) and on debt of Viacom's similarly rated subsidiaries Viacom International Inc. and Infinity Broadcasting Corp. However, the ratings outlook was revised to negative based on indications of a potential shift toward a less conservative financial policy.
The outlook change followed Chairman and CEO Sumner Redstone's statement on Jan. 12 that a BBB category rating level might give the company the latitude to pursue a broader agenda for growth and shareholder returns. He did not outline any imminent plan for acquisitions, expansion of the share repurchase authorization, or borrowing.
While these remarks create uncertainty about the direction of Viacom's financial policy, Standard & Poor's believes that they do not represent a definitive shift in thinking at this time. Viacom has more than $5 billion of debt capacity at the current rating level to address business or financial objectives, which may make any material change in financial policy a gradual process.
The rating on Viacom reflects its broad-base, well-integrated entertainment operations and moderate capital structure. Viacom has strong business positions in network TV, cable TV networks, radio, outdoor advertising, and feature film and TV programming production, but its competition includes similarly well-funded media powerhouses.
Operating performance remains in line with operating income growth guidance of 14% when excluding Blockbuster (BBI
) and certain severance charges. Performance in the nine months through Sept. 30, 2004, reflected cable networks' advertising strength, followed by growth in affiliate fees. The CBS Television Network has been picking up audience share, and the station group reaped political advertising, which together increased revenue, EBITDA (earnings before interest, taxes, depreciation and amortization) and margins gains for the TV group. The radio unit sustained an EBITDA decline in the quarter and nine months, reflecting prolonged sluggish industry trends.
Viacom's balance sheet gross debt to EBITDA was 1.6 times at Sept. 30, 2004, below Standard & Poor's 2.25 times target for the company at an A- corporate credit rating. Guarantees, pension adjustments, securitization debt, and especially capitalization of operating leases raise this measure to nearly 2.6 times. Liquidity benefits substantially from the company's strong discretionary cash flow generation, which was 43% of EBITDA in the 12 months ended Sept. 30, 2004. Healthy discretionary cash flow to EBITDA results from high EBITDA margins, comparatively low capital expenditures, and good working capital management.
The October, 2004, split-off of Blockbuster had a slight negative effect on gross balance-sheet debt to EBITDA and a slight benefit for conversion of EBITDA to discretionary cash flow. However, Standard & Poor's views the effect on Viacom's business profile as somewhat positive, in light of the maturity of Blockbuster's video rental business, near-term concerns regarding increased competition from mass merchants selling low-price DVDs, and long-term concerns about electronic delivery of entertainment.
Management's acquisition-related comments centered hypothetically on cable TV networks, expanding Viacom's online presence, or entering the video game business, any of which may further raise rating concerns, depending on the scenario. A very sizable acquisition, especially if it coincides with a stepped-up share-repurchase authorization, clearly could lead to a downgrade.
The negative outlook reflects Viacom's comments that it is reconsidering its previous commitment to an 'A-' rating. At the same time, Standard & Poor's views the company as having borrowing capacity of at least $5 billion for share repurchases and acquisitions within the current rating. This figure takes into account recent share repurchases of more than $2 billion. Capacity is expected to grow as EBITDA and free cash flow expand. The outlook does not incorporate a scenario of a very sizable acquisition or an extremely large share repurchase done all at once. From Standard & Poor's Ratings Services