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Nordic Payments Firm Nets Downgraded To 'B-' On COVID-19 Impact; Outlook Negative

  • We expect the COVID-19 pandemic will weigh on net revenue in the merchant services division of Nets Topco 3 S.a.r.l (Nets), which we forecast accounted for about 65% of about €1 billion in net revenue from continuing operations in 2019, and increases the risk of merchant chargeback losses.
  • We think this will result in continued negative free operating cash flow (FOCF) in 2020 for Nets, after negative FOCF already in 2019, and cause a spike in our adjusted leverage in 2020 despite some debt repayment from the expected €2.85 billion of proceeds from the pending sale of Nets' account-to-account (A2A) business to Mastercard Inc., which Nets expects will close by the end of the second quarter.
  • We are lowering our long-term issuer credit and issue-level ratings on Nets and its senior secured first-lien debt to 'B-' from 'B'.
  • The negative outlook captures the downside from COVID-19, which could prevent the company from returning to positive FOCF and EBITDA cash interest coverage of at least 1x from 2021, and the risk that Nets uses the majority of disposal proceeds for shareholder returns.
FRANKFURT (S&P Global Ratings) April 23, 2020—S&P Global Ratings today took the rating actions listed above.
We expect the COVID-19 pandemic to harm Nets' revenue in 2020 and see downside risk to our forecast.  We think the economic damage caused by the COVID-19 pandemic--which we reflect in our macroeconomic forecast for a global recession and a steep decline in eurozone GDP of more than 7% in 2020--will harm Nets' topline this year. We estimate that well over 60% of net revenue in Nets' merchant services division (contributing about 65% to total net revenue from continuing operations of about €1 billion in our forecast for full-year 2019) is transaction-related revenue from point-of-sale (POS) and online transactions. POS revenue is severely affected by government-mandated shop closures in Nets' key markets in the Nordics and Germany. Furthermore, we think lower POS revenue will be only partly offset by a shift toward online transactions, also due to the current near halt to online sales in certain sectors such as travel and leisure. In addition, we expect transaction volumes to remain softer throughout the remainder of 2020, even after the possible easing of lockdowns, because economic uncertainty and continued social distancing practices are likely to hamper consumer confidence and spending. As a result, we now forecast group net revenue will decline by 8%-10% in 2020, compared with our previous expectation of 2%-4% organic growth. Furthermore, there are some downside risks to our forecast if it takes longer to contain the COVID-19 pandemic, which might jeopardize our expectation of an economic recovery from second-half 2020.
We see a material risk that COVID-19 will trigger merchant chargeback losses, which could result in substantial cash burn.   In 2019, Nets' German subsidiary Concardis booked a €150 million provision to cover losses related to the insolvency of travel operator Thomas Cook, which lowered reported EBITDA and FOCF by the same amount. We believe Nets could incur additional provisions for chargeback losses as a result of COVID-19-related financial difficulties at merchants. The extent these occur in industries with "payment before delivery", for example travel and leisure, and depending on the payment method used, Nets could be liable for refunding the end customers for the value of any undelivered goods and services. This risk can be reduced by appropriate risk-management techniques, such as limits or exclusions for certain sectors, collateral requirements, predictive analytics, or other provisions in merchant contracts. However, these mechanisms have failed to minimize losses for Nets in the case of Thomas Cook. As a result, we are unsure about Nets' ability to manage credit risk exposure in its acquired businesses during the impending COVID-19-induced economic downturn. We acknowledge, however, that the company has taken measures to improve contract structures in response to the Thomas Cook incident. Noting the significant uncertainty in forecasting the level of such items, we assume merchant chargeback losses and cash-outs in 2020 of 8%-12% of net revenue in our revised base case. In sum, the effect of COVID-19-related topline decline, chargeback losses, and other higher nonrecurring business transformation costs are set to significantly pressure our adjusted EBITDA forecast, with margins that are 15-18 percentage points lower in 2020 than in our previous base case, and still about nine percentage points lower in 2021 (see table). At the same time, we project that Nets will continue to burn cash in the near term, with our forecast of FOCF (excluding discontinued operations) below negative €100 million in 2020, after our estimate of below negative €200 million in 2019 (including discontinued operations).
The expected proceeds from the pending disposal could in principle improve Nets' capital structure beyond 2020, but the magnitude of actual debt reduction by Nets' owners is uncertain.   Given our expectations for the effects of COVID-19 on revenue and adjusted EBITDA, we think Nets' pending decision on the use of proceeds is unlikely to alter our view of its credit metrics in 2020. For 2020, we expect materially negative FOCF and adjusted leverage well above 8x (except if Nets applied 100% of proceeds for debt repayment while avoiding material downside to our EBITDA forecast from chargeback losses or weaker topline, but we currently regard such a scenario as remote). However, the use of the €2.85 billion proceeds from the sale of the A2A business to Mastercard, which Nets expects to close by the end of the second quarter, will have a material impact on the longer-term sustainability of Nets' capital structure, in our opinion. In theory, the cash would allow Nets to repay more than 80% of its €3.5 billion gross debt (as of third-quarter 2019), but the amount of debt prepayment that will occur is unknown at this stage. We believe Nets' financial-sponsor owners will continue to pursue aggressive financial policies and maintain high leverage in the future. This, in our view, implies a high risk that a sizable chunk of the cash will be returned to shareholders. If we assume Nets undertakes debt repayments equal to about 50% of proceeds and our aforementioned operating assumptions hold, Nets' adjusted debt to EBITDA would still be 11x-13x in 2021, with adjusted FOCF to debt of 0%-2% (scenario 1), after leverage of greater than 25x in 2020. If Nets used 75% of proceeds to prepay debt, we forecast adjusted leverage would still be 8x-10x in 2021, with FOCF to debt somewhat stronger at 2%-4% (scenario 2). The absence of or more favorable performance for chargeback losses would affect our leverage projections for 2020, but not 2021 because we have not assumed any such loss beyond 2020.
Environmental, social, and governance (ESG) factors relevant to the rating action: 
  • Health and safety
  • Risk management and internal controls
The negative outlook reflects the risk that COVID-19 results in higher-than-expected cash burn for Nets, paired with the possibility of high shareholder distributions from the disposal proceeds, rendering the capital structure unsustainable in the long term.
We could lower the rating if Nets faced a more pronounced cash burn than we currently expect, preventing the company from returning to positive FOCF and EBITDA cash interest coverage of at least 1x from 2021, or causing unexpected liquidity issues. This could result from COVID-19 triggering higher chargeback losses or putting stronger pressure on revenue, potentially exacerbated by high transformation and integration costs. We could also lower the rating if Nets used the majority of the disposal proceeds for shareholder returns or acquisitions that do not materially enhance our view of the business, leading us to view the capital structure as unsustainable.
We could revise the outlook to stable if Nets successfully contained the effects of COVID-19 on its financial results, allowing the company to return to sustainably positive FOCF and EBITDA cash interest cover above 1x from 2021. In addition, we would require Nets to use a substantial portion of the disposal proceeds to prepay debt to ensure the long-term sustainability of the capital structure.
Although unlikely in the next 12 months, we could raise the rating if Nets successfully managed risks in its merchant customer base during the COVID-19 pandemic, reflected in limited chargeback losses, coupled with a more limited revenue impact than we currently forecast, and if it used the bulk of the disposal proceeds for debt repayment. This could lead to adjusted debt to EBITDA below 8x and FOCF to debt approaching 5% in 2021.
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