DBRS Finalizes Rating of BBB (high) on Teranet Holdings LP

DBRS has today finalized the provisional rating of BBB (high) with a Stable trend on the $1,575 million of senior secured debt issued by Teranet Holdings LP (the Issuer), the financing vehicle unconditionally guaranteed by Teranet Inc. (Teranet or the Company). The issued debt included $475 million of five-year bonds, $450 million of ten-year bonds, $450 million of 30-year bonds and $200 million of 20-year real return bonds. The rating reflects the fact that Teranet owns the Province of Ontario’s (the Province or Ontario) electronic land registry system (ELRS) and has the exclusive right to access the data in and operate the ELRS. It also owns the electronic writs system (the Writs System) in Ontario and has the exclusive right to access the data in and provide electronic searches of the Writs System. Both the ELRS and the Writs System are considered to be essential services. The business generates strong and resilient cash flow based on long-term growth in volume, stable fees and high margins. That said, the registration activity rate, which is highly correlated with the economy, influences revenue and contributes some cyclicality to overall results. Furthermore, while the extension transaction with the Province provides that fees for essential services will be increased by 50% of the consumer price index (CPI) beginning in 2015, the Company’s limited fee-setting autonomy combined with its relatively heavy debt burden limit its financial flexibility somewhat. Nonetheless, Teranet is inherently a very strong free cash flow generating business, with high levels of EBITDA and very low capex requirements.

In November 2010, Borealis Infrastructure (Borealis), Services Ontario and the Ontario Financing Authority finalized a contract by which Teranet will make a payment of approximately $1 billion to the Province for an extended term of exclusivity until March 2067, compared with the previous expiry of March 31, 2017. Fee increases in respect of certain property search services currently performed at $8 and $18 will be increased under the new licence agreement in late 2015, such that all search fees will be harmonized at $28. In addition, the new agreement includes an increase to most fees in 2015 (50% cumulative CPI) with annual increases thereafter (50% of CPI), which provides a partial hedge against inflation and more than covers Teranet’s operating costs, which are currently forecast to be in the 25%-of-revenue range. The agreement also includes royalty payments to the Province that vary with the Registration Activity Rate (RAR) beginning in 2017. In addition to the $1,575 million of debt just issued, Teranet Holdings LP intends to raise approximately $525 million of long-term debt over the next 12 months, and $426 million of additional equity from Borealis (its sole shareholder) to complete the financing for the payment to the Province and harmonized sales tax (HST) thereon, repayment of previously held debt and transaction costs.

Teranet’s revenues increased from approximately $190 million in 2004 to $250 million in 2009, while adjusted EBITDA grew from $89 million (based on March 31 year-end in 2005) to $196 million as the Company increased the number of electronic properties on which it could earn revenue. With the conversion of properties 99.9% complete, a static fee schedule combined with modest parcel growth and RAR assumptions should lead to continued slowed growth in revenue and EBITDA from 2010 to 2015. DBRS’s base case assumption of $100 million to $105 million for annual interest expense in the first few years after recapitalization, should result in a debt service coverage ratio (DSCR) of approximately 1.85 times (x) in 2011, assuming $2.1 billion in debt (of which $200 million are real return bonds), with the ratio improving to above 2.0x by 2015.

Going forward, Teranet is assuming that parcel growth will vary between 1.6% and 1.8% (compared with the last 37-year average of 2.3%), and RAR will increase gradually to a long-term average of 37% (compared with the last 37-year average of 40.1%). Operating margins should also benefit from growth over time as the cost base is largely fixed and Teranet has ambitions to pursue opportunities in core (ESR) and value-added services (VAS) businesses. DBRS is assuming that VAS (including the Geowarehouse and Purview labels) revenues will grow in line with inflation while Do Process, out-of-province VAS growth and ESR businesses will be conducted in separate legal entities and are excluded from DBRS’s analysis.

DBRS believes that these assumptions will lead to base case operating results that should enable Teranet to maintain average EBITDA-to-interest expense of approximately 2.0x over the long run. However, the cyclicality of RAR will create some volatility in operating results that will likely cause the coverage ratio to fluctuate between 1.7x and 2.3x through economic cycles. In terms of financial profile, DBRS estimates that Teranet will generate cash flow from operations of approximately $75 million in 2011 and expects this level to grow steadily over time. Annual capex is expected to be low going forward, as 99.9% of the Company’s Implementation Project was completed as of the end of 2009. That said, DBRS expects that Teranet will return most of its free cash flow to shareholders on a regular basis and keep debt levels steady, although debt-to-EBITDA should improve gradually over the years as EBITDA grows steadily.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Canadian Public-Private Partnerships, which can be found on our website under Methodologies.