Fitch Ratings has assigned the following ratings to Arcos Dorados B.V. (Arcos):
--Foreign currency Issuer Default Rating (IDR) ''BBB-'';
--Local currency IDR ''BBB-'';
--$450 million senior unsecured proposed notes due 2019 ''BBB-''.
The notes will be issued by Arcos and guaranteed jointly and severally, unconditionally and irrevocably by all relevant subsidiaries. The proceeds of the transaction will be used to repay existing debt. The Rating Outlook is Stable.
Arcos is the largest franchisee of McDonald''s in the world, in terms of system-wide sales and restaurants. The company purchased the Latin American operations of McDonald''s in August 2007 by signing a Master Franchise Agreement (MFA) for 20 years (renewable). The MFA sets strict strategic, commercial and financial guidelines for the operation of Arcos, which help support operating and financial aspects of the business as well as the underlying value of the McDonald''s brand in the region. Arcos'' management is experienced and has a long history of managing McDonald''s franchises in the region and is equipped to adequately comply with the terms of the MFA.
Conservative Leverage, Diversified Cash Flow, Adequate Liquidity:
Leverage is low, and the majority of the cash flow generation is concentrated in investment grade countries. For the latest twelve months (LTM) ended June 30, 2009, Arcos had a total debt-to-EBITDA ratio of 1.7 times (x) and a lease adjusted total debt-to-EBITDAR ratio of 3.3x. Lease adjusted debt was calculated with a weighted average multiple for the countries in which it has operations of 6.5x. Under a conservative scenario, Fitch expects maximum total debt-to-EBITDA to be 2.4x and maximum lease adjusted net debt-to-EBITDAR to climb to 3.5x. Annual debt service going forward has been estimated at approximately $70 million.
Free cash flow calculated after capital expenditures and dividends from the Brazilian component alone would cover debt service by more than 1.0x. Arcos had $70 million of cash and marketable securities and short-term debt of $44 million as of June 2009. The issuance of the $450 million notes will be used to repay existing debt with the exception of $50 million which will be kept as a liquidity buffer at the holding company.
Arcos has an aggressive expansion plan. While this could be a concern under the current macroeconomic environment, Arcos has the flexibility to reduce capital expenditures to minimum levels set under the MFA, as minimum capital expenditure requirements are defined over a three-year period. Arcos'' management intends to maintain leverage below 2.5x and will likely need to manage capital expenditures to comply with this target.
Strength of the McDonald''s Franchise:
The ratings also incorporate the strength of McDonald''s as franchisor and its long standing relationship with Arcos'' owners and management. The controlling shareholder of Arcos was the joint venture partner of McDonald''s in Argentina for over 20 years and served as President of the McDonald''s South America division from 2004 until the acquisition. On average, the management team has worked for over 12 years at McDonald''s.
Venezuela a Concern; Mexican Operations Offer Upside:
Venezuela accounted for 31% of Arcos'' EBITDA as of the LTM ended June 30, 2009, a decline from 34% in 2008. In Venezuela, the official exchange rate is established by the Central Bank, subject to a process of approval by the CADIVI. Such approval has become less forthcoming over time; thus companies rely on ''permuta'' operations through the trading of Venezuelan bonds, to pay for imports and other foreign commitments. The gap between the official exchange rate and the ''permuta'' rate has broadened. This has negatively affected Arcos'' Venezuelan operations. Political risk is also high due to the government''s nationalization of many companies in the country.
The performance of the company''s operations in Mexico has been poor and could provide upside to offset declining profitability in Venezuela. During 2008, Mexico represented 8% of the company''s consolidated sales but accounted for only 1% of EBITDA. Profit margins in Mexico are the lowest in Latin America. Arcos is working to turn around these results by recovering some franchised restaurants and redefining the marketing strategy. Mexico is the second most active country in terms of expansion plans (new openings) after Brazil.
Proposed $450 Million Unsecured Notes Due 2019:
The proposed notes will be issued at the holding company level, and all relevant operating subsidiaries will guarantee the debt, which reduces structural subordination risks. Cash is managed by the holding company. Cash is transferred to the holding company either through dividends, capital reductions or intercompany loans. In terms of liquidity management, Arcos intends to maintain $35 million at operating companies and at least 1.0x the next debt service requirement at the holding company at all times.
The proposed notes have a bullet maturity and include an additional debt covenant (Net Debt-to-EBITDA not to exceed 2.5x), limitations on restrictive sales, liens and assets sales, and a change of control triggering event. Upon change of control each holder will have the right to require the repayment of all or portion of the notes at 101%. As of today, Arcos'' real estate value independent estimations exceed $900 million, covering the proposed notes by more than two times.
Under the terms of the MFA, McDonald''s has a call option to repurchase its assets in the region under certain events. Terms of the notes specify that these funds should be applied to debt repayment. The call option price is set as the fair market value of all assets of the operating companies (80% in the case of a material breach), minus debt at operating company and contingencies, plus cash. The MFA requires all group companies to remain current on their financial obligations to avoid a material breach of the agreement.
Potential Rating and Outlook Drivers:
Fitch expects total debt-to-EBITDA to remain around 2.5x during 2009 and to decline thereafter. Arcos'' management is intent on maintaining a conservative leverage structure despite aggressive capital expenditures plan. Any change in this objective could lead to a rating downgrade.
Additional factors that could lead to a consideration of a Negative Outlook or a downgrade include: (I) a material adverse action by the Venezuelan government; (II) weaker than expected recovery in Mexico''s performance; (III) higher than expected deterioration of same store sales; (IV) failure to comply with the terms of the Master Franchise Agreement.
Other credit concerns include: (I) potential transfer and convertibility issues from Argentina and Venezuela (estimated at approximately 13% and 20% of consolidated EBITDA in 2009); (II) global macroeconomic slowdown could pressure consumers'' discretionary spending. Fitch estimates a 2% drop in sales for 2009 (2008 same store sales showed a 20% increase); and (III) exposure to currency mismatch and commodity prices (partially counterbalanced by currency swap and long-term agreements with suppliers).
Arcos operates more than 1,600 McDonald''s restaurants in 19 countries in Latin America with a dominant 10% market share that almost triples that of its closer competitor. Five countries account for above 85% of Arcos'' consolidated sales: Brazil, Venezuela, Argentina, Mexico and Puerto Rico. The company had $396 million of total debt as of June 30, 2009; during the LTM ended in June the company generated $236 million of EBITDA. Brazil is expected to account for approximately 65% of consolidated EBITDA during 2009.
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Contacts:
Fitch Ratings
Gabriela Catri, +54 11 5235 8129 (Buenos Aires)
Marcos
Barbosa, +55 11 4504 2202 (Sao Paulo)
or
Cindy Stoller,
+1-212-908-0526
(Media Relations, New York)
cindy.stoller@fitchratings.com
