IDH Group Downgraded To 'CCC' On Unsupportive Operating Environment And COVID-19 Uncertainty; Outlook Remains Negative

  • U.K.-based dental chain Integrated Dental Holdings, which is owned by Turnstone Midco 2 Ltd. (together, IDH Group), has drawn down the remainder of its super senior committed revolving credit facility (SSRCF) amid growing uncertainty related to the coronavirus pandemic.
  • We expect IDH Group to see a reduction in patient volumes, and therefore earnings, following NHS England's announcement on March 25, 2020, that all routine dental activity must be stopped until further notice.
  • We therefore expect IDH Group's S&P Global Ratings-adjusted cash-paying debt to EBITDA to remain very high and above 11.0x until 2022.
  • Due to the amount of drawdown on the SSRCF, the group will have to comply with a financial maintenance covenant specifying super senior net leverage of 2.3x in the near term.
  • We now expect IDH Group's ability to continue to meet its financial commitments to depend on favorable external conditions.
  • We are therefore lowering our long-term issuer credit rating on Turnstone Midco 2 to 'CCC' from 'B-'. We are also lowering our issue ratings on Turnstone Midco 2's SSRCF to 'B-' from 'B+', and on its senior secured notes due August 2022 to 'CCC' from 'B-'.
  • The negative outlook reflects the possibility that we could lower our ratings on Turnstone Midco 2 again if we see a marked deterioration in its liquidity position. This could happen if the coronavirus pandemic persists in the U.K., thereby leading to a prolonged reduction in patient volumes, and therefore a sharp drop in revenues and earnings.
DUBLIN (S&P Global Ratings) March 26, 2020—S&P Global Ratings today took the rating actions listed above.
Uncertainty from the escalating coronavirus pandemic, very high debt leverage, and insufficient availability under committed bank lines makes IDH Group dependent on a favorable external economic environment to meet its financial obligations.   On March 17, 2020, Integrated Dental Holdings, which is owned by Turnstone Midco 2 Ltd. (together, IDH Group) announced that it had drawn down the remaining £73.2 million under its committed super senior revolving credit facility (SSRCF), as the ongoing coronavirus pandemic poses huge risks for dentists in the U.K. On March 25, 2020, NHS England advised all dentists to effectively stop all routine check-ups and consolidate, where necessary, the provision of essential treatments, following the latest measures by the U.K. government to contain the spread of the virus.
S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
NHS England is providing IDH Group and other dental chains with funding relief in the form of monthly payments in line with their current annual contract values. We view this funding relief positively, but in our view, it only partially mitigates IDH Group's operational risks over the next 12-18 months. For a start, the NHS-contracted business only accounted for about 53% of the group's total revenues as of the third quarter of the fiscal year ending March 31, 2020.
The group's private dentistry unit is its main area of growth and contributed about 19% of total revenues as of the third quarter of fiscal 2020. This unit is particularly exposed to the cessation of all routine dental activity, because it caters to patients who fund their treatments themselves. Therefore, a prolonged shutdown will likely lead to a significant reduction in patient volumes, revenues, and earnings for IDH Group in 2021, with the magnitude of the reductions dependent on the duration of the pandemic.
The decline in EBITDA in 2021 is likely to be particularly noticeable in the event of a prolonged shutdown of clinincs, because we understand that for dental chains to receive the aforementioned relief from NHS England, all associates, nonclinical staff, and other employees should continue to be paid at their previous rates. There is also uncertainty over what will happen in 2022 with regard to the units of dental activity (UDA) that dental practices have not been able to deliver under their standard contractual arrangements with NHS England in 2021. Normally, the practices would need to pay back to NHS England fee payments corresponding to the shortfall in UDA the following year. This could result in heavy working capital absorption in 2022. As a result, IDH Group's liquidity could remain under pressure, especially if volumes and EBITDA do not recover sufficiently.
We anticipate that IDH Group's S&P Global Ratings-adjusted debt leverage will be about 10.2x in fiscal 2020, potentially rising to 11.0x-12.0x in 2021. We have factored in a potential drop in revenues of 3.0%-5.0% in fiscal 2021 and a drop in reported operating margins to about 8.0%-8.5%. The drop in revenues could be higher if the U.K. is in lockdown for more than a full quarter and patient volumes in the private dentist segment fall to zero.
