(The following statement was released by the rating agency) Overview
-- We are affirming our 'BB-' long-term corporate credit rating on Gateway Casinos & Entertainment Ltd., as the company proposes a C$50 million addition to its term loan A.
-- The company will use the borrowings to fund a C$75 million one-time capital distribution to shareholders.
-- We are raising our recovery rating on the company's second-lien notes to '3' from '4', reflecting their improved recovery prospects in our default scenario.
-- The stable outlook on Gateway stems from our expectation that the company's robust discretionary cash flow supports aggressive amortization and debt reduction in the next several years. Rating Action On July 25, 2012, Standard & Poor's Ratings Services affirmed its ratings, including its 'BB-' long-term corporate credit rating, on Gateway Casinos & Entertainment Ltd., as the company proposes a C$50 million addition to its term loan A to fund a C$75 million distribution to shareholders. At the same time, Standard & Poor's raised its recovery rating on the company's second-lien notes to '3' from '4', reflecting our expectation of meaningful (50%-70%) recovery in a default scenario. The outlook is stable. Rationale The ratings on Gateway reflect what Standard & Poor's views as the company's fair business risk profile, characterized by a strong share of the concentrated gaming market in British Columbia (B.C.), where steady growth and a supportive regulatory regime have translated into industry-leading margins for the company. That said, Gateway's business risk profile is constrained by its limited diversity, with cash flows heavily concentrated in a few key assets in B.C. We view the company's financial risk profile as aggressive, with high debt leverage offset by solid free cash flow and strong liquidity. The C$75 million debt-funded one-time capital distribution in the wake of its postponed IPO is consistent with Gateway's historical capital structure, returning pro forma debt to last 12 months EBITDA to about 5.5x. We maintain that we could lower the rating if leverage increased beyond 6.0x. Gateway is majority-owned by Toronto-based Catalyst Capital Group Inc. (not rated), with Tennenbaum Capital Partners LLC (not rated) holding a significant minority stake, and others investors holding the remainder. The assets Gateway owns were previously owned by Gateway Casinos & Entertainment Inc. (not rated), a highly leveraged joint venture between Crown Ltd. (BBB/Stable/A-2) and Macquarie Group Ltd. (BBB/Stable/A-2), which entered into forbearance agreements with lenders in early 2010 and completed a consensual restructuring in September 2010. The portfolio of casinos, however, remained profitable through the recession and the restructuring. Gateway operates three casinos in the Vancouver region, four in the Okanagan Valley, and two in Edmonton, Alta., as well as three recently acquired community gaming centers and a bingo license in B.C. The company's market position is good, in our opinion, with an effective duopoly in Vancouver and a dominant position in the Okanagan market, offset by more competitive conditions in Edmonton. The company's operating diversity is good relative to that of similarly rated peers, though it relies heavily on the three Vancouver properties that accounted for almost 70% of 2011 casino revenue. In addition, the proposed construction of a casino and hotel in South Surrey, B.C. reduces the company's reliance in its three key assets, but extends its concentration in Vancouver. With the overwhelming majority of its cash flows concentrated in B.C., the company is exposed to regulatory changes in that province, although we view this as a secondary risk because the industry's interests appear well aligned with those of the government. That said, we do not believe that the B.C. government will approve more casino licenses in the next several years, and the appetite for increased gaming in downtown Vancouver appears limited, thereby cementing Gateway's position. We believe that Gateway's credit profile benefits from large capital expenditures in recent years, including the opening of two major casinos in Vancouver in 2007 and 2008, and the significant renovation of smaller assets. As such, we expect that steady EBITDA generation should support its higher interest burden, continued modest maintenance capital expenditures, and large growth capital expenditures for South Surrey, contributing to sufficient free cash flow to fund its aggressive debt amortization schedule. Supporting the company's cash flow are facility development commissions (FDCs) and accelerated FDCs in B.C., wherein the British Columbia Lottery Corp. effectively reimburses eligible capital expenditures with the aim of accelerating the development of the industry by improving gaming assets and creating the potential for higher revenue growth. For analytical purposes, we include these reimbursements as a part of EBITDA when calculating leverage and debt service coverage ratios, because of the reliability of the FDCs and the fact that Gateway realizes them as an additional operator's share of gaming win. Gateway's aggressive financial risk profile is characterized by high debt leverage with commensurately low interest coverage, with pro forma fully adjusted debt to EBITDA expected to be more than 5.5x. That said, we expect leverage to drop in 2013 and beyond, as free operating cash flow funds its heavy debt amortization schedule. Liquidity Gateway's liquidity is strong in our view, with some cash on hand and near-full availability on a potentially upsized C$45 million revolving credit facility. Our view of the company's liquidity profile incorporates the following expectations:
-- Liquidity sources (including cash, discretionary cash flow, and availability under its revolving credit facility) will exceed uses by more than 1.5x through 2013;
-- Liquidity sources will continue to exceed uses, even if EBITDA were to decline by 30% in 2012 and 2013;
-- Free operating cash flow generation in 2012 and 2013 will be modestly positive given the company's growth capital spending program, and will contribute to meaningful debt reduction along with aggressive amortization; and
-- The company has good relationships with its banks and solid standing in capital markets, but access to its revolver could be constrained because financial covenants become increasingly restrictive. Recovery analysis Standard & Poor's rates Gateway's senior secured term loans A and B 'BB+' (two notches above the corporate credit rating on the company), with a '1' recovery rating, indicating very high (90%-100%) recovery in a default scenario. We also rate the company's second-lien notes 'BB-' (the same as the corporate credit rating on Gateway), with a '3' recovery, indicating average (50%-70%) recovery in a default scenario. (For the complete recovery rating analysis see "Recovery Rating: Gateway Casinos & Entertainment Ltd.'s Recovery Rating Profile," to be published on RatingsDirect on the Global Credit Portal following this report.) Outlook The stable outlook on Gateway stems from our expectation that the company's robust discretionary cash flow supports aggressive amortization and debt reduction in the next several years. We could raise the rating if Gateway lowers its debt to EBITDA to about 4x and improves funds from operations to debt to about 20%. An upward rating action would also likely be predicated on the continuing regulatory and economic stability in Gateway's core markets in western Canada that support its fair business risk profile and contribute to steady margins and cash flow g