TEXT - S&P rates Harbinger Group new debt
Overview -- New York City-based investment holding company Harbinger Group Inc. is seeking to refinance its existing $500 million 10.625% senior secured notes due 2015 for $650 million 8.0% senior secured notes due 2017. -- We are affirming the company's 'B' corporate credit rating and assigning a 'B' issue-level rating and '3' recovery rating to the new senior secured notes. -- The outlook is stable, which reflects our expectation for weak portfolio diversification over the next few years and debt service coverage to remain weak for the next two years, but for liquidity to remain adequate. Rating Action On Dec. 10, 2012, Standard & Poor's Ratings Services affirmed its 'B' corporate credit rating on Harbinger Group Inc. (HRG). The outlook is stable. At the same time, we assigned a 'B' issue-level rating and '3' recovery rating to HRG's proposed $650 million 8.0% senior secured notes due 2017. The '3' recovery rating indicates our expectation of meaningful recovery (50% to 70%) for creditors in the event of a payment default or bankruptcy. We will withdraw our 'B-' issue-level rating and '5' recovery rating on the company's $500 million 10.625% senior secured notes upon completion of the transaction. Rationale The ratings on HRG reflect our analysis that the company's creditors will remain structurally subordinated to the liabilities of its current and future operating subsidiaries. It also reflects our view that HRG has a "vulnerable" business risk profile because its operating portfolio lacks diversification, though it's expected to slowly improve through future acquisitions, and management has a limited track record with its stated investment strategy of seeking controlling equity stakes and maintaining ownership over an extended time horizon. We also believe there is limited transparency with respect to the nature of its temporary investments. We view financial policy to be "aggressive," principally because we believe the company's high cost of capital impedes its investment strategy. We view management and governance to be "fair." We forecast debt service coverage ratios will remain weak based on the current portfolio composition. HRG is a publicly-listed holding company focused on obtaining controlling equity positions across a diversified set of industries, including consumer products/retail, insurance and financial services, energy, natural resources, and agriculture. Harbinger Capital Partners LLC (Harbinger Capital) acquired a majority interest in HRG in July 2009 and provides advisory and consulting services to HRG. Many of HRG's employees are former and current employees of Harbinger Capital Partners. Current operating subsidiaries include Spectrum Brands Inc. (B/Positive/--) and Fidelity & Guaranty Life Insurance Co. (BB/Positive/--). The company is in the process of adding a third controlling equity position through its investment in a private oil and gas Master Limited Partnership (MLP). HRG, through wholly owned subsidiary HGI Energy, and EXCO Resources (B/Negative/--) recently agreed to form a partnership to create a private oil and gas MLP (EXCO-HGI JV). We forecast debt service to remain weak based on the current and pending portfolio composition. Specifically, we expect debt service coverage to remain in the mid-1x area through fiscal year-end September 2014. Dividends and investment returns are HRG's sole cash sources. We forecast about 33% of cash sources will be dividends from the company's insurance operations, about 25% will be dividends from Spectrum Brands, and about 40% will be dividends from the pending EXCO-HGI JV. Dividends should become a greater source of cash and investment returns should become a lesser source of cash as the company completes more acquisitions. As this occurs, we believe the stability of the company's cash sources should improve. HRG's strategy is to acquire controlling equity positions in companies and hold the investments over an extended time horizon. Spectrum Brands was acquired in January 2011, and Fidelity & Guaranty Holdings was acquired in April 2011. The EXCO-HGI JV transaction is scheduled to close in January 2013. HRG's stated investment strategy has a limited track record. In addition, HRG's strategy contrasts with the investment strategy at Harbinger Capital Partners whose portfolio turnover is more frequent relative to HRG. Our ratings on Spectrum Brands reflect our view that the company continues to have a "weak" business risk profile and a "highly leveraged" financial risk profile, which factors in our analysis of the company's proposed acquisition of the Hardware and Home Improvement Group (HHI) from Stanley Black & Decker (A/Stable/A-1). We believe the company's businesses remain highly competitive, and its input costs remain volatile. The strong negotiating power of the company's concentrated retailer customer base remains a key risk factor. The company benefits from its ongoing value-priced product offerings, diverse product lines, and geographic diversification. We continue to view the company's financial risk profile as "highly leveraged," given financial ratios weakening to levels indicative of this profile pro forma for the acquisition of HHI, financial