TEXT - S&P cuts Verso Paper Holdings LLC
Overview -- Difficult operating conditions for North American coated paper producers, such as Verso Paper Holdings LLC, are likely to persist throughout 2013 based on weak economic growth prospects. -- We are lowering our corporate credit rating on Verso Paper to 'B-' from 'B' and also lowering our issue-level ratings on the company's debt. -- The stable rating outlook reflects our view of Verso Paper's adequate liquidity and expectation that EBITDA and credit metrics, albeit weak, will modestly improve in 2013 from its Sept. 30, 2012 trailing 12-month level. Rating Action On Nov. 27, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Memphis, Tenn.-based coated-paper manufacturer Verso Paper Holdings LLC (Verso Paper) to 'B-' from 'B'. The outlook is stable. At the same time, we lowered our issue-level rating on the company's $150 million asset based lending facility due 2017, $50 million revolving credit facility due 2017, and $345 million senior secured 11.75% notes due 2019 to 'B+' (two notches higher than the corporate credit rating) from 'BB-'. We have also lowered our issue-level rating on Verso Paper's $271.6 million senior secured 11.75% notes to 'B-' (the same as the corporate credit rating) from 'BB-' and have revised our recovery rating on these notes to '4' from '1'. We also lowered our issue-level rating on the company's $396 million senior secured 8.75% notes due 2019, $142.5 million subordinated 11.375% notes, and Verso Paper Finance Holdings LLC's senior unsecured term loan to 'CCC' (two notches below the corporate credit rating) from 'CCC+'. Rationale The downgrades and revisions follow our revised assessment of Verso Paper's business risk profile as "vulnerable" and expectations that credit metrics will be more consistent with a 'B-' corporate credit rating throughout 2013. We have revised our business risk profile to reflect the significant challenges facing the North American coated paper industry in the weak economic environment ahead which could lead to an acceleration of consumption shifting away from print media to electronic media. The downgrade also reflects the company's significant debt burden and our expectations that interest coverage will remain weak at 1.5x or below throughout 2013. The 'B-' corporate credit rating on Verso Paper reflects Standard & Poor's view of the combination of its "highly leveraged" financial risk and vulnerable business risk. The highly leveraged financial risk profile reflects the company's significant debt burden, cyclical cash flows, and weak forecasted credit metrics. Verso Paper continues to face significant risks associated with North American coated paper markets, which are subject to periods of overcapacity and structurally declining demand due to the ongoing shift to digital media. In addition, sluggish economic growth prospects over the next year in North America are likely to curtail growth in advertising spending, which in turn has a negative effect on coated paper consumption. Our ratings also incorporate the company's limited product diversity and vulnerability to fluctuations in input costs (including chemicals, wood, and energy) and selling prices. Our 2012 and 2013 EBITDA forecasts for Verso Paper reflect our cautious economic outlook over this period. Under our baseline scenario, we forecast Verso Paper's 2012 EBITDA to approximate $145 million, compared with $142 million for the trailing 12 months ended Sept. 30, 2012. In addition, we expect 2013 EBITDA could approximate $195 million if a modest improvement in coated paper prices holds throughout the year. Key assumptions to our EBITDA forecast include: -- Sluggish annual real GDP growth of 2.1% in 2012 and 2.3% in 2013; -- Permanent capacity closures coupled with weak coated paper demand result in total tons shipped declining to 1.8 million tons in 2012 and to slightly below 1.75 million tons in 2013, compared with 2 million tons in 2011; -- Average selling prices for coated paper increase in the low single-digits percentages in 2013; -- Cost-savings initiatives offset modest input increases over the next 12 months. A key downside risk to our forecast is a U.S. recession that could accelerate the secular demand decline for coated papers over the near term. Furthermore, our EBITDA forecast is highly sensitive to increases in raw-material costs that are unable to be offset by price increases or cost savings. A key upside risk to our EBITDA forecast would be better-than-expected increases in coated paper prices, although we view that as unlikely given the sluggish economic growth prospects. We believe that Verso Paper's financial results and credit measures will fluctuate widely during the course of a cycle because demand correlates closely to general economic conditions and highly cyclical advertising spending. Total debt (including about $90 million of adjustments for pension liabilities, operating leases, asset retirement obligations, and accrued interest) was about $1.38 billion on Sept. 30, 2012, compared with $1.35 billion at year-end 2011. Based on our EBITDA assumptions, we expect Verso Paper to remain highly leveraged with debt to EBITDA declining from slightly below 10x as of Sept. 30, 2012, to about 7x by the end of 2013. In addition, interest coverage is likely to remain below 1.5x and funds from