The drawdown under the SSRCF means that IDH Group now has to comply with the financial maintenance covenant on this facility throughout 2021, with no other committed credit lines at its disposal. While the covenant test will take place at the end of March this year, we expect that the group will pass it with headroom, with super senior net leverage of about 1.65x, as we understand that the group did not see a reduction in volumes until mid-March. However, there is uncertainty around the duration of the pandemic and the additional measures the U.K. government and NHS England could take to further contain the spread of the virus, if the existing measures do not help contain it. We therefore estimate that a deviation from our base case of 100 basis points could lead EBITDA to decline below £44 million. This would lead to a breach of the covenant depending on the level of drawdown under the SSRCF.
The group's current capital structure and the narrowing window of opportunity to deleverage will likely test its ability to refinance its debt once the due date approaches.  The coronavirus outbreak comes at an inconvenient time for IDH Group as it faces a large refinancing risk in August 2022, when its £100 million SSRCF, £275 million senior secured fixed-rate notes, and £150 million floating-rate notes are due. We think that the group's ability to refinance its capital structure will be challenged, based on its leverage of above 9.0x on a reported basis (9.3x as of Dec. 31, 2019) and our expectations that its leverage will be even higher by the end of fiscal 2021.
In our fully adjusted debt figures, we include £655 million of long-term borrowings; about £94 million of operating leases resulting from the implementation of International Financial Reporting Standard 16; £736.7 million of shareholder loan notes; and £56.9 million of preference shares at Turnstone Equity Co 1 Ltd., Turnstone Midco 2's parent. We do not deduct cash from debt, reflecting the group's majority-ownership by private equity groups Carlyle Group and Palamon Capital Partners.
Recent operational improvements and a shift in the service mix have allowed the group to improve its operating margins, but associated investments have prevented it from improving its credit metrics.   Over the past two fiscal years, IDH Group has focused its efforts on improving its cost structure and shifting its service mix toward private dentistry, due to the inherent recruitment issues in its NHS-contracted business. The NHS-contracted business accounted for about 53% of the group's total revenue as of the third quarter of 2020. Cost-structure optimization efforts have mainly revolved around closing or merging about 42 nonprofitable clinics since March 2018.
Simultaneously, the group has been investing in the expansion of its private dentistry offering, which accounted for about 19% of total revenues in the third quarter of fiscal 2020, up from about 16% in fiscal 2018, in line with market trends. To support this shift, the group has successfully rolled out the affordable private treatment range "{my}options", capturing both patients from other dental chains and those unable to access NHS dental services. The group estimates that around 50% of new patients cannot access the NHS services because they do not meet certain criteria. We understand that about 50,000 patients have taken advantage of the {my}options offering to date.
Within the {my}dentist division, the group has opened 14 specialist treatment centers under the Advanced Oral Health brand since spring 2018, and expects to open three more in the near future. In addition, the group has also expanded its DD division (formerly known as Dental Directory), with new corporate contracts with dental providers in Ireland, and with Galderma, the former dermatology treatment and skin care product subsidiary of Nestle.
We expect the shift toward private dentistry to continue in the near-to-medium term, due to the unfavorable market conditions in the NHS-contracted business. IDH Group's operating margin has improved recently, to what we expect to be about 10% on a reported basis in 2020 from 8.4% in 2018. However, this improvement is rather modest, and the group still has a sizable dependence on NHS business. This has ultimately prevented it from deleveraging to more sustainable levels, with adjusted debt to EBITDA of around 9.5x over 2018-2019.
The negative outlook reflects the possibility that we could lower our ratings on IDH Group again within the next 12 months if we see a worse decline than we expect in the group's revenue and earnings generation capacity. This could put pressure on the group's liquidity position because there is insufficient availability under committed bank lines. A reduction in the group's earnings generation capacity will likely happen if the coronavirus pandemic persists such that the U.K. government prolongs the lockdown period, thereby leading to significantly reduced patient volumes across the group's practices.

We could raise the issuer credit rating on IDH to CCC+' if risks from the coronavirus pandemic subside, with only a temporary shutdown of dental practices, and therefore a lower drop in patient volumes than we expect. In our view, this would alleviate the pressure on the group's liquidity position in light of the committed bank lines being already fully drawn. It would also allow senior management to continue to work on the ongoing turnaround plan and address the upcoming refinancing needs.
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