TEXT-S&P rates Eastman Chemical notes 'BBB'

Tue May 29, 2012 2:20pm EDT

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 	
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