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TEXT-S&P affirms Gateway Casinos & Entertainment rating
July 25, 2012 / 7:28 PM / 5 years ago

TEXT-S&P affirms Gateway Casinos & Entertainment rating

 (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

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