OREANDA-NEWS. Fitch Ratings has placed UK gaming group Ladbrokes Plc's (Ladbrokes) Issuer Default Rating (IDR) of 'BB' on Rating Watch Negative (RWN) and placed Gala Coral Group Limited's (GCG) IDR of 'B' on Rating Watch Positive (RWP). The rating actions follow the announcement made by both companies that they have agreed to merge by way of exchange of shares. The enlarged group will be renamed Ladbrokes Coral plc.

The transaction is subject to various conditions precedent, including shareholder approval and anti-trust clearance from the Competition and Markets Authority (CMA), and therefore is not expected to conclude before mid-2016. A complete list of rating actions is included below.

Ladbrokes also announced a new share placement of around GBP115m, completed last week, and a reduction of dividend to 3p per share (from the current 8.9p per share), resulting in a significant cash inflow to be reinvested in the business between 2015 and 2017.

We believe the combination of Ladbrokes with most of GCG would create a UK market leader with a stronger business profile than either group could achieve separately, leading to the RWP on GCG. We assume around GBP865m net debt of GCG's existing indebtedness will become part of Ladbrokes following the merger, and despite the equity issue, the initial leverage profile of the combined group will be somewhat weaker than Ladbrokes' existing one, resulting in the RWN being placed on Ladbrokes. This is notwithstanding the benefits to its business profile and possible improved cash flows after synergies from the merger. However, the announced equity placement, modest dividend and leverage targets signal the intention to move to a stronger balance sheet.

While cost savings arising from the merger should support profitability over time and any business disposals on EBITDA multiples of between 6x and 8x could improve debt metrics, we see some execution risks in completing the merger and integrating both groups. These include potential acceleration of betting shop disposals and the amalgamation of the digital platform, as consumer demand moves swiftly online, where GCG has been more successful than Ladbrokes. These risks are reflected in the assigned RWN on Ladbrokes. At present we estimate that the combined entity's IDR would probably be no more than one notch below Ladbrokes' current 'BB' rating, subject to the final capital structure at completion.

Fitch aims to resolve the rating watches pending the successful completion of the announced merger (most likely in 2016) and once there is greater clarity with regard to Ladbrokes' post-merger strategy and potential synergies.

KEY RATING DRIVERS

Strengthening Business Risk Profile
The business profile of the enlarged group will be supported by the combination of GCG's strong online presence, where Ladbrokes has underperformed, and its Italian operations, with Ladbrokes' and GCG's large UK shop portfolio, well-known brands and long UK track records. Ladbrokes' Australian presence would strengthen the combined group's international diversification.

Improving Profitability Prospects in UK Retail
While Ladbrokes' UK retail will see further profit erosion in 2015 driven by rising taxes, increasing regulation and high competition, the merger with GCG's estate should limit competition while we expect some stabilisation in over-the-counter gross win in UK retail and steady growth in machine revenues.

We see the potential for material cost savings through the disposal of some of the combined group's 4,000 UK betting shops. Other synergies and cost savings are also expected such as joint procurement and reduced corporate costs.

Anti-Trust Hurdles
The merger will face high scrutiny from the UK competition authorities. An attempt by Ladbrokes to buy GCG in 1998 was blocked due to concerns it would reduce competition. The subsequent migration of the industry to online means we do not expect a deal would be blocked, but the companies could be forced to sell parts of their UK portfolio, especially given the significant overlap between the two companies in high-street locations.

Digital Performance Key
The UK gaming sector is undergoing a structural shift towards more online betting, where Ladbrokes has been lagging its peers. Its digital business showed encouraging signs of stabilisation following steep declines in 2013 when the group transferred over to the Playtech platform. Coral.co.uk has shown strong growth of active players, driven by successful marketing programmes and a high level of Coral Connect multi-channel sign ups.

We expect some execution risks, particularly around integrating the two online businesses, and customer response. However, the recently appointed Ladbrokes CEO (who will remain CEO of the combined group) has a strong background in digital gaming, and we consider his role as key to shaping the group's future direction in this fast-growing segment. In addition, GCG has demonstrated that it can successfully build profitable online operations, and both groups use the Playtech platform.

