Standard & Poors lowered the debt ratings of Varsity Brands Co. Inc., the parent of Varsity Spirit, Herff Jones and BSN Sports, as the COVID-19 pandemic is leading to a growing number of school closures and event cancellations. An emphasis on social distancing and restrictions on large gatherings are also disrupting the company’s business, the rating agency noted.

S&P said in a statement, “We believe the revenue and profit of U.S.–based Varsity Brands Holding Co. Inc. and Hercules Achievement Inc., collectively known as Varsity Brands, could decline materially due to its participation in the school affinity market.”

S&P said it is lowering its issuer credit rating on Varsity Brands to ‘CCC+’ from ‘B-‘ and its issue-level rating on its first-lien term loan to ‘CCC+’ from ‘B-‘. The ‘3’ recovery rating on the first-lien term loan is unchanged.

The negative outlook reflects the potential for a lower rating over the next 12 months if, in its view, the risk of a near-term default has increased, including a liquidity crisis, violation of financial covenants, or restructuring.

S&P said in a statement, “Sales and profits will decline materially at least in the near term. The COVID-19 pandemic has forced widespread school closures in the U.S., and it is likely that many schools will remain closed at least over the near term. In addition, an emphasis on social distancing and restrictions on large gatherings could also result in weaker demand even if the school closures are short-lived. While our economists’ best-case scenario points to a rebound in the second half of calendar year 2020, there is substantial uncertainty around the rate of spread and peak of COVID-19 and its lingering effects on the U.S. economy. Many public schools rely on state tax revenues for funding for activities and, so far, they haven’t seen an immediate economic impact because budgets tend to lock in a year ahead. However, if the coronavirus is not contained in the near term and it prolongs the recession and subsequent recovery, schools could see funding declines going into next year which will further hurt Varsity Brands’ sales and profits.

“The negative outlook reflects the potential that we could lower the rating over the next 12 months if we see an increased risk of a near-term default.

“We could lower the rating if Varsity Brands’ sales and profit decline substantially amid the pandemic leading to free cash flow dropping to below $10 million or EBITDA interest coverage sustained near 1x. We could also lower our rating if we believe Varsity Brands is likely over the subsequent 12 months to file for bankruptcy protection or enter into a restructuring agreement with its lenders that we would view as tantamount to a default. This could be precipitated by dwindling liquidity, an expected financial covenant violation, or an unsustainable capital structure.

“We could take a positive rating action if COVID-19 is contained and the macroeconomic environment shows signs of recovery from the pandemic and Varsity Brands strengthens its profits and free cash flow with EBITDA interest coverage approaching 2x. This could occur if the forward-booking volume and incoming orders pick up and the company benefits from its digital platform and cost-saving initiatives.”

Photo courtesy Varsity Brands/Bain Capital