New Era debt rating downgraded due to increased financial sponsor ownership
S&P Global Ratings lowered its issuer credit rating on New Era Cap LLC from “B” to “B” following the decision by private equity firm ACON Investments in early August to significantly increase its stake in New Era through a non-common stock transaction.
ACON Investments, New Era’s first institutional investor, has significantly increased its stake from its initial 15% stake.
The rating agency said it treats non-ordinary shares as debt in its debt calculation, which results in significantly higher S&P adjusted leverage and reflects a more aggressive financial policy.
At the same time, S&P downgraded its rating on the company’s senior term loan due 2027 to “B+” from “BB-“; recovery rating “2” is unchanged, reflecting S&P’s expectation for substantial recovery (70% to 90%, rounded estimate: 75%) in the event of default.
The stable outlook reflects S&P’s view that the global headgear industry will continue to grow as demand trends continue for at least the next 12 months, helping New Era maintain cash flow. free operating and FFO cash interest coverage ratios at current levels.
S&P said in its analysis: “Although the CEO and management of the company retain control, we believe that this increase in ACON’s stake allows it to be very influential in decision-making regarding financial policy. and corporate governance, for these reasons S&P now views New Era as a sponsor-owned and controlled entity.Current CEO – Chris Koch, a fourth-generation family member with a 20-year term in the role – retains majority ownership and will continue as CEO Concurrent with this transaction, Major League Baseball, the National Basketball Association and the National Football League became minority owners of the company.
“As part of this transaction, the owners of the company have contributed capital in the form of Class A and Class B non-common shares. We view the contributed and existing non-common shares as a debt-like obligation and added it to our adjusted debt calculation. This is because the LLC arrangement allows for extraordinary distributions that could reduce the capital contribution of non-common equity. There is also no contractual alignment of interests between the Class A and B Units and the Common Shares. As a result, the pro forma adjusted debt leverage calculated by S&P Global Ratings will be around 8x for the 12 months to June 2022 compared to the mid-zone of 1x excluding non-common stocks. Despite the significant deterioration in our adjusted leverage metrics, S&P has forecast free cash flow generation of over $100 million (over $50 million after tax distributions) and interest coverage in Cash FFO of 6x indicate a better financial risk assessment than the adjusted leverage measures indicate.
“We expect New Era’s operating performance to remain strong for the remainder of 2022. For the six months ended June 30, 2022, the company delivered year-over-year revenue growth of 26% and growth adjusted EBITDA by S&P Global Ratings of 9.6 percent Growth was driven by price increases and strong demand for the company’s products across all regions as it expands in the lifestyle and mode of the caps market. The company’s continued focus on growth initiatives, including distribution expansion and incremental marketing, also contributed to the strong operational performance. In the second quarter, New Era’s performance was largely untouched by the generally weaker consumer sentiment that has hurt its peers in the apparel sector.We believe this is attributable to its leading position as a sell eur of licensed headwear for major league sports in the United States and around the world, as consumers shifted their spending to post-pandemic events and experiences. Its products are typically associated with these experiences and benefit from consumers returning to in-person sporting events. We also believe the headwear category is performing well, as caps and hats represent smaller purchases than other apparel categories, and as the category leader, New Era’s growth continues to be strong. Therefore, we expect revenues to grow in the mid-teen percentage zone in 2022, but at a slower pace in the second half. Additionally, we expect the company’s S&P Global Ratings-adjusted EBITDA margins to remain under pressure in 2022 due to increased raw material and freight spend and the company’s continued investments to expand its manufacturing capabilities. e-commerce.
“Inflation and a weaker economy remain the main risks. Our economists estimate that there is a 35-45% chance of a recession over the next 12 months. Given reduced consumer activity and the heightened recession risk, we believe demand for the company’s products could decline given the highly discretionary nature of its products.While not factored into our base case, revenues and adjusted EBITDA of the Company could decline significantly if deteriorating economic activity or sustained high inflation lead to an erosion of consumer confidence and reduced demand for the Company’s products.
“The stable outlook reflects our view that the global headwear industry will continue to grow as demand trends continue for at least the next 12 months. Accordingly, we expect the company to continue to generate operating free cash flow and FFO cash interest coverage ratios at current levels.