S&P Global Ratings revised its debt ratings outlook on Fanatics Holdings, Inc. (FHI) after the sports fan retailing giant reported meaningful margin deterioration through the first half of fiscal 2023 amid slowing consumer demand and cost pressures partly tied to strategic investments. Fanatics Commerce’s sales were approximately flat in the second quarter while Lids “experienced top line and bottom line pressures.”
S&P said it expects challenging operating conditions and ongoing strategic investments to lead to elevated leverage over the next 12 months.
The rating agency affirmed its ‘BB-‘ issuer credit ratings on FHI and its core operating subsidiaries–Fanatics Commerce Intermediate Holdco LLC (Fanatics Commerce) and Fanatics Collectible Intermediate Holdco Inc. (Fanatics Collectibles). The negative outlook reflects S&P’s expectation for leverage to remain near the mid-6x area through fiscal 2023 before improving to 4x and below in fiscal 2024.
S&P said in its analysis, “Fanatics Commerce reported roughly flat revenue growth in the second quarter (ended June 30, 2023) due to slowing consumer demand for its discretionary product offering. At the same time, Fanatics Collectibles reported revenue growth of 4 percent in its second quarter and lowered its guidance for the year due to production delays and updated product launch schedules. In addition, both businesses experienced significant margin deterioration through the first half of fiscal 2023. Fanatics Commerce’s company-adjusted EBITDA margins declined more than 675 basis points (bps) in the second quarter due to fulfillment cost pressures, planned investments in customer experience, and inventory return challenges. Fanatics Collectibles reported more than a 550 bps decline in company-adjusted EBITDA margins due to elective infrastructure investments and sales deleveraging. Lastly, Lids Sports Group (Lids), in which FHI holds a 61 percent stake, experienced top-line and bottom-line pressures attributable to softer macroeconomic trends. These factors resulted in consolidated second-quarter S&P Global Ratings-adjusted EBITDA margins declining nearly 550 bps to 2.5 percent.
“Meanwhile, the company continues to spend heavily on its new online gaming and betting venture, which contributes to higher overhead and subsidiary investment costs. FHI’s significant cash balance (roughly $2.3 billion as of June 30, 2023) helps support its strategy of investing in new ventures even during periods of weaker demand at existing businesses; however, it meaningfully strains its credit metrics.
“FHI’s S&P Global Ratings-adjusted debt to EBITDA spiked to above 7x on depressed earnings and revolver borrowings of about $440 million at Fanatics Commerce as of June 30, 2023. We expect leverage will remain at mid-6x in fiscal 2023 before falling below 4x by the end of fiscal 2024 as the company grows its earnings base. The company has a stated gross leverage target of 3x-4x at its core operating subsidiaries. In contrast to our adjusted credit metric calculations, this target does not incorporate overhead costs or costs associated with new subsidiary investments at FHI.
“Challenging economic conditions are a key risk, notwithstanding some growth opportunities. We forecast nearly 30 percent revenue growth for FHI in fiscal 2023, which mostly reflects the consolidation of Lids into its financials, though also incorporates roughly 10 percent revenue growth at Fanatics Commerce and 12 percent revenue growth at Fanatics Collectibles. We expect consolidated revenue growth of more than 10 percent in fiscal 2024, supported by Fanatics Collectibles’ UFC licensing additions and the Euro Championship, which is held once every four years. We note that this is below our prior forecast because we expect softer economic conditions and dampened consumer spending will broadly impact FHI’s businesses.
“Moreover, Fanatics Commerce’s licensing agreements include guaranteed minimum royalty payments that it must pay to intellectual property owners regardless of its sales volume. We believe these royalty guarantees could further weaken its profitability if it is unable to increase its sales in line with its contractual obligations.
“In addition, Fanatics Collectibles remains concentrated in a niche category with a limited customer base. While agreements with the NBA, NBA Players Association, NFL, and NFL Players Association support its longer-term growth potential, MLB property (i.e. baseball cards) will remain a primary source of revenue over the next couple of years. This concentration presents a risk that slowing demand could lead to lagging revenue growth relative to our forecast.
“Despite performance uncertainty over the next 12 months, FHI holds a solid position in the sports merchandise and collectibles market. Fanatics Commerce maintains long-term exclusive rights to manufacture and distribute branded fan apparel, and Fanatics Collectibles holds exclusive rights to produce and sell trading cards and other collectible products using the intellectual property (IP) of its partners. In our view, its broad portfolio of exclusive merchandising and retailing rights provides it with a reliable, long-term competitive moat. In addition, its diversified revenue channels and vast database of customers offset some near-term risks. Lastly, there is a significant cash balance at FHI, which supports news ventures and is available to subsidiaries during periods of stress. We apply a positive one-notch comparable rating analysis adjustment to our anchor on the company to reflect our view that these factors positively differentiate FHI from other retailers.
“The negative outlook reflects our expectation for performance headwinds across FHI’s businesses due to slowing consumer demand and cost pressures, leading to compressed profitability and elevated leverage over the next 12 months.”
Photo courtesy Fanatics
