DBRS Morningstar Upgrades Ratings of Yellow Pages Digital & Media Solutions Limited and Confirms Rating of Yellow Pages Limited

DBRS Limited (DBRS Morningstar) upgraded Yellow Pages Digital & Media Solutions Limited’s (Yellow Pages Digital) Senior Secured Notes (the Secured Notes) rating to BB from BB (low) and Subordinated Exchangeable Debentures (the Subordinated Debentures) rating to B (high) from B (low), as well as their Recovery Ratings to RR2 from RR3 and to RR4 from RR6, respectively. DBRS Morningstar also confirmed Yellow Pages Limited’s (Yellow Pages or the Company) Issuer Rating at B (high). All trends are Stable.

The upgrade to Yellow Pages Digital’s Secured Notes and Subordinated Debentures reflects the benefits of the recovery prospects based on the significant reduction in principal over the last 12 months. Yellow Pages’ B (high) Issuer Rating continues to reflect its digital growth opportunity, strong brand recognition, valuable customer relationships, ability to generate cash flow and diminishing debt balance. The ratings also consider the continued erosion of the print business and intensely competitive digital advertising landscape.

On December 19, 2018, DBRS Morningstar confirmed the Company’s rating and Stable trend and indicated that if debt repayment continued to be prioritized as its top use of cash flow, financial leverage may improve to a level more in line with a higher-rated company despite the persistence of a challenging operating environment. While leverage has declined materially, revenue and EBITDA performance has trended well below DBRS Morningstar’s conservative expectations, which preclude a positive rating action on the Company’s Issuer Rating at this time.

YP Segment revenue (revenue from continuing operations) declined by 16.7% year over year (YOY) in 2018 and by 18.2% YOY in H1 2019 over the comparable prior-year periods. Although the decline in both periods reflected softness in both digital and print businesses and continued customer losses, revenue ticked up sequentially quarter over quarter in Q2 2019 and the pace of customer losses slowed. The YP Segment EBITDA margin was 38.1% in 2018 (+680 basis points (bps) YOY) and 42.1% in H1 2019 (+313 bps YOY), as the Company has been focused on streamlining internal operations, continued cost-cutting initiatives and prioritizing the creation of a profitable business rather than revenue performance. As a result, YP Segment EBITDA was $185 million in 2018 (+1.3% YOY) and $88.5 million in H1 2019 (-11.7% YOY).

In terms of financial profile, in 2018 the Company used its free cash flow and proceeds from divestitures to repay $145 million in debt, reducing its debt balance to $264 million as at year-end and resulting in a 2018 lease-adjusted debt-to-EBITDA of 1.60 times (x) compared with 2.48x in 2017. In H1 2019, Yellow Pages generated $53 million in DBRS Morningstar free cash flow (cash flow after capex but before changes in working capital) and repaid another $90 million in debt, thereby taking Q2 2019 debt to $176 million, or a last 12 months ended Q2 2019 lease-adjusted debt-to-EBITDA of 1.27x.

Looking ahead, Yellow Pages’ earnings are expected to remain under pressure for the remainder of 2019 and 2020 as the print and digital businesses are expected to continue to post annual double-digit revenue declines. However, the pace of annual decline is anticipated to slow as a result of narrowing customer losses and modest average revenue per customer growth. As a result, revenue is expected to range between $330 million and $350 million in 2020. EBITDA margins are expected to remain essentially flat in the high 30% range over the 2019 to 2020 period.

Full-year 2019 cash from operations is expected to be about $100 million, or roughly flat YOY. DBRS Morningstar anticipates capital intensity to be about 2.5% and notes that there is no dividend. As a result, 2019 free cash flow after capex but before working capital is expected to be $90 million to $100 million. DBRS Morningstar estimates that Yellow Pages will repay approximately $160 million in debt (including $70 million that was announced when Q2 2019 was reported) in full-year 2019. As a result, the Company’s debt balance is expected to decline to $100 million to $105 million as at 2019 year end (~1.0x lease-adjusted debt-to-EBITDA). Free cash flow in 2020 is expected to be approximately $80 million, which should enable the Company to essentially retire its remaining debt balance in the following year.

In order to analyze the potential recovery for debtholders of the Secured Notes in the event of default, DBRS Morningstar typically establishes a range of default scenarios reflecting the inherently imprecise nature of the default simulation. The default scenarios estimate under which circumstances a default could hypothetically occur and reveal the expected financial condition of the Company in the event of such default. Estimations of operating income, debt levels and credit metrics derived from the default scenario provide DBRS Morningstar with the ability to determine whether the various claims of creditors would be satisfied under such a default scenario.

As Yellow Pages’ Issuer Rating of B (high) is considered non–investment grade, the “DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers” methodology is applicable. Specifically, DBRS Morningstar must assess the recovery prospects on specific debt securities for the purpose of establishing credit ratings on those respective debt securities. Under various approaches, in a path to default over the medium to longer term, DBRS Morningstar believes that it is likely that holders of the Secured Notes would likely recover 100% of their value, representing a Recovery Rating of RR2. Using similar approaches, holders of the Subordinated Debentures are likely to recover 30% to 60% of their value, a level that corresponds with a Recovery Rating of RR4.

Despite operating pressures over the near to medium term, DBRS Morningstar believes the Company has the willingness and ability to completely deleverage in 2021. Yellow Pages’ intention to continue to direct cash flow toward debt repayment combined with evidence of a stabilization in digital revenue performance may result in a positive rating action. Conversely, if the Company’s earnings pressure is significantly more intense than currently contemplated and the Company’s deleveraging goal stalls, a negative rating action could occur.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Companies in the Publishing Industry and DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on dbrs.com under Methodologies & Criteria.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.

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