TEXT-S&P affirms Cabot Corp 'BBB+' rating
Overview -- U.S.-based chemical company Cabot Corp. plans to raise $600 million in unsecured notes to partly fund its $1.1 billion acquisition of Norit N.V., the parent company of Norit Holding B.V. -- We are assigning our 'BBB+' issue rating to the company's proposed notes, affirming our ratings on Cabot Corp., including the 'BBB+' corporate credit rating, and removing all ratings from CreditWatch with negative implications. -- Our ratings on Norit Holding B.V., including the 'B+' corporate credit rating, remain on CreditWatch with positive implications pending the close of the acquisition. -- The negative outlook on Cabot reflects the risk that an unexpected slowdown in operating performance and integration-related challenges could constrain expected improvement to the company's leverage-related credit metrics. Rating Action On July 9, 2012, Standard & Poor's Ratings Services affirmed its ratings on Cabot Corp., including its 'BBB+' corporate credit rating. The outlook is negative. We are removing the ratings from CreditWatch, where we placed them with negative implications on June 21, 2012, following Cabot's announcement of its plans to acquire Norit N.V., the parent company of Norit Holding B.V. (B+/Watch Pos/--) for $1.1 billion. At the same time, we are assigning our 'BBB+' issue ratings to the company's proposed $600 million in unsecured notes, consisting of two series of notes of $300 million each. The company plans to use the notes, along with $250 million in drawings under a revolving credit facility and $250 million of cash, to fund the acquisition. We expect the acquisition to close in fiscal-year 2012, ending Sept. 30. Our ratings on Norit Holding B.V., including the 'B+' corporate credit rating, remain on CreditWatch with positive implications. Rationale The ratings on Cabot reflect the company's "satisfactory" business risk profile and "intermediate" financial risk profile as a leading global player in a largely commodity product category. Our view is that the acquisition strengthens aspects of the business risk profile, albeit only modestly so that the overall business risk profile remains satisfactory. We also believe that the largely debt-funded acquisition ($850 million in debt and $250 million in cash on the balance sheet) weakens the financial risk profile somewhat, but we assume that improvements to operating performance and management's commitment to maintaining credit quality at the current rating will drive improvements to leverage-related credit metrics so that they strengthen to levels appropriate for the ratings in the next 12 to 24 months. Cabot is a global leader in the carbon black segment with considerable geographic diversity--about 80% of sales are from outside the U.S. It is the most geographically diversified major carbon black producer and is well-positioned to benefit from a global increase in carbon black consumption. To benefit from rapidly growing emerging markets, Cabot announced in 2011 that it will invest to expand capacity in China, Indonesia, and South America through 2013. The company also invests in research to boost new product development as a means of increasing the proportion of higher-value-added applications in its products. Given the unrelated nature of Norit's products and markets, we do not expect the acquisition to provide any meaningful benefits to the company's cost or market position in its existing commodity businesses. However, we do expect the acquisition to accelerate its strategic objectives, especially those related to increasing the proportion of value-added products in the overall business mix and providing a measure of diversity in revenue and earnings streams. The company's EBITDA margins have been 13% to 16% in the recent past, except during the economic downturn in 2008 and 2009 when margins declined sharply. We expect that Cabot's operating margins will benefit from the addition of Norit, which has a track record of attractive profitability. We also expect the acquisition to lend greater stability to Cabot's margins, though potential volatility in margins remains a risk. Still, Norit's higher-margin business will only be a small portion of the combined company given Norit's relatively small revenue base of slightly above 10% of combined pro forma revenues for 2011. Our base case scenario assumes that Cabot's EBITDA in 2012 will be an improvement over 2011 based on the following observations and assumptions: -- First-half 2012 adjusted EBITDA is approximately $250 million, which puts the company on a path to exceed the $430 million it achieved in fiscal 2011 (excluding earnings from the recently divested "supermetals" business in both years). -- We expect the pricing improvements that have contributed to better margins to continue. -- The company is likely to benefit from new capacity in fast growing regions including China, which we expect to offset slowdowns in markets such as Europe from a weak economy. Despite the