S&P Global Ratings lowered its issuer credit rating on New Era Cap LLC to ‘B’ from ‘B+’ following the move by private equity firm ACON Investments in early August to increase its ownership stake significantly in New Era through a non-common equity transaction.
Acon Investments, New Era’s first institutional investor, increased its ownership stake significantly from its initial stake of 15 percent.
The rating agency said it treats the non-common equity units as debt in its calculation of debt, resulting in significantly higher S&P adjusted leverage and reflecting a more aggressive financial policy.
At the same time, S&P lowered its rating on the company’s first-lien term loan due in 2027 to ‘B+’ from ‘BB-‘; the ‘2’ recovery rating is unchanged, reflecting S&P’s expectation for substantial recovery (70 percent-to-90 percent, rounded estimate: 75 percent) in the event of a default.
The stable outlook reflects S&P’s view that the global headwear industry will continue to grow as demand trends are sustained at least through the next 12 months, helping New Era maintain free operating cash flow and FFO cash interest coverage ratios at current levels.
S&P said in its analysis, “While the CEO and company leadership maintain control, we believe this increase in Acon’s ownership enables it to be highly influential in the decision-making regarding the company’s financial policy and governance, for these reasons, S&P now views New Era as a sponsor owned and controlled entity. The current CEO, Chris Koch, a fourth-generation family member with a 20-year tenure in the role, maintains majority ownership and will continue as CEO. In conjunction with this transaction, Major League Baseball, the National Basketball Association, and the National Football League became the minority owners in the company.
“As a part of this transaction, the company’s owners contributed capital in the form of Class A and Class B non-common equity units. We view the contributed and existing non-common units as a debt-like obligation and added it to our calculation of adjusted debt. This is because the LLC agreement allows for extraordinary distributions to be made that could reduce the capital contribution of the non-common equity. There is also no contractual alignment(stapling) of interests between the Class A and B units and the common equity. As a result, pro forma S&P Global Ratings-calculated adjusted debt leverage will be about 8x for the 12 months through June 2022 compared to the mid-1x area when excluding the non-common equity. Despite the significant deterioration in our adjusted leverage metrics, S&P forecasted free operating cash flow generation of over $100 million (more than $50 million after-tax distributions) and FFO cash interest coverage of 6x are indicative of a better financial risk assessment than the adjusted leverage metrics indicate.
“We expect New Era’s operating performance to remain strong for the rest of 2022. For the six months ended June 30, 2022, the company posted a year-over-year revenue increase of 26 percent and S&P Global Ratings-adjusted EBITDA growth of 9.6 percent. The growth stemmed from price increases and strong demand for the company’s products across all regions as it expands in the lifestyle and fashion segments of the cap market. The company’s continued focus on growth initiatives, including expanding distribution and incremental marketing, also contributed to strong operating performance. In the second quarter, New Era’s performance remained largely unscathed by the generally weaker consumer sentiment that has hurt apparel peers. We believe this is attributable to its leading position as the licensed headwear seller for the major league sports in the U.S. and internationally as consumers shifted their spending to events and experiences after the pandemic. Its products are typically associated with these experiences and benefit as consumers return to in-person sports events. We also believe the headwear category is performing well as caps and hats are smaller ticketed purchases compared to other apparel categories, and as the category leader, New Era’s growth continues to be strong. Therefore, we forecast revenues to grow in the mid-teen percentage area in 2022, albeit at a slower rate in the second half of the year. In addition, we expect the company’s S&P Global Ratings-adjusted EBITDA margins to remain pressured in 2022 due to increased input raw material and freight expenses and the company’s continued investments to grow its e-commerce capabilities.
“Inflation and a weaker economy remain key risks. Our economists estimate a 35 percent-to-45 percent chance of a recession within the next 12 months. Given the reduced consumer activity and increased risk of recession, we believe that demand for the company’s products could decline given the highly discretionary nature of its products. While not incorporated into our base-case scenario, the company’s revenues and adjusted EBITDA could drop significantly if the deteriorating economic activity or sustained high inflation translates into eroding consumer confidence and lower demand for the company’s products.
“The stable outlook reflects our view that the global headwear industry will continue to grow as demand trends are sustained at least through the next 12 months. As a result, we expect the company to continue to generate free operating cash flow and FFO cash interest coverage ratios at current levels.”
