Fitch Rates Cielo S.A.'s IDR and Proposed Notes 'BBB+'; Outlook Stable
Fitch Ratings has assigned the following ratings to Cielo S.A. (Cielo) and its subsidiary Cielo USA Inc.:
--Foreign currency Issuer Default Ratings (IDR) 'BBB+';
--Local currency IDR 'BBB+';
--Long-term national scale rating 'AAA(bra)'.
Cielo USA Inc.
--Foreign currency IDR 'BBB+';
--Proposed Senior unsecured notes 'BBB+'.
The Rating Outlook for the corporate ratings is Stable.
Cielo's investment grade ratings reflect the company's leading position in the Brazilian card payment industry and the strength and resilience of its business model, which is supported by the growing and predictable revenue stream from a diversified base of affiliated merchants. Cielo has a solid capital structure, liquidity position, and the ability to generate strong and resilient cash flow in its business.
Cielo's ratings also incorporate the low counterparty risks associated with the Brazilian banking system, as more than 95% of credit and debit transactions are settled with investment grade banks. The support and the strength of its controlling shareholders, Banco Bradesco S.A. (Bradesco) [rated 'AAA(bra)' National Scale; local currency IDR 'A-' and foreign currency IDR 'BBB+' by Fitch] and Banco do Brasil S.A. (Banco do Brasil) [rated 'AAA(bra)' National Scale; local and foreign currency IDR 'BBB' by Fitch] are also incorporated in the ratings. Cielo's ratings are not limited by the credit profile of one of its main shareholders, Banco do Brasil, as it divides the control of the company with Bradesco and its access to Cielo's cash flow is restricted to dividends.
The Brazilian card payment industry has high barriers to entry, which support Cielo's strong market position. Fitch views Cielo's business model as sustainable over the medium term, despite the highly competitive environment. Cielo's strong competitive advantage in the industry relies, among other factors, on the relationship and distribution network of four important banks in the Brazilian financial system.
Cielo USA Inc. is a wholly owned subsidiary of Cielo. The proposed senior unsecured notes of approximately USD750 million to USD1 billion are unconditionally and irrevocably guaranteed by Cielo. The use of proceeds are for debt refinancing and for general corporate purposes. The credit quality of Cielo and Cielo USA Inc. have been linked according to Fitch's 'Parent and Subsidiary Rating Linkage' criteria report dated Aug. 8, 2012.
Leading Position in the Brazilian Card Payment Industry:
Cielo is the leading company in the merchant acquiring and payment processing industry in Brazil and in Latin America. The company's estimated market share of 55% is based on the value of transactions with credit and debit cards. Currently, Cielo and Redecard account for more than 95% of the market and given the barriers to entry, Fitch does not expect a material reduction in its market share over the medium term. The penetration of credit and debit cards in Brazil is low, which supports Cielo's long-term growth prospects, and despite the more competitive environment; Cielo's strategy to preserve margins may result in a moderate reduction of market share in the short term.
Cielo affiliation with several of the leading banks in Brazil, gives it access to their broad customer base to acquire merchants accounts and creates high barriers to entry; approximately 60% of merchant accounts are established through affiliations with banks. Cielo has a strong competitive advantage, as the company relies on the strong relationship and distribution network of Banco do Brasil, Bradesco, HSBC and Caixa, with total branches of 13,266 (about 60% of the Brazilian banking system). Although Fitch does not expect a significant change in the Brazilian card payment industry in the short term, the uncertainties about the new entrants to the market and also possible new regulatory requirements will be closely monitored.
Low Risk of Credit Loss:
Cielo currently has virtually no direct credit exposure to cardholders, as the card-issuing bank guarantees cardholder's payment. The company is, however, exposed to card-issuing bank defaults on a payment settlement for Visa transactions. The licensing agreement with Mastercard mitigates this risk, as it guarantees the settlement of all transactions. The risk associated to Visa transactions is mitigated by the fact that more than 95% of the volume of credit and debit transactions is concentrated in investment grade banks. For non-investment grade banks, Cielo's prudent risk management policy requires the card-issuing bank to pledge collateral.
