TEXT - S&P affirms Houghton International ratings

Mon Nov 26, 2012 3:15pm EST

Related Topics

Overview
     -- India-based Gulf Oil Corp. Ltd., which is part of Hinduja Group, 
agreed to buy Valley Forge, Pa.-based metalworking fluids producer Houghton 
International Inc. in a transaction valued at approximately $1.045 billion.
     -- We are affirming our 'B' corporate credit rating on Houghton and 
removing all ratings from CreditWatch with negative implications.
     -- The stable outlook reflects our expectation that operating results and 
cash flow generation will support gradual improvement of the financial profile 
in 2013 and that the company will take steps to reduce debt leverage.
 
Rating Action
On Nov. 26, 2012, Standard & Poor's Ratings Services affirmed its 'B' 
corporate credit rating on Houghton International Inc. The outlook is stable. 
At the same time, we removed all ratings on the company from CreditWatch with 
negative implications, where we placed them on Nov. 7, 2012, following the 
announcement that Hinduja Group subsidiary, Gulf Oil Corp. Ltd., had entered 
into a definitive agreement to acquire the company.

At the same time, we assigned our 'B' issue-level ratings (the same as the 
corporate credit rating) to Houghton International Inc.'s $50 million 
revolving credit facility and $410 million first lien term loan facility. We 
also assigned our 'B' issue-level rating to Houghton Europe B.V.'s EUR100 
million first-lien term loan. The recovery ratings are '3', indicating our 
expectation of meaningful recovery (50%-70%) in the event of a payment default.

We also assigned our 'CCC+' issue-level rating and '6' recovery rating to 
Houghton International Inc.'s $250 million second-lien term loan facility, 
indicating our expectation of negligible recovery (0%-10%) in the event of a 
payment default.

The company proposes to use the proceeds from the new debt, along with equity 
from Gulf Oil, to refinance existing debt and fund the acquisition of Houghton 
from AEA Investors L.P.

Rationale
The ratings on Houghton reflect the company's participation in the highly 
competitive metalworking fluids industry, exposure to cyclical end markets, 
volatile raw material cost base, and increased debt leverage resulting from 
the proposed transaction. The company's limited track record and some 
uncertainty about financial policy under new ownership are also risk factors. 
Houghton's leading industry market share position, the essential nature of its 
products, and ability to generate free operating cash flow partially offset 
these factors. We characterize Houghton's business risk profile as "weak" and 
its financial risk profile as "highly leveraged". 

Our rating incorporates our expectation that weak economic conditions in much 
of Europe over at least the next few quarters and uncertain conditions in 
North America and Asia will limit potential for volume growth for Houghton in 
2013. Nevertheless, we expect that the company to be able to maintain positive 
selling price increases and modestly improve EBITDA margins due to raw 
material pass-through provisions and its ability to control costs. Although 
our assumptions include acquisitions in the $50 million to $100 million range 
over the next few years as the industry consolidates further, we do not 
anticipate Houghton will make any acquisitions in the next 12 months. Our base 
case also incorporates our expectations that Houghton will not return cash to 
its new owner but instead take steps to reduce debt leverage.

The proposed transaction will increase Houghton's debt and weaken credit 
metrics at close. Pro forma total adjusted debt to EBITDA will increase to 
about 6.4x and the ratio of funds from operations (FFO)-to-total adjusted debt 
will decline to about 7%. We adjust this amount to include about $40 million 
of operating leases and postretirement benefit obligations. As of Sept. 30, 
2012, FFO-to-total adjusted debt was about 11%. Based on our scenario 
forecasts, we expect modest improvements to financial metrics over the next 12 
months. Although we do not anticipate dividends over the near term, the lack 
of a track record with new ownership and uncertainty about how the company 
will approach growth and shareholder rewards remains a risk to the financial 
profile. At the current rating, we expect Houghton to improve the  
FFO-to-total adjusted debt ratio to the 10% to 12% range. 

Houghton operates in the niche metalworking fluids industry. It primarily 
sells its products to the cyclical automotive, steel, and aluminum industries, 
where the products provide essential process characteristics such as 
lubrication, rust prevention, heat dissipation, operating efficiency, and 
cleanliness (of machine parts). Houghton's products also represent a small 
portion of end-product cost. Customer loyalty, which it enhances through its 
technical engineering and service, provides a barrier to entry. Nonetheless, 
substitute products from competitors and significant excess capacity cause 
price competition.

