TEXT-S&P Assigns 'B' Rtg To P.F. Chang's; Debt Also Rated

Overview

-- Centerbridge Partners has acquired U.S. Asian-themed restaurant operator P.F. Chang's China Bistro in a $1.1 billion leveraged buyout.

-- Concurrently, P.F. Chang's has replaced its unrated $150 million credit facility with a new $75 million revolver, a $305 million term loan B, and $300 million in senior unsecured notes.

-- After receiving final documents and reviewing the terms, we are assigning a 'B' corporate credit rating to the company, as well as 'B+' issue-level ratings with '2' recovery ratings to the revolver and term loan and a 'CCC+' issue-level rating with a '6' recovery rating to the notes.

-- The stable outlook reflects our belief that despite modest operational erosion, credit protection metrics will remain in line with our financial risk assessment over the intermediate term.

Rating Action

On July 26, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate credit rating to Scottsdale, Ariz.-based Asian-themed restaurant operator P.F. Chang's China Bistro Inc. The outlook is stable.

At the same time, we assigned 'B+' issue-level ratings with '2' recovery ratings to the revolver and term loan. The '2' recovery ratings indicate our expectation for substantial (70% to 90%) recovery of principal in the event of a payment default. We also assigned a 'CCC+' issue-level rating with a '6' recovery rating to the notes. The '6' recovery rating indicates our expectation for negligible (0% to 10%) recovery of principal in the event of a payment default.

P.F. Chang's funded the transaction with almost $525 million in Centerbridge common equity, the term loan, and the notes. The company used the proceeds from the acquisition mainly to purchase $1.1 billion in public stock.

Rationale

The rating on P.F. Chang's reflects Standard & Poor's expectation that the company's financial risk profile will remain "highly leveraged" and its business risk profile will remain "vulnerable" this year despite efforts to improve operations and grow sales at both flagship Bistros and smaller Pei Wei Asian Diners.

P.F. Chang's increased total debt to EBITDA from 1.6x in the year ended April 1, 2012, to 5.8x pro forma for the deal, reflecting the Centerbridge Partners LBO. Pro forma debt includes the $300 million term loan, $300 million of senior notes, and an estimated $1 million to $2 million in other debt. Interest coverage declined to an estimated 2.2x from 7.2x before the transaction.

Our outlook for the casual-dining sector that includes P.F. Chang's main Bistro restaurants remains negative in the coming year due to oversupply and declining traffic. The outlook is more favorable for the fast-casual sector that includes P.F. Chang's Pei Wei Asian Diners, which are expected to generate about 25% of total company sales in fiscal 2012. P.F. Chang's "vulnerable" business risk profile reflects its singular focus on Asian cuisine to date and concentration in California, Arizona, Florida, and Texas, where it has about half of its U.S. stores. We forecast efforts to expand the company's licenses for international restaurants and domestic retail grocery products will contribute less than 1% of total sales in the coming year.

We expect a 1.5% EBITDA decline for the fiscal year ending Dec. 30, 2012, due to flat Bistro comparable-store sales and continued modestly negative results at Pei Wei. We also expect the company's EBITDA margin will decline 40 basis points (bps) to 10.3% in fiscal 2012 as costs associated with opening new restaurants continue to erode operating leverage. We believe future growth will come from expanding domestic Pei Wei Asian Diners and international Bistros rather than adding Bistros in the saturated U.S. market. This trend will also pressure margins since Pei Wei Asian Diners are smaller and less profitable than Bistros. We expect the company will have more Pei Wei Asian Diners than Bistros globally within the next five years.

Standard & Poor's economists currently forecast a 20% likelihood of a U.S. recession, with GDP growing 1.9% in the second half of 2012 and 2.1% in 2013, unemployment continuing to remain at or above 8%, and consumer spending growing 2.2% in 2012 and 2.4% in 2013. Considering these economic assumptions, our forecast for P.F. Chang's operating performance for fiscal 2012 includes the following:

-- We expect overall sales will increase 2.5% as the company opens two new Bistros and seven new Pei Wei restaurants in the U.S. and comparable-store sales improve slightly.

-- We believe gross margin will increase 10 bps as the new Centerbridge owners reduce food, labor, and other operating expenses, with an additional 70 bps of margin enhancement expected in fiscal 2014.

-- We anticipate total selling, general & administrative (SG&A) expenses will increase in the 10% range due to incremental salary costs to support restaurant growth.

-- We project total capital expenditures of about $50 million to support initiatives, including new Pei Wei Asian Diners.

-- We forecast funds from operations to debt will be in the 14% range after the deal as a result of added leverage.

We expect P.F. Chang's will redirect cash flow historically spent on dividends and share repurchases as a public company to reduce debt following the transaction. We also expect Centerbridge will identify at least $5 million of cost savings for the restaurateur in the coming year. Still, we project free cash flow will decline from $62.5 million in fiscal 2011 to $35 million in fiscal 2012 as P.F. Chang's spends about $45 million on new interest expense and increases capital spending an estimated 30%.

Liquidity

We view P.F. Chang's liquidity as "adequate" as we expect sources of liquidity to be greater than uses over the next 12 to 18 months. The new revolver included in this transaction provides a more flexible leverage covenant than the previous facility. Sources of cash include the new revolver, cash flow from operations, and modest excess cash following the transaction. Cash uses include debt amortization and increased capital spending.

Our assessment of the company's liquidity profile includes the following factors and assumptions:

-- We forecast cash sources will exceed cash uses by more than 1.2x over the next 12 months and remain positive over the next 24 months.

-- We also forecast net sources would remain positive, even if EBITDA were to decline 15%.

-- The company will have two financial covenants under the senior credit facility, and we expect 30% cushions for both in the coming year.

-- There are no near term debt maturities.

Recovery analysis

For the complete recovery analysis, see the recovery report on P.F. Chang's, to be published as soon as possible on RatingsDirect following the release of this report.

Outlook

The stable outlook reflects our expectation that modest operational erosion, coupled with limited debt reduction, will result in flat credit measures in the coming year. We could lower the rating if negative same-store sales trends persist and the new owners do not reduce food and labor costs in the coming year. This would result in gross margin falling 200 bps and EBITDA declining about 15% from our expectations for fiscal 2012. It could also occur if SG&A grows at more than double the 10% rate we are forecasting. In this scenario, interest coverage would fall below 2.0x, leverage would approach 6.5x, and FFO to total debt would decline below 10%. Given P.F. Chang's expected credit measures and restaurant expansion plans and our industry outlook, we are not expecting to raise our ratings over the near term.

Related Criteria And Research

-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009

-- Key Credit Factors: Business And Financial Risks In The Restaurant Industry, Dec. 4, 2008

Ratings List

New Ratings

P.F. Chang's China Bistro Inc. C

orporate Credit Rating B/Stable/--

Senior Secured US$75 mil revolver bank ln due 2017 B+

Recovery Rating 2

US$305 mil term loan B due 2019 B+

Recovery Rating 2

Senior Unsecured US$300 mil 10.25% nts due 2020 CCC+

Recovery Rating 6