Deleveraging Prospects
For Ladbrokes alone (ie. pre-merger) we expect leverage to improve by up to 1x by end-2016 from 3.8x in 2015 after the equity issue and dividend cut which would, in isolation, lead to a Stable Outlook. However, the merged group will inherit net debt of GBP865m from GCG's business (excluding Bingo). We expect an FFO adjusted net leverage of around 5.0x for 2015 (pro forma for the merger), which could decline to below 4.0x by 2017 if management is able to extract some cost savings and free cash flow (FCF) remains positive (3%-5% of sales). If achieved, such cash flow generation and leverage would remain compatible with a 'BB' rating.

Steady Financial Flexibility
The announced reduction in dividend pay-out, more in line with other listed peers in the sector, will unlock resources to be reinvested in the business and help Ladbrokes remain competitive. We expect FFO fixed charge cover (pro-forma for the merger) to steadily improve to 2.8x by 2017 from 2.4x at 2015 which would be comfortable for a 'BB' category. Current liquidity for Ladbrokes remains satisfactory, with an expected combined pro-forma end-2015 cash of around GBP220m. We expect Ladbrokes' existing committed facilities to remain in place post-merger (totalling around GBP350m for the combined group), as well as the two bonds totalling GBP325m.

GCG Senior Secured Creditors' Prospects
At present we assume GCG's senior secured notes and senior notes will be part of Ladbrokes Coral although Ladbrokes and GCG have said it is their intention to put new committed funding in place by the time of the shareholder circular. Over the next few months we expect to receive more clarity regarding the deal and any changes to the capital structure resulting from the legal merger and creditors' rights for either sides of the group; or when management puts in place a permanent debt structure more commensurate with the profile of the combined group.

LIQUIDITY

At end-2014 Ladbrokes had GBP21m of unrestricted cash on balance sheet and access to GBP283m of the group's GBP405m bilateral facilities available. This is sufficient as Ladbrokes does not face any meaningful debt redemptions in 2015. The next major debt maturity is its GBP225m bond due in March 2017.

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. Although subject to shareholder and CMA approval, key Fitch forecast assumptions for the merged group include:

-Group revenue of GBP2.2bn for 2015, weighed down by tighter regulation, increased taxes and intense competition, against a more competitive online offering.
-EBITDA margin of between 16% and 18% for 2015, rising to at least 20% by 2017, including at least GBP65m of cost savings
-Capex of at least 5% of sales
-Dividend of GBP53m for 2015

RATING SENSITIVITIES

Future developments that could lead to a negative rating action for Ladbrokes plc if the merger does not proceed include:
- Evidence of further deterioration in UK retail operating profits, adverse regulatory developments and no significant improvement in digital operating profits.
- Declining profitability and/or high capex resulting in neutral to negative FCF
- FFO adjusted net leverage above 4.0x (2014: 3.8x) on a sustained basis
- FFO fixed charge cover below 2.5x (2014: 2.7x)

Future developments that could lead to Ladbrokes' Outlook being revised to Stable include:
- Stable UK operating profits, stable or growing digital profits and no change in regulation or tax environment leading to sustained positive FCF at least 2%-3% of sales (post dividends)
- FFO adjusted net leverage below 4.0x on a sustained basis
- FFO fixed charge cover above 2.5x

At the same time, once the merger is complete, an upgrade of GCG's IDR (of minimum two notches) will depend on management's ability to achieve:
- Strengthening of the business risk profile, critically in the online business, without any significant customer losses and profitability erosion across segments
- FFO adjusted net leverage below 4.0x (2014: 6.3x) on a sustained basis
- FFO fixed charge cover above 2.5x (2014: 1.6x)

Failure to merge would likely result in GCG's IDR being affirmed at the current 'B' level.

FULL LIST OF RATING ACTIONS
Ladbrokes Plc
Long-term IDR: 'BB'; placed on RWN
Short term IDR: affirmed at 'B'
Senior unsecured debt: 'BB'; placed on RWN

Gala Coral Group Limited
Long-term IDR: 'B'; placed on RWP

Gala Group Finance plc
Senior secured notes: 'BB'/'RR1'/96%; on RWP

Gala Electric Casinos plc
Senior notes: 'CCC+'/'RR6'/0%; RWP