operations (FFO) to debt well below 10% over this similar period. Verso is the second-largest coated paper manufacturer in North America and accounts for about 15% of total production capacity. A substantial proportion of its sales are to catalogs and magazines end users, which we believe are susceptible to substitution risks due to changing customer preferences for greater electronic content, particularly with increased penetration of e-readers and tablet computers. Liquidity Our assessment of Verso Paper's "adequate" liquidity profile is based on the following assumptions: -- We expect that sources of liquidity (including FFO, cash balances, and availability under the credit facilities) will exceed uses by 1.2x or more over the next 12 months; -- We expect that liquidity sources will continue to exceed uses, even if EBITDA were to decline by 15%; and -- Covenants will survive a 15% drop in EBITDA. As of Sept. 30, 2012, the company's primary sources of liquidity include about $10 million of cash and $122 million of availability (net of $43 million of issued letters of credit) under its $150 million asset-based lending facility and $50 million revolving credit facility. The ABL facility includes a fixed-charge coverage ratio requirement of 1x if availability falls below a certain threshold. The revolving credit facility includes a net first-lien leverage ratio covenant of 3.5x, which applies if loans or letters of credit are outstanding under the facility. Verso Paper's working capital is subject to seasonal fluctuations as the third quarter is typically the stronger quarter of the year. As a result, accounts receivable generally peak in the third quarter, while inventory generally peaks in the second quarter. We expect working capital to be a source of cash in the fourth quarter of 2012. Liquidity will improve in the fourth quarter of 2012 from the receipt of $44 million of cash to settle its loss claim with its insurance carrier related to the recent Sartell mill fire and explosion offset by less than $20 million of remaining Sartell-related cash outlays. Given our operating assumptions, we expect the company to generate negative free cash flow in 2012 after consideration of an estimated $55 million to $60 million of net capital expenditures and a modest decline in working capital levels. For 2013, we forecast free cash flow to be slightly positive based on capital expenditures of $50 million and minimal working capital growth if the company's EBITDA improves to our forecasted level of $195 million. The company's nearest debt maturity occurs in February 2013 when Verso Paper Finance Holdings LLC's unsecured term loan is due. We expect the company to refinance this obligation, and believe it has the capacity, if needed, to repay the entire amount at maturity from cash balances and remaining availability on its credit facilities. Recovery analysis For our complete recovery analysis, see Standard & Poor's recovery report on Verso Paper published Nov. 28, 2012, on RatingsDirect. Outlook The stable rating outlook reflects our view of Verso Paper's adequate liquidity and expectation that EBITDA and credit metrics will modestly improve in 2013 from its Sept. 30, 2012 trailing twelve month level. Our adequate liquidity assessment contemplates the company being able to successfully repay or refinance its upcoming term loan maturity in February 2013 and recognizes the extension of a significant portion of debt maturities in early 2012. A downgrade could occur if the company's liquidity position were to become less than adequate, which could result from an inability to repay or refinance its 2013 maturity or interest coverage declining to below 1x. For this to occur forecasted 2013 EBITDA would have to be sustained around $130 million to $140 million, which would likely result in continued operating losses and negative free cash flow. Under this scenario, liquidity would likely weaken and the company would likely need to rely of borrowings under its revolving credit facilities to fund operating requirements. We view an upgrade as unlikely over the next 12 to 18 months given the low probability that Verso Paper's EBITDA could increase to a level such that the company could generate sustained positive free cash flow, improve interest coverage to 2x, and leverage to below 5x. For this to occur, EBITDA would have to be sustained around $260 million to $270 million, or approximately 35% above our 2013 forecast. Related Criteria And Research -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Criteria For Rating The Forest Products Industry, Dec. 11, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Temporary telephone contact numbers: Tobias Crabtree (917-539-4614); James Fielding (917-734-3477) Ratings List Downgraded; Outlook Stable To From Verso Paper Holdings LLC Verso Paper Finance Holdings LLC Corporate Credit Rating B-/Stable/-- B/Negative/-- Downgraded To From Verso Paper Holdings LLC Senior Secured B+ BB- Recovery Rating 1 1 Senior Secured CCC CCC+ Recovery Rating 6 6 Senior Secured B- BB- Recovery Rating 4 1 Subordinated CCC CCC+ Recovery Rating 6 6 Verso Paper Finance Holdings LLC Senior Unsecured CCC CCC+ Recovery Rating 6 6 Verso Paper Inc. Senior Secured B+ BB- Recovery Rating 1 Senior Secured CCC CCC+ Recovery Rating 6 6
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