DBRS Morningstar Confirms Cogeco Communications Inc.’s Ratings Following WideOpenWest, Inc. Acquisition Announcement

DBRS Limited (DBRS Morningstar) confirmed Cogeco Communications Inc.’s (Cogeco or the Company) Issuer Rating at BB (high) and Senior Secured Notes & Debentures rating at BBB (low) with a Recovery Rating of RR1. All trends are Stable. The confirmations follow Cogeco’s announcement that its U.S. subsidiary, Atlantic Broadband (ABB), has entered into a definitive agreement with WideOpenWest, Inc. (WOW) to purchase all of its broadband systems located in Ohio (the Acquisition).

The transaction is valued at USD 1.125 billion and is expected to be financed through a combination of (1) USD 900 million committed secured debt at ABB, which is nonrecourse to Cogeco, and (2) approximately USD 225 million in cash. WOW’s Ohio broadband system’s revenue for the 12-month period ended March 31, 2021, was USD 244 million and pro forma adjusted EBITDA reflecting ABB’s cost structure and USD 2 million in cost synergies was approximately USD 103 million. The transaction is expected to close in Cogeco’s Q1 2022 (September to November 2021).

In December 2020, DBRS Morningstar confirmed Cogeco’s Issuer Rating at BB (high) with a Stable trend. The Issuer Rating is predicated on Cogeco’s consolidated indebtedness and reflects the probability of default within the consolidated entity. At that time, DBRS Morningstar noted that Cogeco’s EBITDA performance was in-line with expectations and that credit metrics were solid with F2020 gross leverage at 2.72 times (x) compared with DBRS Morningstar’s initial estimate of approximately 3.00x, reflecting both a decline in lease-adjusted gross debt and an increase in EBITDA.

Today’s rating action is based on several factors, including (1) the attractiveness of the acquisition target, which enables ABB to expand its service footprint into an adjacent region; (2) material revenue growth potential given low fibre-to-the-home penetration rate by local competitors; (3) an acceptable transaction valuation, the attractiveness of which is enhanced by the present value of tax benefits created by the Acquisition; (4) management’s intention to use free cash flow (FCF) to aggressively reduce leverage following the transaction close; and (5) the solid track record that ABB has established through multiple acquisitions in the U.S. including the USD 1.4 billion MetroCast acquisition that was completed in early 2018.

In its analysis, DBRS Morningstar focused on (1) the business risk profile of the combined entity, including the benefits and risks associated with integration and realization of operating synergies; (2) the financial risk profile, including assessing the cash-generating capacity of the combined entity; and (3) the Company’s longer-term business strategy and financial management intentions.

DBRS MORNINGSTAR ANALYSIS

(1) Business Risk
DBRS Morningstar believes that the Acquisition’s primary benefit to Cogeco’s business risk profile is the continued growth of ABB’s scale and geographic revenue diversification in the north-east region of the U.S. market and future growth potential. WOW’s Ohio broadband system provides roughly 196,000, 61,000, and 35,000 Internet, video, and voice subscribers, respectively. With an estimated 688,000 homes passed in the Ohio broadband system’s network, the ~29% subscriber penetration rate provides considerable long-term revenue growth opportunity despite being a three-player market. As a result of the Acquisition, ABB’s overall Internet subscriber base is expected to increase ~38% to 707,000 subscribers. DBRS Morningstar believes ABB is well positioned to leverage WOW’s DOCSIS 3.1 network platform in order to offer attractive consumer bundles that include Internet protocol television (IPTV) services to drive revenue and EBITDA growth and reduce churn. Further, a low enterprise penetration rate provides growth potential in Cleveland and Columbus as does the potential of urban edge-outs in the long term.

That said, industry headwinds persist for Cogeco (and the cable industry) as the competitive environment intensifies in both Canada and the U.S. Cogeco competes with numerous (and, in some cases, much larger) players for telephony, broadband, and, more recently, video services in the form of IPTV services. Further, as ABB expands its service footprint, it is expected to compete more directly (even in rural regions) with considerably larger integrated U.S.-based communications companies that may be able to offer a greater breadth of services and/or bundles. As such, cable operators such as Cogeco/ABB may continue to lose market share to IPTV providers in the future and face continued cord shaving and cutting trends, although Cogeco’s feature-rich digital video platform may partially mitigate this pressure.

