Clouds Gather ‘Round Internet Marketing Co.

Several issues including too much debt and a duo of reputation-damaging lawsuits are kneecapping an internet services company backed by One Equity Partners and other investors.

Vertrue Inc. and its subsidiaries offer members savings opportunities, membership rewards and other benefits for shopping and entertainment. One Equity, Brencourt Advisors LLC, Oak Investment Partners and Rho Ventures led an $800 million buyout of the company in 2007.

The company’s revenues fell 17 percent in the first half of the year due to a declining member base, according to Moody’s Investors Service, which recently downgraded the company’s debt ratings. By June 2012, an agreement with lenders not to let its total leverage exceed 6.75x its EBITDA will take effect, though Moody’s expects the company’s total leverage to exceed 7x EBITDA by the end of this year. The company has also exhausted a $30 million revolving line of credit.

“Given the recent earnings decline and resulting increase in financial leverage, Moody’s believes Vertrue’s capital structure may be unsustainable,” analyst Suzanne Wingo wrote in a report detailing the downgrade.

The company is losing members in part because of two lawsuits that have damaged its brand, Wingo told Buyouts. As of June 30, the company reported $16 million of cash on its balance sheet, most of which it needs to run daily operations, according to Moody’s.

In one case, a court in Iowa recently ordered the company to pay more than $30 million for using deceptive practices to market club memberships in the largest consumer protection verdict ever awarded in that state, according to the office of Iowa’s attorney general. For example, the company would lure customers to take a trial membership in exchange for $25 gift cards or other premiums, then set up obstacles designed to delay efforts to redeem the premiums. The company also recently settled a class action lawsuit against it in Tennessee alleging it enrolled consumers in its membership programs and charged monthly fees to their debit cards without their written approval.

The company is also losing members because it has cut back its spending on marketing critical to attain and retain them. On this topic, Moody’s portrays the company in a damned-if-you-do, damned-if-you-don’t predicament: The ratings agency doesn’t expect free cash flow to turn positive in the near-term unless the company continues to reduce its spending on marketing; however, further reductions in spending on marketing will hurt future revenues and medium-term earnings and cash flow.

Vertrue’s revenues were approximately $546 million for the 12 months ending June 30, according to Moody’s.

Moody’s downgraded the company’s corporate family and probability of default ratings to ‘Caa2’ from ‘B3.’ It also downgraded its $30 million first lien revolver and term loan to ‘B3’ from ‘B1’ and its $200 million second lien term loan to ‘Caa3’ from ‘Caa2.’ An upgrade is unlikely in the near-term, the ratings agency said.

One Equity manages $11 billion of investments and commitments for JPMorgan Chase & Co. The firm, currently investing from $3 billion fourth fund, typically invests around $50 million to $50 million per transaction.

Executives from One Equity declined to comment. Executives from Brencourt, Rho Capital and Oak Investment either did not respond to a request for comment or could not be reached.