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QVC taps the market after hiatus

| January 31, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

After a roughly six-year hiatus from the new issue market, split rated QVCN (Ba2/BBB-/BBB-) took advantage of the lower rate environment and strong investor demand to tap the market for $575 million. The deal was heavily oversubscribed and came 25 bp tighter than initial price talk. With the new deal trading roughly a point higher from new issue, the bonds still look attractive relative to its existing 4.85% 4/1/24 bonds.

The notes, as with the company’s existing secured debt and credit facilities, are secured by a first-priority lien on the capital stock of QVC. As with its last issuance back in 2014, proceeds from the deal will be used to repay a portion of its credit facility, making it a leverage neutral transaction. As of 9/30/19, QVCN had $1.78 billion outstanding under its combined $3.65 billion facilities. QVCN uses the facilities for working capital needs, the repayment of debt and the payment of dividends to its parent, Qurate Retail, Inc. (QRTEA).

Initial price talk of 5% for a seven year deal was attractive enough for book to be oversubscribed by nearly four times, leading QVCN to upsize the deal by $75 million, and price the deal 25 bp tighter from IPT.  QVCN’s 2024 to 2027 curve is worth roughly 80 bp g-spread, which is essentially in line with the US Corporate BB curve and not giving QVCN any credit for its two IG ratings (Exhibit 1). Furthermore, QVCN’s curve is roughly 30 bp steeper than other split rated credits including Seagate Technology PLC (STX – Baa3/BB+/BBB-).

Exhibit 1: QVCN and STX curves

Source: Bloomberg, Amherst Pierpont Securities

Reiterated Commitment to 2.5x Leverage

QVCN has long managed its leverage, as defined by its credit agreement, to the 2.5x area.  As of 9/30/19, QVCN’s leverage was 2.3x, which we note was flat sequentially.  The maximum leverage allowed under the existing credit facilities is 3.5x. The tick up in leverage from the low witnessed in 4Q18 is primarily due to slightly weaker OIBDA.  Management reiterated its commitment to the 2.5x leverage ratio on its most recent earnings call after being questioned about increasing shareholder remuneration at the parent level.  In light of recent stock performance, management is likely to be more opportunistic when considering share repurchases versus looking at repurchases from an absolute level.  Year to date, QRTEA equity is up 4.86%, ahead of index performance.

Exhibit 2: QVCN leverage ratio (1Q17 – 3Q19)

Source: QVCN company reports, Amherst Pierpont Securities

High Free Cash Flow Conversion

Given the low capital intensity associated with QVCN’s business, the company’s free cash flow conversion is much higher than other retail peers. On an LTM basis, QVCN’s OIBDA to free cash flow conversion was 45%.  (OIBDA is a QVCN’s version of EBITDA).  This compares favorably to investment grade department store peers Macy’s and Kohl’s, whose EBITDA to cash flow conversions are 26% and 36%, respectively. QVCN has noted that its free cash flow conversion is set to increase as capital expenditures begin to moderate to more normalized run rate levels. Increased capital spending is attributable to its initiatives surrounding optimization of its U.S. fulfillment network coupled with IT and commerce platform investments.  On an LTM basis, capital expenditures were 13% of OIBDA.  QVCN’s run rate is closer to the 10%-11% area.

Loyal Customer Base

Approximately 87% of QVCN’s sales are derived from existing customers.  Importantly, retention rates of existing customers are very high, 90% at QVC and 86% at HSN.  On an LTM basis, QVCN saw the number of purchases per year of existing customers remain flat, with average selling price per purchase down slightly by 1%.  Additionally, QVCN noted that new customers, who represent 7% of sales, were up a strong 5% over the last twelve months.  3Q19 marked QVC’s ninth consecutive quarter of positive or flat new customer growth and HSN’s second consecutive quarter.

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