The outlook revision primarily reflects our revised forecasts for Parques Reunidos’ fiscal year ending Sept. 30, 2012, and particularly our view that the group’s covenant headroom could significantly tighten.
We have revised downward our base-case scenario on the back of weak current trading trends, particularly driven by deteriorating macroeconomic conditions, especially in Spain and Italy. Spain and Italy represent about 35% of the Group’s EBITDA. In addition, we believe that Parques Reunidos’ operating performance could remain weak in fiscal 2013, given our expectations of a prolonged economic recession in these two countries. Still, our base-case scenario incorporates our view that the group could use a significant part of its available equity cure--totaling about EUR42 million--to prevent a covenant breach over the next 12 to 18 months.
Specifically, Parques Reunidos’ fiscal year-to-date earnings performance to July 2012, which typically accounts for about 40% of the group’s EBITDA for the fiscal year, reveals a significant drop in both revenue and EBITDA on last year, with a decrease of about 2.5% and 12.5%, respectively. These results are also well below our expectations of low single-digit revenue growth and EBITDA margins in line with the previous year.
As evidenced by current trading conditions, ongoing austerity measures have taken a toll on discretionary consumer spending. This had a notable impact on low-ticket items such as regional attraction parks, with an entrance ticket price averaging around EUR16 per visitor for Parques Reunidos. In our view, the difficult economic environment and strain on consumer spending will likely continue well into 2013 (see “The Curse Of The Three Ds: Triple Deleveraging Drags Europe Deeper Into Recession,” published July 30, 2012, on RatingsDirect on the Global Credit Portal).
Despite the recent covenant reset as part of the amend and extend agreement signed in late July, we anticipate that the drop in revenue and negative impact on EBITDA could result in Parques Reunidos’ financial covenant headroom falling significantly below 15% in fiscal 2012, with a potential for further tightening as the difficult economic environment in its main markets persists.
According to our revised base-case scenario for fiscal 2012, we now anticipate low to mid single-digit revenue decline owing to lower-than-anticipated attendance rates and per capita spending. With regard to profitability, we expect declining revenues and the group’s high operating leverage to result in a drop in margins by about 150 basis points (bps). In terms of leverage metrics, we anticipate that Parques Reunidos’ adjusted debt to EBITDA will stand at about 10.0x in fiscal 2012 compared with 8.8x in fiscal 2011, after adjusting for operating leases and about EUR380 million of existing shareholder loans.
Overall, Parques Reunidos’ tightening headroom under its financial covenants and its highly leveraged capital structure are currently the main rating drivers.
We assess Parques Reunidos’ liquidity as “less than adequate,” as defined by our criteria, particularly in light of expected tight headroom under financial covenants at its European operations.
Our assessment of Parques Reunidos’ liquidity position takes into account:
-- Sources of liquidity, including cash and revolving credit facility (RCF) availability, which will likely exceed its uses by 1.2x or more over the next 12 months;
-- Cash balances of about EUR79 million on June 30, 2012, which include about EUR42 million of shareholders’ equity funds to be used if necessary as equity cures for potential covenant breaches;
-- Approximately EUR35 million of undrawn committed back-up lines, with a maturity of less than 12 months; and
-- The absence of mandatory debt repayments until 2017.
We understand that Parques Reunidos signed an amend and extend agreement in late July, thereby extending its maturities by two years to 2017-2018 and the RCF by two and a half years to September 2016. Additionally, the covenant headroom was also reset to provide further flexibility.
However, ongoing pressure on revenue and the consequent negative impact on EBITDA could result in covenant headroom falling below our 15% threshold, despite the recent covenant reset. We note that the company has recourse to three additional equity cures for potential covenant breaches. In particular, we factor into the ratings and our liquidity assessment our expectation that the group would have a significant portion of its EUR42 million reserve available for equity cure purposes.
In addition, Parques Reunidos could also choose to repay part of its debt by using additional cash on balance sheet (considering the leverage covenant is calculated on a gross level). Moreover, under the terms of the U.S. operations’ debt instruments, the group could also potentially upstream about $25 million annually, which could then be used to further alleviate covenant headroom pressure.
-- The issue rating on the senior secured $430 million bond due 2017 is ‘B-'. The recovery rating on this instrument is ‘4’, indicating our expectations of average (30%-50%) recovery for bondholders in the event of a payment default. The bond was co-issued by Parques Reunidos’ fully owned U.S. subsidiary Palace Entertainment Holdings LLC (Palace) and Palace’s 100%-owned finance subsidiary Palace Entertainment Holdings Corp.
-- Bondholders have no claim or guarantee outside the U.S., and there is no cross-default with Parques Reunidos’ non-U.S. debt. Our recovery analysis therefore only considers the Parques Reunidos’ U.S. business, excluding any value or claim coming from the European business at the point of default.
-- Our issue and recovery ratings on the bond reflect our valuation of Palace as a going concern, which is underpinned by our view of this subsidiary’s strong market share, its sizable portfolio of theme parks in good locations, and the relatively high barriers to entry typical of the sector. The ratings are further supported by our view of the fair security and guarantee package provided to the bondholders, and Palace’s exposure to the U.S. insolvency regime, which we view as rather favorable for creditors.
-- At the same time, the ratings are constrained by the presence of the $120 million super senior RCF, which would rank ahead of the bond in a post-default waterfall, and by our view of Palace’s high leverage.
-- Our simulated default scenario contemplates a default in 2014, assuming primarily a reduction in discretionary consumer spending. Our going-concern analysis leads to a stressed gross enterprise value of about $290 million at our simulated point of default, translating into a blended enterprise value-to-EBITDA multiple of about 6x.