years, especially with regard to debt-funded acquisitions. The company is increasing the size of its current ?234 million senior secured notes by ?75 million to repay its bridge loan and to fund bolt-on acquisitions. Additionally, the sale-and-leaseback of University of Law (Ulaw) buildings, which was agreed upon by its previous owners, came into effect in fiscal 2015 (year-ended Nov. 30, 2015), and has led to an increase in our adjusted debt figure by about ?126 million. We now anticipate adjusted debt to EBITDA (leverage) of between 4.5x and 5.0x, compared with the less than 4.0x we forecast last year for fiscal 2016. This gives limited headroom under the current 'B+' rating. Finally, the group's board-approved commitment to reduce and maintain net reported leverage below 2.0x in 2017 has now been postponed to fiscal 2018 and beyond.
We continue to assess GUS' business risk profile as weak, reflecting our view of the group's limited geographic diversification outside the U. K., and its somewhat limited scale and operations in a niche market, despite the recent acquisitions announced. The U. K. market for undergraduate and postgraduate offerings primarily consists of public education providers, with only 3% of undergraduates and 9% of postgraduates taught by private higher education institutions. We view positively the ongoing integration of Ulaw within the group and the renewal and transfer of Ulaw's university title, Taught Degree-Awarding Powers (TDAP), course designation, and U. K. Visas and Immigration under the group's regulated activities. Management has successfully extracted synergies from its past mergers and acquisitions, which bodes well for the Arden, IBAT, and two potential acquisitions. We believe that the group's strong brands and established relationships with accrediting bodies and other regulators, as well as its TDAP and university title following the Ulaw acquisition and Arden, will enable the group to maintain a leading market position in the growing private higher education market in the U. K. We also view favorably the group's diversification in terms of disciplines and student domiciles, reducing its exposure to the economic cycle and regulatory changes. Lastly, we think that the group's brands, flexible timetables, and digital capabilities will enable it to retain and attract students, providing some degree of visibility on revenues.
The aggressive financial risk profile reflects our expectation of adjusted debt to EBITDA of 4.5x-5.0x in 2016 and 2017 under our base case, including the impact of the acquisitions. The current capital structure comprises the ?234.4 million senior secured bond issued last year to finance the Ulaw acquisition, the ?75 million new bond issuance, the ?15 million fully drawn RCF, and about ?11 million of shareholder loans. Our adjusted debt figures also include about ?126 million of operating leases.
The negative outlook reflects our expectation that GUS' debt to EBITDA will increase toward 5.0x in 2016, incorporating the increase in acquisition-related debt. Therefore, there is limited headroom under the current 'B+' rating, and we consider that a more aggressive financial policy, or operational underperformance than in our base case, could lead us to downgrade GUS in the coming 12 months.
We could lower the rating if the group's operational performance weakened, or if GUS undertook further debt-funded acquisitions, such that adjusted funds from operations (FFO) to debt fell below 12% or adjusted debt to EBITDA rose above 5x. We could also lower the rating if free operating cash flow (FOCF) weakened or turned negative, or if we believed that management's financial policy had become more aggressive.
We could revise the outlook to stable if GUS performed at least in line with our base case, such that reported EBITDA reached ?75 million-?80 million in fiscal 2016, and if there was evidence of further growth thereafter, with substantial and growing FOCF. The revision of the outlook to stable would hinge on GUS' ability to reduce its leverage so that FFO to debt remained sustainably above 12% and adjusted debt to EBITDA comfortably below 5.0x. A financial policy supportive of this level of leverage would also be a prerequisite.