Overall, DBRS Morningstar believes the Acquisition is a net positive for Cogeco’s business risk profile reflecting (1) the expansion of ABB’s footprint to adjacent markets without operating overlap; (2) a demographic profile that should provide long-term growth potential through the introduction of bundled service plans and the launch of additional features such as IPTV, increased data packages, and an enhanced enterprise offering; and (3) ABB’s solid track record of acquiring assets that it is able to successfully leverage to drive revenue and EBITDA growth. DBRS Morningstar believes these positives mitigate the anticipated 18–24 month integration period, including the introduction of a new billing system and an estimated $82 million in incremental integration capital expenditures (capex).

(2) Financial Risk Profile
In terms of financial profile, the Acquisition is expected to result in an increase in Cogeco’s consolidated debt balance to approximately $4.5 billion (DBRS Morningstar estimate including spectrum funding) at close, up from $3.2 billion as at Q2 2021 (ended February 28, 2021). Pro forma gross debt-to-EBITDA is expected to peak at roughly 3.30x at the time of close compared with 2.67x for the 12-month period ended February 28, 2021. EBITDA coverage is forecast to decrease to between 7.0x and 7.5x at close compared with 8.38x for the 12-month period ended February 28, 2021.

Post-close, DBRS Morningstar forecasts that FCF after capex and dividends and before changes in working capital as a percent of debt will be at a reasonably sound level at about 8.0% to 8.5%, despite the increase in debt. DBRS Morningstar expects the Company to deleverage to below 3.0x by the end of F2023 primarily by applying the majority of FCF (after dividend payments) to debt repayment.

(3) Business Strategy and Financial Management Intentions
The positive impact of the Acquisition on the business risk profile reflects the continued growth in the ABB service footprint and incremental revenue and EBITDA growth potential. Although the U.S. cable market is highly competitive, the nonmetropolitan markets in which ABB primarily operates feature a more fragmented competitive environment, typically less advanced communications networks, and/or a more attractive demographic profile.

While the integration of WOW’s Ohio broadband system entails execution risk related to the integration of the target’s billing system, DBRS Morningstar believes that ABB’s experience in integrating and subsequently driving revenue and EBITDA growth from numerous previously acquired assets (including various MetroCast assets) over the last several years should largely mitigate integration and operational risks. Further, DBRS Morningstar believes that Cogeco has the ability and willingness to deleverage after the close of the Acquisition. DBRS Morningstar estimates Cogeco will generate over $1,000 million of consolidated FCF from F2022 to F2024, with ABB generating roughly 40% to 45%. This magnitude of consolidated FCF (with a significant portion expected to be applied to debt reduction) combined with modest EBITDA growth should result in the Company deleveraging to below 3.0x by YE2023.

DBRS Morningstar’s confirmation of the Issuer Rating reflects its view that financial deleveraging to below 3.0x by YE2023 is reasonable in both magnitude and time frame for the BB (high) rating category. Should Cogeco’s gross debt-to-EBITDA not trend toward 3.0x by YE2023 and the Company experience a deterioration in operating performance, a negative rating action could result.

The Recovery Rating remains RR1 for Cogeco’s Senior Secured Notes & Debentures. While DBRS Morningstar examines recovery scenarios through an enterprise-valuation approach, because ABB’s debt is nonrecourse to Cogeco, the Recovery Rating on Cogeco’s senior debt is based only on a valuation of its Canadian operations. Therefore, the increase in debt at ABB as a result of the Acquisition does not affect the Recovery Rating of Cogeco’s debt. In accordance with “DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers,” DBRS Morningstar has confirmed the security rating of BBB (low) with a Recovery Rating of RR1 for Cogeco’s Senior Secured Notes & Debentures, which is one notch above the Company’s Issuer Rating of BB (high).

Cogeco’s ratings continue to be supported by its established footprint in existing markets and the growth potential and diversification of the U.S. cable segment, which DBRS Morningstar believes is enhanced by the Acquisition. The rating actions taken by DBRS Morningstar also continue to consider intensifying competition, consumer cord cutting and/or shaving trends, the shifting wireless competitive landscape in Canada and the Company’s lack of a wireless offering at this time, and risks associated with technological and regulatory changes.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Communications Industry (July 30, 2020; https://www.dbrsmorningstar.com/research/364691) and DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 24, 2020; https://www.dbrsmorningstar.com/research/366063), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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@dbrsmorningstar.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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

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

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