TEXT-S&P rates Eastman Chemical notes 'BBB'
May 29 - Overview -- U.S.-based diversified chemical producer Eastman Chemical Co. plans to issue approximately $2.3 billion of senior unsecured notes to partly finance its planned acquisition of U.S.-based specialty chemical maker Solutia Inc. -- We are assigning a 'BBB' to the new notes. -- All our other ratings on Eastman, including the 'BBB' corporate credit rating, remain unchanged. -- The stable outlook reflects our belief in Eastman's ability and intent to strengthen its financial profile to levels appropriate for the ratings within two years. Rating Action On May 29, 2012, Standard & Poor's Ratings Services assigned its 'BBB' senior unsecured debt rating to Eastman Chemical Co.'s proposed offering of approximately $2.3 billion of senior unsecured notes with five-, 10-, and 30-year maturities. The company plans to use the proceeds, along with proceeds from a $1.2 billion five-year unsecured term loan, up to 15.8 million shares of Eastman common stock (valued at about $780 million at the current share price), and cash on hand to finance its approximately $5 billion acquisition of Solutia Inc. (BB/Watch Pos/--). This amount includes funds to refinance Solutia's outstanding debt and estimated transaction costs. The parties expect the transaction, which is subject to Solutia shareholder approval and customary closing conditions, to close by mid-2012. All our other ratings on Eastman, including the 'BBB' corporate credit rating, remain unchanged. The outlook is stable. Rationale The acquisition of Solutia would strengthen Eastman's business risk profile to "strong" from "satisfactory." The purchase, the price of which represents about 10x Solutia's last-12-month EBITDA (excluding expected cost and tax benefits), would add a substantial specialty chemical business with high and relatively stable operating margins to Eastman's portfolio. We believe it should enhance Eastman's competitive position by adding some complementary technologies and accelerating access to high-growth markets, particularly in Asia. We also believe that it would improve manufacturing site, product, geographic, and end-market diversity. Moreover, Eastman should benefit from increased overall size and scale, and lower capital intensity. Finally, the acquisition appears to offer the opportunity for meaningful tax and cost synergies. The integration has a high probability of success given Eastman's experienced management team and recent track record with smaller transactions and because its plans do not call for major operational restructuring. Solutia's businesses consist of: -- Technical Specialties (43% of 2011 revenues) includes insoluble sulfur (a vulcanizing agent for tires), heat-transfer fluids, aviation hydraulic fluids, and rubber chemicals; -- Advanced Interlayers (43%) includes PVB (polyvinyl butyral) interlayers and resins (the former increase the functionality of glass by enhancing strength, flexibility, and safety); and -- Performance Films (14%) includes specialty films for use in windows, touch screens, and handheld electronic devices. Eastman's primary products include: -- Acetate fibers used in cigarette filters and other filters and textiles; -- Coatings, additives, solvents, and resins used in paints and adhesives; -- Performance chemicals and intermediates used in a wide variety of applications; and -- Specialty plastics. Although Eastman's operating profitability remains subject to industry cyclicality and raw material cost swings, in recent years management has increased the level and stability of operating profits through various actions including acquisitions and divestitures, new product development, product line extensions, and raw material sourcing. The acquisition of Solutia should further increase margins and enhance stability. As a result, we expect Eastman's operating profitability to become more typical of a specialty, rather than commodity, chemical producer, with EBITDA margins averaging about 20%. Although the cost of the acquisition initially depresses return on capital somewhat, we think pretax return on capital is likely to gradually strengthen from approximately 15%, pro forma for the acquisition. Despite these credit strengths, the transaction increases debt leverage and weakens cash flow protection measures. Following the transaction, we expect debt (which we adjust to include unfunded postretirement and environmental liabilities and capitalized operating leases) to total about $6.6 billion, and pro forma debt to EBITDA (before synergies) to be about 3.5x. However, the improved business risk assessment, coupled with the issuance of about $780 million of equity (at Eastman's current share price) and the use of $500 million to $600 million in cash on hand to partially finance the transaction, is sufficient to maintain the ratings and outlook. The company's cash-generating ability and our expectation that management will make debt reduction a high priority in the years immediately following the acquisition are critical to maintaining the ratings. One year following the acquisition, we expect the ratio of funds from operations (FFO) to total adjusted debt to be in the low-20% area, and we expect this ratio to strengthen to about 25% by the end of year two. Given Eastman's strong business risk profile following the transaction, we expect this ratio to be 25% to 30% after those two years. We continue to view Eastman's financial policy as moderate. In addition to management's commitment to credit quality, we factor in its track record of prudent financial policies. These include substantial actions to conserve cash during the 2008-2009 recession and the strengthening of the financial profile in advance of the Solutia acquisition beyond what is required for the current ratings. Liquidity We regard Eastman's liquidity as "adequate" (as defined by our criteria). At closing of the Solutia acquisition, we expect Eastman's liquidity to consist primarily of full or nearly full availability under its $750 million revolving credit facility maturing in 2016 and a $250 million accounts receivable securitization program maturing in 2015. Headroom under the 3.5x maximum debt to EBITDA covenant in the company's credit facilities will decline but remain adequate, in our view. By the second year following the transaction, we expect Eastman to generate more than $400 million of annual discretionary cash flow. This is after midsize pension contributions, meaningful investment in working capital to support sales growth, capital spending we estimate will average roughly $600 million in each of the next few years, and dividends that could increase modestly from a pro forma level of about $160 million. Until credit measures have strengthened to the appropriate levels for the ratings, we expect Eastman to direct discretionary cash flow primarily to debt reduction, including term loan amortization and scheduled note maturities in 2015. Outlook The stable outlook reflects moderate financial policies that should support our investment-grade ratings on the company. In the years immediately following Eastman's acquisition of Solutia, we expect share repurchases to be minimal and additional debt-financed acquisitions to be very limited. Credit measures should meet our expectations even in the face of only modest global economic growth this year. Nevertheless, we could lower the ratings if FFO to total adjusted debt were to drop below 20% with limited near-term prospects for recovery. We believe this could occur if revenue growth slowed to 1.5% from expected pro forma 2012 levels and EBITDA margins dropped to about 17% from roughly 20%. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Key Credit Factors: Business And Financial Risks In The Commodity And Specialty Chemical Industry, Nov. 20, 2008 Ratings List Eastman Chemical Co. Corporate Credit Rating BBB/Stable/A-2 New Rating Eastman Chemical Co. Senior Unsecured notes due 2017 BBB Senior Unsecured notes due 2022 BBB Senior Unsecured notes due 2042 BBB Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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