TEXT-S&P cuts Tyco International senior unsecured notes to 'BBB+'
Overview -- Switzerland-based Tyco International Ltd. has completed the separation of its North American residential security and its flow control businesses. -- We are affirming our 'A-' long-term and 'A-2' short-term corporate ratings on Tyco and wholly owned finance subsidiary Tyco International Finance S.A. (TIFSA). -- We are lowering our issue-level ratings on Tyco's and TIFSA's senior unsecured notes to 'BBB+' from 'A-', one notch below the corporate credit rating, and are removing the ratings on these notes from CreditWatch with negative implications. -- The outlook is stable, reflecting our expectation that the company will calibrate its acquisition and shareholder returns spending to its cash flow generation, such that leverage remain at about 2x, consistent with our expectations for the rating. Rating Action On Oct. 3, 2012, Standard & Poor's Ratings Services affirmed its 'A-' long-term and 'A-2' short-term corporate ratings on Tyco and wholly owned finance subsidiary Tyco International Finance S.A. (TIFSA). The outlooks are stable. We are lowering our issue-level ratings on Tyco's and TIFSA's senior unsecured notes to 'BBB+' from 'A-', one notch below the corporate credit rating, and are removing the ratings on these notes from CreditWatch with negative implications, where they were placed on Sept. 19, 2011. Rationale The affirmation of the 'A-/A-2' corporate credit ratings follows the completion of Tyco's separation into three separate entities and our expectation that Tyco will maintain a "strong" business risk profile and an "intermediate" financial risk profile. The downgrade of the senior unsecured notes rating to one notch below the corporate credit rating reflect the elevated degree of structural subordination of Tyco and TIFSA's debt obligations to priority liabilities at the companies' operating subsidiaries. Following the completion of the spin-offs of its North American residential security business and flow control businesses, we expect Tyco to continue to operate with credit metrics that are adequate for the 'A-' rating. In particular, while acquisitions, shareholder distributions, and the company's exposure to cyclical construction markets may at times result in leverage that is somewhat higher than at separation, we expect debt to EBITDA will not meaningfully exceed 2x more than temporarily. We consider Tyco's business risk profile to be strong. The company is the global leader in its industry, with a No. 1 share (we estimate it to be about 10%) in highly fragmented global markets. Its portfolio of product and service capabilities is among the most comprehensive in the sector and it benefits from well-known brands and a balanced global footprint, with good exposure to faster-growing emerging markets. Within its commercial markets, Tyco has broad customer diversity spanning the retail, industrial, institutional, and energy sectors. In addition, business stability benefits from the significant proportion of recurring revenues (about 45%) derived from relatively stable service contracts. This has in the past, and should continue to, help temper the cyclicality of the product and installation businesses and the company's exposure to construction and business investment cycles. Business risks include the company's exposure to economic, competitive, and technological trends affecting the commercial security and fire protection markets and to commercial construction cycles and markets. The industry is fragmented and competitive and Tyco competes with a few other global security and fire protection service providers, which sometimes have more extensive building management and integration capabilities, and with a multitude of smaller regional or local players. Tyco's profitability, with our expectation for 2012 EBITDA margins in the mid-teens, is average for the capital goods sector and similar to margins of other participants in the security and safety industry or large industrial companies with whom Tyco competes (including United Technologies Corp.'s CCS division, Stanley Black & Decker, Ingersoll-Rand PLC). The company's operations are less capital-intensive than prior to the divestiture of the residential security business, but still somewhat more than its peers, at about 4% of sales. About 50% of capital expenditures relate to company-owned security systems installed in customer's premises outside of North America. Factors that will influence profitability include the company's ability to adjust its corporate expenses to its reduced size (managements expect these to be about $225 million annually), trends in raw material and labor costs, trends in attrition rates, and the intensity of price competition for the company's products and services, especially for system installations and certain commoditized product lines. We characterize Tyco's financial profile as intermediate. In connection with the spin-offs, Tyco has reduced its debt to $1.5 billion from about $4 billion previously. Adjusting for operating leases, postretirement obligations, and for our assumption of up to $500 million in contingent tax liabilities, Tyco's financial leverage is slightly below 2x and funds from operation to total debt exceeds 40%. According to the 2012 tax-sharing agreement, Tyco retains up to $500 million of pre-2007 legacy tax liabilities, and would share any additional liabilities with ADT Corp. and Pentair Ltd. As of June 30, 2012, the company had reserved $406 million for these matters, and an additional $72 million was recorded upon separation. The ultimate amounts and the timing of possible cash outflows remain undetermined, however, and the company expects to litigate certain unresolved matters. Should liabilities ultimately significantly exceed the $500 million that we have assumed, the rating could come under pressure. We rate Tyco and TIFSA's senior unsecured notes 'BBB+', one notch below the corporate credit rating. Tyco guarantees the obligations, and as was previously the case, the notes do not benefit from upstream guarantees from operating subsidiaries. Assets at the parent and finance company are essentially limited to investments in these subsidiaries. Although there is no meaningful external financial indebtedness at the operating subsidiaries, we estimate that the ratio of priority obligations (including trade payables, pensions, and other obligations) at these entities to adjusted total assets significantly exceeds our notching threshold of 20%, and has increased postseparation. In addition, we also considered that the company's business lines are now more focused, and we are placing less reliance on diversification than before as a potential mitigating factor to the structural disadvantage of the parent company's obligations. Both factors contribute to the lowering of the issue-level rating. Liquidity The short term rating on Tyco is 'A-2'. We expect the company to maintain "strong" liquidity. Following the redemption of $2.6 billion of debt as part of the separation, Tyco's debt maturities are now essentially long term, including about $258 million due in 2015, and $364 million due in 2019. We have assumed the following liquidity sources in our analysis: Annual funds from operations of about $1 billion, a cash balance of about $600 million, and access to a $1 billion revolving credit facility that matures in 2017. The facility backs-up commercial paper borrowings, and availability is governed by financial covenants, including a leverage test of no more than 3.5x. We expect Tyco to maintain adequate headroom over this requirement. Liquidity uses we expect include capital expenditure of about $450 million next year, and annual dividend payments that the company target will approximate 30% to 35% of net income (or about $300 million in 2013). Cash flow generation tends to be weak during the first quarter of the fiscal year end because of seasonal working capital requirements, and to be strongest in the third and fourth quarter. Other liquidity uses could include payments related to contingent liabilities, acquisition, and share buybacks. Outlook The outlook is stable. We expect financial leverage to remain at about 2x as low- to mid-single-digit revenue growth and slow margin expansion provide for moderate profit growth and management uses free cash flow for growth and shareholder returns. We could lower the ratings if either weak global commercial construction activity or lower capital spending in key end markets such as retail or oil and gas cause revenues to decline more than 10% along with EBITDA margin falling toward 13%. We could also downgrade the company if more aggressive acquisition or buyback activity, or an unexpected significant increase in contingent liabilities causes leverage to exceed 2x and FFO to fall and remain below 40%. We could raise the rating if Tyco further diversifies its business portfolio and shows sustained improvement in EBITDA margin and return on capital measures, and if the company continues to make progress toward the resolution of its contingent liabilities while maintaining financial policies consistent with a higher rating, such as FFO to total debt of 45% to 50%. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed Tyco International Ltd. Corporate Credit Rating A-/Stable/A-2 Tyco International Finance S.A. Corporate Credit Rating A-/Stable/-- Commercial Paper A-2 Rating Lowered; CreditWatch Action To From Tyco International Finance S.A. Senior Unsecured BBB+ A-/Watch Neg
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