Fitch Rates Discovery's Proposed Notes 'BBB'
Proceeds from the offering are expected to be used for general corporate purposes, which could include acquisitions, repayment or refinancing of debt, or capital expenditures. The notes will be guaranteed on a senior unsecured basis by Discovery Communications, Inc. (Guarantor). As of Dec. 31, 2014, Discovery had approximately \$7.2 billion of debt outstanding.
KEY RATING DRIVERS:
--Strong portfolio of cable networks supports the ratings;
--Recent acquisition and investments, including the incremental investments in international markets, are in line with Fitch's expectations and the company's strategy to grow and improve the performance of international operations;
--Discovery retains ample flexibility within the ratings for share repurchases and moderate acquisition activity.
Overall, Discovery's solid free cash flow (FCF) generation, strong credit protection metrics and minimal near-term scheduled maturities afford the company considerable financial flexibility at the current ratings. The company generated \$1.2 billion of FCF in FY2014, and Fitch believes the company's high operating margins and the low capital intensity associated with the cable programming business positions Discovery to generate annual FCF of approximately \$1 billion-\$1.3 billion.
The company's liquidity position is further supported by the \$367 million of cash on hand as of Dec. 31, 2014, and approximately \$1.46 billion available under a revolving credit facility maturing June 20, 2019. Scheduled maturities are well laddered and manageable considering expected FCF generation, reliable market access and backup liquidity, and add to Discovery's overall financial flexibility. Discovery's next scheduled maturity is not until 2019 when \$500 million of senior unsecured notes and the revolver are scheduled to mature.
Discovery's \$1.5 billion revolver serves as the liquidity back-stop for its commercial paper program. Financial covenants include the maintenance of a maximum consolidated leverage ratio of 4.5x and an interest coverage ratio of at least 3x. Discovery maintains substantial headroom relative to the financial covenants.
Total debt outstanding as of Dec. 31, 2014 was approximately \$7.2 billion reflecting a 36% increase relative to debt outstanding as of year-end 2012. Consolidated leverage edged up to 2.8x as of Dec. 31, 2014, up from 2.6x in 2013, reflecting higher debt levels.
Debt incurrence to fund share repurchase activity is incorporated into the ratings up to Fitch's 3x leverage threshold for Discovery's 'BBB' rating. Fitch believes Discovery's credit profile has sufficient flexibility to accommodate continued share repurchase activity at the current ratings, given Discovery's solid FCF generation, strong credit protection metrics for the ratings category, and a minimal near-term maturity schedule.
In terms of capital allocation, Discovery's priority remains investing in its core business through programming existing networks or through acquisitions. While large-scale M&A activity is not anticipated given the dearth of cable network assets available for sale, Fitch believes there is room at the 'BBB' level to absorb some mid-sized acquisitions. This is underscored by Fitch's current belief that the company would restore leverage to under 3x within a 12-month timeframe.
The share repurchase program is consistent with Fitch's expectation for FCF to be directed towards share repurchase and acquisitions. Discovery repurchased \$1.2 billion of common stock and \$190 million of preferred stock during 2014, up from \$1.05 billion and \$256 million, respectively, in 2013. Preferred stock repurchases are made outside of Discovery's authorized stock repurchase program. As of Dec. 31, 2014, Discovery had approximately \$738 million of capacity remaining under its authorization, which will expire on Feb. 3, 2016.
Discovery's ratings are supported by its strong core brands - in particular the strength of the company's Discovery and TLC brands, both of which reach nearly 100 million subscribers across the U.S. and continue to generate solid ratings. In addition, the ratings incorporate the revenue and growth prospects of Discovery's international business segment, global carriage, leverageable content, robust FCF and solid credit metrics. Ratings concerns continue to center on the significant contribution of cyclical advertising revenue, a competitive landscape of similar programming on other cable channels, the general volatility associated with hit-driven content and the company's dependence on the Discovery and TLC brands.
Fitch's key assumptions within the rating case for the issuer include:
--Strong FCF generation of \$1 billion-\$1.3 billion;
--Share repurchase activity to remain similar to 2014;
--Any debt incurrence to support share repurchases not to cause leverage to exceed 3x;
--Continue investing in its core business through programming existing networks or through acquisitions.
--An upgrade is unlikely over the medium term, given the company's stated leverage targets and the limited depth of brands;
--Future upgrades would only be considered from a combination of the following: 1) an explicit commitment from management and a compelling rationale for Discovery to operate at a more conservative leverage metric and 2) material viewership on new-channel launches that will drive increased advertising and affiliate fees and enhance revenue diversity.
--Negative ratings pressure could result from a more aggressive financial policy with leverage exceeding Fitch's 3x threshold in the absence of a credible plan to reduce leverage under 3x.
--Rating pressure could also result from meaningful customer defections to free viewing platforms or significant margin and FCF pressure from higher programming costs.
Fitch currently rates Discovery as follows:
--Senior unsecured bank facility 'BBB';
--Senior unsecured notes 'BBB'.