With approximately 12% market share, Houghton is the leading producer in the 
fragmented and competitive $6 billion global metalworking fluids market. 
Houghton's manufacturing activity continues to migrate to growing markets in 
Eastern Europe, Asia, and South America, where the company generates 
approximately one-third of sales. The new relationship with Gulf Oil could 
provide additional exposure to faster-growing Asian markets. In order to 
compete more effectively, we expect Houghton to continue to reduce fixed 
costs, primarily by improving manufacturing efficiency and reducing its number 
of employees, thereby maintaining profitability and margins at levels above 
prerecession highs.

Liquidity
We consider Houghton's liquidity to be adequate and expect the company's 
sources of liquidity to more than cover its needs over the next two years, 
even in the event of moderate, unforeseen declines in EBITDA. Pro forma for 
the closing of the transaction, liquidity should include roughly $20 million 
in cash and full availability under the new $50 million revolving credit 
facility due 2017. We also expect the company to generate moderate free 
operating cash flow of about $40 million annually, with modest capital 
spending and working capital needs. Debt maturities should be manageable, with 
annual amortization of about $5.4 million over the next few years and no 
maturities until 2017, when the revolver matures.

Relevant expectations and aspects of our assessment of Houghton's liquidity 
profile include:

     -- Sources of liquidity will exceed its uses by 1.2x or more over the 
next 12 to 24 months;
     -- Net sources would be positive, even with a 15% drop in EBITDA;
     -- Covenant compliance would survive a 15% drop in EBITDA; and
     -- We believe the company has the ability to absorb high-impact, 
low-probability shocks based on its flexible cost structure, positive cash 
flow, and available liquidity.
 
Recovery analysis
For the complete recovery analysis, see our recovery report on Houghton to be 
published following this report on RatingsDirect. 

Outlook
The stable outlook reflects our expectation that Houghton will maintain 
profitability and generate sufficient cash flow to improve financial metrics 
over the next year, despite an increase in reported debt.

We could lower the ratings if volumes continue to decline in 2013 without 
offsetting cost reductions or improvements to material margins. In such a 
scenario, revenue could decline by at least 5% and EBITDA margins could drop 
by almost 200 basis points. This could result in FFO-to-adjusted debt 
approaching 5%. We could also lower the ratings if the new ownership 
institutes financial policies that do not allow Houghton to reduce debt 
leverage.

While we view this scenario as less likely because of the significant increase 
in debt, we could raise the ratings if revenues grow by about 10%, EBITDA 
margins improve by more than  200 basis points, and the company uses excess 
cash flow to reduce debt. To consider a higher rating, we would also need 
further insight into new ownership's financial profile and financial policies, 
including how they plan to balance debt reduction, growth investment, and 
returning capital to shareholders.

Related Criteria And Research
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 
     -- Key Credit Factors: Criteria For Rating Companies In The Global 
Commodity Chemicals Industry, Sept. 19, 2012 
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 
Sept. 18, 2012 
     -- Key Credit Factors: Business and Financial Risks In The Commodity And 
Specialty Chemical Industry, Nov. 20, 2008 
 
Ratings List

Ratings Affirmed; CreditWatch/Outlook Action
                                        To                 From
Houghton International Inc.
 Corporate Credit Rating                B/Stable/--        B/Watch Neg/--

Houghton International Inc.
 Senior Secured                         B                  B/Watch Neg
  Recovery rating                       3                  3

New Rating

Houghton International Inc.
 Senior Secured
  US$410 mil 1st lien term bank ln due  B                  
  December 2019                            
   Recovery Rating                      3                  
  US$50 mil 1st lien revolver bank ln   B                  
  due December 2017                        
   Recovery Rating                      3                  
  US$250 mil 2st lien term bank ln due  CCC+               
  December 2018                            
   Recovery Rating                      6                  

Houghton Europe N.V.
 Senior Secured
  EUR100 mil 1st lien term bank ln due  B                  
  December 2019                            
   Recovery Rating                      3
FILED UNDER:
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