S&P Global Ratings affirmed the debt ratings of Varsity Brands Holding Co., the parent of BSN Sports, Varsity Spirit and Herff Jones, following the company’s plans to extend the maturity on its $1.33 billion senior secured first lien term loan by two years to December 2026.
S&P affirmed its ‘B-‘ issuer credit rating on Varsity Brands and its ‘B-‘ issue-level rating on its $150 million senior secured notes. S&P’s rounded recovery estimate on the first-lien secured debt was revised to 55 percent from 65 percent because the facility is being amended to permit $350 million of priority debt. At the same time, S&P assigned its ‘B-‘issue-level and ‘3’ recovery rating to the company’s proposed first-lien term loan.
The stable outlook reflects S&P’s expectation that the company will continue to improve profitability and effectively manage its working capital while deleveraging to the low-8x area over the next 12 months from the low-9x area pro forma for the transaction.
S&P said in its analysis, “While we think the transaction is credit positive, we note that it entails higher interest costs, effectively increasing the company’s annual cash interest expense by about $20 million. Additionally, Varsity will pay a substantial fee to the consenting and new term loan lenders, which it intends to fund via cash and an ABL draw. Our adequate liquidity assessment reflects our expectation that the company will be able to upsize the ABL facility in a reasonable time frame following the term loan extensions. We could revise our liquidity assessment to less than adequate if the company cannot upsize and extend the ABL over the near term at the terms provided to us. As part of our rating, we also expect the company to successfully extend the majority of its second-lien term loan, so it does not trigger the springing maturity on its new first-lien term loan.
“Further, we assume the aggregate amount of the extended first-lien term loan facility and existing (non-consenting) first-lien term loan facility will not exceed $1.33 billion, though the company could upsize the extended facility to take out some or all of the senior secured notes dollar for dollar. Therefore, we view this as a minimally leveraging transaction.
“Varsity’s operating performance has improved, but its credit metrics and free operating cash flow (FOCF) are trending below our expectations.
“The company’s leverage and FOCF are trending weaker than our previous forecasts, mainly because it had high working capital outflows in 2022, which it funded by drawing on its ABL, and some material one-off expenses, including consulting fees. Varsity disclosed that some of its elevated working capital usages was related to the timing of its accounts receivable and higher inventory build. We believe the company will maintain its growth momentum in 2023, especially in its BSN Sports and Varsity Spirits segments, supported by distribution gains and its expansion into new categories. While margins have declined over the past couple of years, we expect the company will be able to strengthen margins as inflationary conditions ease and it expands higher-margin private label sales, especially in its BSN Sports segment.
“We estimate the company’s FOCF will at least reach break-even in 2023 supported by a normalization of its working capital, top-line growth, and margin expansion.”
