S&P Cuts Zuffa’s Credit Rating, Issues Negative Outlook

By Adam Swift Nov 28, 2007
Standard & Poor's, a leading financial services company, cut Zuffa's credit rating in a report issued Tuesday.

The downgrade from "BB" to "BB-" was the result of the company's weaker than expected performance in the third quarter of 2007. This marked "the second consecutive quarter of operating performance that was meaningfully below [S&P's] expectations."

The third-quarter results are more troubling than disappointing results in the second quarter. Zuffa's underperformance in the second quarter could be attributed largely to international expansion. For the third quarter, however, S&P reported "the company experienced a meaningful decline in [pay-per-view] buys, as compared to our expectation for continued strong growth."

Revenues from domestic pay-per-view events as a whole, including buys and gates, were down "at a low-single-digit rate" in the third quarter. In the second, pay-per-view buys -- Zuffa's key source of revenue -- had been up 35 percent.

The decline of the company's core pay-per-view business was especially worrisome to S&P.

"Given Zuffa's reliance on the UFC brand and lower growth prospects internationally, the company's ability to grow its core UFC operations is integral to maintaining the current rating," the report said. Moving forward, revenue and cash flow generation are expected to remain weak through the fourth quarter of 2007 based on Zuffa's revised guidance.

The new rating represents the company's "revenue and cash flow volatility given its primarily event-driven business model, vulnerability to changing consumer tastes, and relatively short operating history," the report stated. "These risks partly are offset by the company's well-recognized UFC brand, healthy free cash flow conversion, and modest expected debt leverage."

It should be noted that Zuffa remains profitable. The cut is the result of a failure to meet high expectations set for the company by S&P and apparently by the company itself. Zuffa continued its rapid expansion this year in anticipation of growth similar to last year. Instead, business has been flat to slightly down, forcing the company to tighten its belt.

Dave Meltzer recently reported in the Wrestling Observer Newsletter that there have been cutbacks across the board at the corporate headquarters. To make matters worse, the company has been forced to promote more shows with a tighter budget this year.

S&P also issued a negative outlook for the company's credit rating. A negative outlook in an S&P report on Sept. 14 preceded the current rate cut.

In explaining the negative view, S&P cited weaker-than-expected EBITDA generation -- EBITDA represents earnings before interest, taxes, depreciation and amortization -- due in large part to fewer pay-per-view buys and higher operating costs.

"The rating could be lowered further if in 2008, the UFC brand does not continue to gain momentum in the U.S. (as measured by PPV performance and ticket sales) or if Zuffa continues to report material losses in international markets," Thursday's report said. "Conversely, we would consider a stable outlook if the popularity of mixed martial arts events continues to grow, leading to meaningful revenue and earnings growth in the coming year."

Zuffa's total outstanding debt as of Sept. 30 is $325 million. It still has full availability on its $25 million revolving credit facility because of the company's strong cash flow. As a result of its limited capital expenditure requirements, the company's free cash flow conversion is expected to remain strong at greater than 50 percent of EBITDA.

S&P expects most of that surplus will be used to pay down debt. The report also noted that dividend payments to the owners -- Station Casino magnates Frank and Lorenzo Fertitta own 90 percent of Zuffa, and UFC president Dana White owns 10 percent -- will be increasingly limited due to the company's disappointing returns.

Adam Swift is the Editor of www.MMAPayout.com
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