strength of its market positions, the business risk assessment considers several limiting factors such as Cabot's narrow product focus, dependence on the automobile sector, and exposure to volatility in its key hydrocarbon based raw material. Carbon black sales, through its rubber black and performance products segments, constitute a major portion of revenue for the company, even after factoring in the acquisition. The chief application for the company's products is in tire markets across the world. Earnings have been susceptible to downturns in the automobile industry and economy, though a meaningful portion of the demand for carbon black is for replacement tires, which is not directly dependent on automobile production. Norit is the largest global producer of activated carbon--in a market valued at about $1.5 billion globally--and generates approximately half of its revenues in the U.S. Norit's activated carbon products are generally critical inputs into its customers' products and processes, with demand resulting from a high value proposition, legislation, and a growing awareness of environmental issues. The company's global market leadership position and well-diversified geographic markets contribute to a favorable competitive position. Customers, including power-generating plants, food and beverage producers, and automobile producers, use Norit's products to meet pollution regulations and improve product quality. These factors contribute to the company's high profitability, with EBITDA margins above 25%, stability in earnings, and predictable end-market demand. We expect Cabot's financial risk profile to weaken as a result of an increase in debt related to the acquisition. Pro forma for the acquisition we expect the ratio of funds from operations to total debt to be slightly below 30% as of March 31, 2012, a level we consider somewhat weak for the ratings. We expect the ratio to improve to between 35% and 40% over the next 12 to 24 months to support the ratings. Our expectation is that an improvement in earnings in both businesses, combined with a reduction in debt, will drive this improvement in key credit metrics. We expect the company will use at least $226 million, which is a minimum expected amount of remaining proceeds from its January 2012 sale of its mainly tantalum-related supermetals business, to reduce debt over the next 12 to 24 months. Liquidity Liquidity is "adequate." As of March 31, 2012, Cabot had no drawings under its $550 million revolving credit facility and about $366 million in cash. We expect that sources of funds will at least equal 1.2x uses of funds over the next 12 months. We also expect that EBITDA cushions under covenants will be at least 15%. Other assumptions and expectations include: -- The company will increase its revolving credit facility to at least $750 million from the current $550 million, as planned. -- The company will use about $250 million of the revolving credit facility and $250 million of cash to fund part of the acquisition, in addition to the $600 million in unsecured notes. -- Free cash flow will be positive in the future, though it could be lower in years of increased capital spending. -- The company will be prudent with discretionary elements of growth capital spending, including those in the activated carbon business, and in pursuing shareholder rewards. -- The company will use surplus cash to pay down modest amounts of debt over the next 24 months, including the potential receipt of additional proceeds from the sale of the supermetals business. Outlook The negative outlook reflects the risk that an unexpected slowdown in operating performance, integration-related challenges, or unanticipated constrains on liquidity could prevent the improvement we expect for the company's leverage-related credit metrics. We would the lower ratings if the key ratio of funds from operations to total debt falls below our expectation for an improvement to 35% to 40% and appears likely to remain below 30% over the next 12 to 24 months. This could happen if revenue growth stalls or turns negative, or if combined EBITDA margins are in the low- to mid-teens percentage area. Our ratings assume management's commitment to maintaining credit quality, including using surplus cash primarily to reduce debt. If management adheres to these objectives and operating results improve as we expect, we would likely revise the outlook to stable during the next two years. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27,2009 Ratings List Ratings Affirmed; Removed From CreditWatch; Outlook Action To From Cabot Corp. Corporate Credit Rating BBB+/Negative/-- BBB+/Watch Neg/-- Ratings Affirmed; Removed From CreditWatch Cabot Corp. Senior Unsecured BBB+ BBB+/Watch Neg Cabot Finance B.V. Senior Unsecured BBB+ BBB+/Watch Neg New Rating Cabot Corp. Sr Unscd $300 mil. notes due 2018 BBB+ Sr Unscd $300 mil. notes due 2020 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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