policies remaining aggressive, and liquidity remaining adequate. Our insurer financial strength rating on Fidelity & Guaranty Holdings reflects the company's improving competitive position, which it derives from its product manufacturing capabilities and distribution relationships within the equity-indexed annuity market. The rating also reflects a return to stable statutory earnings in 2011 and 2010. Offsetting these strengths are the companies modest capital position, concentrated business mix, and higher exposure to 'BBB' (NAIC 2) investments relative to the industry. Liquidity We continue to view the company's liquidity as "adequate." Cash sources include excess cash, dividends from portfolio companies, debt issuance, and short-term returns on excess cash. Cash uses include investment-related expenses, debt service, debt repayment, and potential acquisitions. Our liquidity assessment includes the following factors, expectations, and assumptions: -- We expect cash sources to exceed cash uses by more than 1.2x over the next 12 months. We expect net sources to remain positive over the next 24 months. -- As of Sept. 30, 2012, we calculate HRG has cash and cash equivalents of about $430 million. Pro forma for the refinancing and investment in the EXCO-HGI JV, we estimate cash and cash equivalents of just over $200 million. -- HRG's cash balance may quickly fall because the amount and pace of future acquisition activity is unclear. -- We believe covenant cushion will remain sufficient. According to covenants for the proposed notes, HRG's collateral coverage ratio must not fall below 2x on the last day of the fiscal year and the last day of the second fiscal quarter, and its liquid collateral coverage ratio must not fall below 1.1x on the last day of each fiscal quarter. -- We view Spectrum Brands' and Fidelity & Guaranty's liquidity to be adequate. Besides HRG's existing cash and cash equivalents, these two companies represent HRG's main sources of cash for its obligations. We forecast Spectrum Brands will generate free operating cash flow of between $230 million and $250 million in 2013 and between $260 million and $280 million in 2014. This incorporates our forecast for capital expenditures of between $75 million and $80 million per year through 2014, which is about twice the amount of our prior forecast to account for the addition of HHI. We believe the company can reduce capital expenditures to below $70 million per year after 2014 as it fully realizes certain integration benefits. It also incorporates our expectation for modest working capital growth. We assume dividends range between $40 million and $60 million per year through 2014, and share repurchase activity remains negligible. Harbinger currently owns between 55% and 60% of Spectrum Brands' common equity. We forecast Fidelity & Guaranty Life will generate between $90 million and $100 million in pretax adjusted statutory net income in 2012 and 2013. Management has indicated that FGL will pay a dividend of $40 million annually to HRG over the next four years. We believe this dividend expectation will have no negative impact on FGL's capitalization. FGL has a maximum allowable regulatory dividend of about $85 million annually, which limits HGL's ability to extract capital beyond that point. Harbinger currently owns 100% of FGL common equity. Recovery analysis For the complete recovery analysis, please see the recovery report on Harbinger Group Inc., to be published on RatingsDirect following this report. Outlook Our outlook is stable. This reflects our expectation for weak portfolio diversification over the next few years and debt service coverage to remain weak for the next two years, but for liquidity to remain adequate. We expect debt service coverage ratios may be volatile if HRG is unable to acquire controlling interests in companies with the ability to pay consistent dividends. We could lower our ratings if liquidity becomes less than adequate. We believe the most likely scenario for liquidity to become less than adequate is if HRG makes acquisitions of companies with the inability to pay consistent dividends, resulting in secured debt coverage falling below 1x and cash and cash equivalents falling below $100 million. Debt service coverage could fall below 1x if expected dividends from the three portfolio companies fall by $35 million. We could raise our ratings if HRG makes acquisitions of companies demonstrating the ability to pay consistent dividends, which would reduce the expected volatility of the company's cash flow sources. In this scenario, HRG would need to show the ability to maintain debt service coverage ratios consistently above 2x, which could be done by acquiring a company with a track record of consistent cash flow generation. Debt service coverage above 2x could be achieved by adding $25 million of recurring dividends per year to cash sources or by reducing debt service by more than $10 million. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Ratings List Rating Affirmed Harbinger Group Inc. Corporate credit rating B/Stable/-- Ratings Assigned Harbinger Group Inc. Senior secured $650 mil. 8.0% notes due 2017 B Recovery rating 3
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