Fitch Ratings has revised the Outlook on eDreams ODIGEO S.A.'s (eDreams) Issuer Default Rating (IDR) to Positive from Stable, and affirmed the IDR at 'B'. Fitch has also upgraded the company's senior secured rating to 'B' from 'B-' and revised the Recovery Rating to 'RR4' from 'RR5'.

The Positive Outlook reflects eDreams' deleveraging and strong operating performance, confirming the company is on track to deliver on its targets for the fiscal year ending March 2025 (FY25). We believe the company's credit profile will be consistent with a 'B+' rating if it continues the successful implementation of its subscription-based model and further reduces its leverage.

The 'B' rating continues to reflect eDreams' good brand recognition in Europe and positive free cash flow (FCF) generation, balanced by its small scale, concentration on flight ticket sales and higher business profile risk than other subscription-based businesses.

Key Rating Drivers

Software Development Costs Expensed: We believe that eDreams' credit profile needs to be assessed considering an EBITDA adjustment for capex, which is related to capitalisation of internally-developed software and mostly consists of personnel costs. These expenses are aimed at improving eDreams' online platform to further drive business growth. We adjusted EBITDA by treating 80% of capex as operating expenses.

Strong Performance: eDreams outperformed our rating case in FY23, with Fitch-adjusted EBITDA reaching EUR54 million, and we project EBITDA of around EUR80 million for FY24. This includes the adjustment for costs of internally developed software and deferred revenue from the prime business (FY23: EUR51 million), which we reclassify from changes in working capital to better align EBITDA with cash generation. We project EBITDA margins to improve further in FY24 as the share of the more profitable prime business increases, while the number of subscribers that stay with the company for two or more years also grows.

Sector Recovery Continues: eDreams' performance benefited from the change in the business model and the post-pandemic recovery in travel and we believe that sector fundamentals remain supportive for the business in 2024. Fitch expects EMEA air travel volumes to increase by around 9% in 2024, fully recovering to 2019 levels, and then grow at 3%-5% per year. eDreams' business is not prone to inflationary pressures, with personnel costs the only cost item that is subject to inflation.

Execution Risks from Transitioning Strategy: eDreams has made significant progress in its business model transition into the first subscription model for the travel industry, with 5.1 million prime members as of end-2QFY24. However, the company's product offer and travellers' response to this proposition are still evolving and we see execution risks in its strategy to increase market penetration and maintain the pace of net new subscriber additions as churn rates are high.

'B' Category Business Profile: We view eDreams' business profile as in line with the 'B' category. This considers its relatively small business scale (measured by EBITDA) and concentration on flight ticket sales, balanced by its brand recognition in Europe and limited exposure to price movements of fares or hotel rates. We also believe that eDreams' subscription model is riskier than other rated subscription-based businesses, for instance gym operators, given higher customer churn rates and less mature business model. This limits eDreams' debt capacity compared with similarly-rated peers.

Fast Deleveraging: We expect eDreams' EBITDA leverage to fell to 4.9x in FY24 (FY23: 7.1x), before dropping below 4x in FY25, well below our positive rating sensitivity for an upgrade to 'B+'. We believe the company may continue deleveraging in FY26-FY27, if it manages to maintain its new subscriber additions at a similar pace and does not materially allocate its capital to shareholder remuneration or bolt-on M&A. Clarity of the company's targets beyond FY25 will be important to determine the leverage profile in FY26-FY27.

Cash-Generative Business Model: eDreams operates an asset-light business model with a majority of its costs being variable and mostly consisting of customer acquisition, merchant, IT and call centre costs. The business also has limited capex requirements, resulting in positive FCF generation, which favourably differentiates eDreams from other 'B'-rated peers. We project eDreams will sustain positive FCF over the medium term, assuming a continued growth in the prime business and neutral changes in working capital (after adjusting for deferred prime revenue).

Strong Positioning in Competitive Market: The global online travel agent market is characterised by low switching costs and intense competition from bigger and more diversified operators, metasearch sites and the direct channels of airlines and hotels, making industry players more vulnerable to higher customer acquisition costs and rates of churn.

However, the highly fragmented travel industry in Europe continues to favour the use of intermediators and online-based players are enjoying increasing penetration. The fully online model of eDreams, with well-developed mobile channels and different web-based brands, is a competitive advantage.

Derivation Summary

eDreams lags global online travel agents Expedia Group, Inc. (BBB-/Positive) and Booking.com in terms of scale, geographic diversification, market penetration and diversification of offer across hotels, flights, cars and insurance. Expedia also has higher EBITDA margins than eDreams and lower leverage and benefits from ample liquidity and stronger financial flexibility.

Compared with other-subscription-based businesses, such as gym operators, eDreams bears higher business risk in view of its less sticky customer based and more discretionary product. Fitch rates eDreams at the same level as Deuce Midco Limited (B/ Stable), which operates gyms under the David Lloyd brand in the UK, despite it having lower leverage. eDreams is rated one notch higher than UK gym operator Pinnacle Bidco plc (B-/ Stable) due to a more conservative financial structure and better FCF profile.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Revenue from non-prime business reducing to around 20% of total revenue by FY27

Addition of 1.4 million new prime subscribers in FY24

No deterioration in churn rates and increasing share of subscribers that stay with the company for two and more years

Stable working capital (after adjusting for changes in deferred prime revenue)

Fixed costs at EUR95million-115 million a year (excluding personnel costs that Fitch reclassifies from capex)

Capex of around EUR50 million a year, out of which 80% is expensed, reducing Fitch-adjusted EBITDA

No bolt-on M&A

No dividend distributions

Recovery Analysis

KEY RECOVERY RATING ASSUMPTIONS

eDreams would be considered a going concern in bankruptcy and would be reorganised rather than liquidated; we have assumed a 10% administrative claim in the recovery analysis.

Fitch assumes a going concern EBITDA of EUR70 million, which we believe should be sustainable post-restructuring. This implies EUR6 million uplift from our previous estimate, given higher and more stable earnings base, with maturity business profile and prime subscriber base.

We assume a 5.0x distressed enterprise value-to-EBITDA. The distressed multiple reflects a weaker competitive position than global leaders and represents around 50% discount to the current trading multiple.

These assumptions result in a distressed enterprise value of about EUR350 million.

Based on the payment waterfall, we have assumed the group's EUR180 million revolving credit facility (RCF) to be fully drawn and ranking senior to its senior secured debt. Our waterfall analysis generates a ranked recovery for its senior secured notes in the 'RR4' band, indicating a 'B' instrument rating, in line with eDreams' IDR. The waterfall analysis output percentage on current metrics and assumptions is 36% for the EUR375 million senior secured notes.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Successful transition to a subscription model, reflected in stable or decreasing churn rates of prime members and sustained profitability improvements

EBITDA leverage below 4.5x on a sustained basis, supported by a consistent financial policy

FCF margin in the mid- to high- single digits

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Increasing churn rates or diminishing share of prime subscribers that have been with the company for two and more years

EBITDA leverage above 6x on a sustained basis

Increased volatility in profitability

Liquidity deterioration, leading to cash drawings under the RCF

Liquidity and Debt Structure

Satisfactory Liquidity: As of end-September 2023, eDreams had EUR66.5 million of reported cash and EUR163.5 million available for cash drawings under its EUR180 million revolving credit facility (RCF). We project positive FCF will contribute to cash build-up over the next four years as there are no near-term debt maturities. eDreams' RCF matures in January 2027 and the senior secured notes are due in July 2027.

Issuer Profile

eDreams is the world's leading travel subscription platform and one of the largest e-commerce businesses in Europe.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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