On Mar. 22, Standard & Poor's lowered its credit rating on Reader's Digest Association (RDA) to BB+, below investment grade status, from BBB-, following the company's agreement to acquire the assets of Reiman Publications LLC for $760 million in cash.
Reader's Digest Association, based in Pleasantville, NY, publishes one of the world's highest-circulating paid magazines and is a leading direct marketer of books, videos, and music. Total debt as of Dec. 31, 2001, was $216 million.
Standard & Poor's analyst Hal Diamond believes the purchase provides a good strategic fit and complements Reader's Digest's position in the highly-competitive magazine publishing and direct marketing industries. Potential operating synergies and cost saving opportunities have the potential to increase profitability and cash flow generation over the near term.
Over the long term, though, Standard & Poor's believes there are questions as to its growth prospects. The Reiman transaction would be the largest purchase in Reader's Digest's history, reflecting a shift from more moderate financial policies. The deal increases financial risk at a time when the profitability of the core U.S. magazine and books and home entertainment (BHE) businesses are weak, Diamond says.
The addition of Reiman improves operating and cash flow diversity. Reiman publishes 12 magazines oriented to the rural market, which rely on stable subscriptions for the about 95% of magazine revenue. Reiman has also leveraged its subscriber base through the publication and direct marketing of high-margin books that borrow content from its magazines. Over the near-term, Reiman can benefit from Reader's Digest's expertise in international distribution, newsstand and advertising sales. Reader's Digest can profit from Reiman's non-sweepstakes promotional expertise, content, and customer list.
However, in Standard & Poor's view, the demographic and lifestyle trends of the rural population may not offer significant long-term growth potential. Reader's Digest's core U.S. magazine and BHE direct marketing businesses, accounting for half of fiscal 2001 revenues, are underperfoming. Overall EBITDA declined 37% over the last three quarters ended Dec. 31, 2000, due to lower magazine advertising demand and increased testing of new subscription sources.
In addition, BHE profitability fell due to lower response rates resulting from the implementation of the 2000 multistate legal settlement on sweepstakes marketing. Reader's Digest's QSP (youth magazine subscription) and Books are Fun (school book fairs) subsidiaries and international operations provide some operating and geographic diversity.
The debt-financed transaction results in an increase in financial risk and lower pro forma interest coverages. EBITDA coverage of gross interest expense declines to a pro forma level of 4.3 times for the 12 months ended Dec. 31, 2001, from an actual level of about 10.0 times.
Standard Poor's expects acquisitions and share repurchases to remain minimal over the near term due to heightened debt levels and the company's operating challenges. Standard & Poor's also expects that Reader's Digest will use the majority of its free cash flow to reduce debt levels to restore flexibility. From Standard & Poor's RatingsDirect