TEXT-Hamilton Sundstrand Industrial Rated 'B'; Outlook Stable

Tue Nov 27, 2012 7:23pm EST

Overview

-- U.S.-based industrial products manufacturer Silver II Borrower S.C.A. d/b/a Hamilton Sundstrand Industrial is raising financing for its pending acquisition by private equity firms BC Partners and the Carlyle Group from United Technologies Corp. for about $3.4 billion.

-- We are assigning our 'B' corporate credit rating to Hamilton Sundstrand Industrial.

-- We are also assigning a 'B+' issue rating and '2' recovery rating to the senior secured credit facilities and a 'CCC+' issue rating and '6' recovery rating to the senior unsecured notes. Silver II US Holdings, LLC will be a co-borrower under the credit facility and will co-issue the notes.

-- The stable outlook reflects our expectation that Hamilton Sundstrand Industrial will be able to generate good free cash flow over the next 12 to 18 months and that the company's credit measures will improve to metrics in line with the rating, including funds from operations to debt of about 10%. Rating Action On Nov. 27, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate credit rating to Hamilton Sundstrand Industrial (HSI).

The outlook is stable. At the same time, we assigned our 'B+' issue-level rating to the company's $1.85 billion senior secured credit facilities, which comprise a $1.55 billion senior secured first-lien term loan and a $300 million revolver. We assigned a '2' recovery rating to the senior secured credit facilities to indicate our expectation that lenders would receive substantial (70%-90%) recovery in the event of a payment default. We also assigned our 'CCC+' issue-level rating to the company's $775 million senior unsecured notes, and a '6' recovery rating indicating our expectation that lenders would receive negligible (0%-10%) recovery in the event of payment default. Rationale Our ratings on Windsor Locks, Conn.-based HSI reflect the company's "highly leveraged" financial risk profile, which more than offsets its "fair" business risk profile. We consider HSI's financial risk profile to be highly leveraged, marked by high debt levels and thin cash flow protection measures. We believe private equity ownership could lead to aggressive financial policies.

Pro forma for the acquisition, we estimate the ratio of funds from operations (FFO) to total adjusted debt at less than 10% and debt to EBITDA at about 7.0x at the end of 2012. We expect that debt reduction from moderate free cash flow generation of about $100 million annually could enable the company to improve leverage toward 6.0x and FFO to debt toward 10% within 12 to 18 months, which we consider appropriate for the rating. HSI's good market positions, engineering capabilities, and a geographically diverse distribution network support our fair business risk profile assessment. The company operates through two platforms. Flow control (53% of revenues) provides high speed centrifugal pumps, gas compressors, sealless pumps, metering pumps, high pressure pumps and valves, gas odorization injection systems, dosing pumps, and other niche flow control products. The industrial air compressors platform (47% of revenues) provides stationary and portable air compressors.

We expect HSI to continue to operate in a variety of cyclical and fragmented end markets that include chemical and hydrocarbon processing, construction and mining, industrial manufacturing, oil and gas production, and water and wastewater treatment. HSI competes with both larger diversified industrial manufacturers (such as Atlas Copco AB, Ingersoll-Rand PLC, and Flowserve Corp.) and smaller specialty manufacturers, and we believe it will continue to hold top 3 market positions in most of its addressable markets. Our assessment is that the company's management and governance is "fair". We expect the company's revenues to grow by 3%-5% in the next 12 to 18 months driven by modest increases in end market activity as well as growth in emerging markets. The company's overall geographic diversity should continue to be well-balanced, with about 60% of revenues coming from outside North America; its presence in emerging markets should continue to increase as these markets exhibit higher growth potential. We expect HSI's primary three brands--Milton Roy, Sundyne, and Sullair--to continue to command premium pricing.

The company's customers should remain less price-sensitive due to the mission-critical nature of products designed to operate in end markets (such as oil and gas, chemical, and mining) where downtime is costly. We believe the company will continue to derive a sizeable proportion of its revenues from aftermarket parts and services, which tend to have higher margins and contribute to revenue and cash flow stability. The company focuses on product design and assembly, which limits capital intensity, and it has a track record of efficient cost management. This should allow HSI to maintain its good EBITDA margin at about 24% going forward.

We believe HSI will continue to be able to pass most raw material inflation on to the customer, although there could be a time lag between the cost increase and price increase, which can temporarily affect margins. Liquidity We believe HSI will have "adequate" sources of liquidity to cover its needs in the next 12 months, even if EBITDA were to decline unexpectedly. Our assessment of the company's liquidity incorporates the following expectations and assumptions:

-- We expect the company's sources of liquidity, including cash and facility availability, to exceed its uses by 1.2x over the next 12 months.

-- We expect net sources to remain positive, even if EBITDA declines by 15%. We expect HSI will have about $20 million in cash and no drawings on its $300 million revolving credit facility. We expect the revolver to be subject to a springing net first-lien leverage ratio covenant, which comes into effect when the amount drawn exceeds $75 million. We expect HSI to maintain sufficient availability under the revolver such that the covenants remain untested over the next four to six quarters. In addition, sources of liquidity include our estimate of funds from operations of around $150 million next year. We believe this will be sufficient to support capital expenditures, which we expect be about 2% to 2.5% of revenues, and modest working capital outflows. We do not expect the company to make any sizeable acquisitions in the near term. Recovery analysis For the complete recovery analysis, see our recovery report on HSI to be published following this report on RatingsDirect. Outlook The outlook is stable. The rating assumes slowly improving credit measures over the next two years, based on our expectation for mid-single digit revenue growth in line with our regional GDP forecasts, relatively steady margins, and modest debt reduction from free cash flow.

We could lower the ratings if weakness in the company's operating performance limits improvement in credit measures. This could happen, for instance, if, because of global growth slowdown and contraction in industrial production, margins contract by more than 250 basis points and the company appears unlikely to maintain FFO to total debt of more than 5% or if we expect it to be unable to generate positive free cash flow. We could raise the ratings if we expect operating performance to improve so that debt to FFO to total debt appears likely to exceed 10%. This could occur if, for example, HSI significantly reduces debt, possibly through excess cash balances and free operating cash flow generation.

Related Criteria And Research

-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009

-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Rating Silver II Borrower S.C.A. d/b/a Hamilton Sundstrand Industrial Corporate Credit Rating B/Stable/

-- New Rating

Silver II Borrower S.C.A. d/b/a Hamilton Sundstrand Industrial

Silver II US Holdings, LLC

Senior Secured

US$1.55 bil term bank ln due 2019 B+

Recovery Rating 2

US$300 mil revolver bank ln due 2017 B+

Recovery Rating 2

Senior Unsecured US$775 mil sr nts due 2020 CCC+

Recovery Rating 6