Historically, Cielo has reported very low credit losses. The company is exposed to merchants that accept cards processed by Cielo in terms of their performance, payment of the rental of the equipment, fraud, and losses due to customer charge-backs. Nonetheless, loss from transactions that result in fraud, charge-backs, cancellation of sales by merchants and default in the payment of the rental of equipment represented less than 1% of net revenues.
Low Liquidity Risk:
Cielo's liquidity is solid. As of Sept. 30, 2012, Cielo had cash and marketable securities of BRL393 million and the company has strong financial flexibility to quickly build up a cash cushion if necessary.
During the latest 12 months (LTM) ended September 2012, Cielo generated BRL3.7 billion of adjusted EBITDA, including financial income derived from the discounting and pre-payment of its receivables to its merchants, BRL2.4 billion in funds from operations (FFO) and BRL1.9 billion in cash flow from operations (CFFO). These results compare with BRL3 billion, BRL2 billion and BRL1.8 billion, respectively, in 2011.
High dividends and the company's acquisition strategy have pressured the company's free cash flow. In the LTM ended September 2012, investments totaled BRL1.4 billion and dividends totaled BRL1.4 billion. In July 2012, Cielo acquired a 100% participation in an American company, Merchant e-Solutions (MeS), for USD670 million (BRL1.365 billion), which was partially financed with debt. MeS should positively contribute to Cielo's growth strategy. Cielo has a minimum dividend distribution policy of 50% of net income and in 2011, the company distributed dividends of about 70% of net income.
Recurring and Growing Revenues:
Cielo's business model is stable, with a low correlation to economic cycles. The revenue growth is generally driven by the increasing migration to an electronic payment system from a cash system and increasing card payment penetration in Brazil. In the LTM ended September 2012, net revenues was BRL5,024 million, compared to BRL4,209 million in 2011, and does not include financial income from pre-payment of payables to merchants. Cielo processed volume of BRL316 billion of credit and debit card transactions in 2011, and BRL276 billion in the first nine months of 2012. In 2011, revenues from the rental of POS equipment equaled BRL1.1 billion and financial income from pre-payment/discounting of payables to merchants equaled BRL587 million and also contributed to growth. Strong customer diversification also supports the ratings.
Significant changes in the competitive landscape in the Brazilian card payment industry have occurred since July 2010 as the market opened up to competition, which has pressured Cielo's operating margins. In the LTM ended September 2012, adjusted EBITDA margin was 63.5%, compared to 67.2% in 2010. Fitch does not expect a significant reduction in net merchant discount rate (MDR) and adjusted EBITDA margins should remain around 63% over the near term.
Leverage to Remain Low:
Cielo's leverage is low. As of Sept. 30, 2012, total debt was BRL1,121 million, composed of a bridge loan of USD400 million to finance the MeS acquisition and FINAME loans of BRL310 million to finance the purchase of POS equipment. In the LTM ended September 2012, total debt to adjusted EBITDA ratio was 0.3x, compared to 0.1x in 2011. Leverage should increase to about 0.6x following the proposed issuance of approximately USD750 million to USD1 billion; leverage is not expected to materially change over the next few years. The proceeds will used to repay the bridge loan issued to finance MeS acquisition, and for future working capital needs.
Potential Rating or Outlook Drivers:
Ratings upgrades are not likely in the short to medium term. Cielo's IDRs are already positioned at the same level of Brazil's country ceiling of 'BBB+'. Ratings downgrades would most likely be driven by an increase in the volume of credit and debit transactions with non-investment grade banks or not guaranteed by Mastercard; by a weakening credit profile of the main banks that operate with Cielo; and/or by a significant loss due to fraud and charge-backs. Factors that could lead to consideration of a Negative Outlook or downgrade also include effects on the business caused by the competitive environment and significant changes in the regulatory risk.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'National Ratings Criteria' (Jan. 19, 2011);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
National Ratings Criteria
Parent and Subsidiary Rating Linkage
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