S&P Report on Zuffa – Analysis
October 1, 2009
Today, Standard & Poor’s released its latest credit report on Zuffa LLC that documented the corporation’s latest financing initiatives.
Below is a summary of the report’s action:
- Zuffa requested an additional $100 million in incremental term loans to help pay off part of the existing revolving credit line and fund a dividend to the owners of the company.
- Standard & Poor’s reaffirmed Zuffa’s credit rating at BB- (stable).
- S&P dropped Zuffa’s recovery rating to ‘4’ from ‘3.’
S&P re-affirmed the BB- (stable) credit rating for Zuffa, which means the bonds will still be considered high yield and accompanied by higher interest rates. The report cited lingering concerns related to Zuffa’s heavily event-driven business model, relatively short operating history, susceptibility to changes in consumer tastes, and the weak economy for the ratings hold.
The report did acknowledge the fact that Zuffa has made tremendous strides in the past few quarters – specifically mentioning the video game and improved margins in the UK.
However, the fact of the matter remains that Zuffa is operating in a volatile, uncertain business environment. The company has really only been profitable for the last four years, and that’s not enough time to a.) build long-term creditor confidence, or b.) develop enough cushion to insulate the corporation from a severe industrial downturn (i.e., hedge against business risk).
The following caught my eye, because it raises the issue of balancing dividend policy with credit policy:
“Given management’s relatively aggressive posture toward dividends, an outlook revision to positive or ratings upside potential is limited over the intermediate term, despite the likelihood for some improvement to credit measures over the next several quarters.”
The disbursements themselves aren’t a tremendous concern, because they are limited under loan convenants. The underlying issue that I see – albeit a small one – is that the company increased its leverage in part to fund the dividend disbursement, and that ultimately influenced S&P’s decision not to upgrade Zuffa’s credit rating.
The real, tangible difference between credit ratings like BB- and BB+ or BBB- is the interest rates paid on the debt. Not only are they paying more in interest, but through operating in Nevada, a lower percentage of those interest payments are tax deductible due to the absence of corporate tax in the state.
It’s just a small issue, though, as what matters most is Zuffa’s ability to meet those payments. Since the last report, Zuffa has increased its coverage ratios to something more in line with their current credit rating, which is an improvement from the “slightly weak” coverage of last July.
Overall, Zuffa appears to be healthy: the company has managed to stabilize its EBITDA margins, improved its profitability internationally, and has begun to diversify its revenue streams. The concerns laid out in the report are more of an indictment of the business risk involved than they are of any management issues on-going within the company.