TEXT-S&P assigns Calceus Acquisition preliminary 'B' rating
Overview -- New York-based Calceus Acquisition Inc., maker of Cole Haan footwear and accessories, proposes to issue $270 million in secured debt to fund a portion of its $570 million acquisition by a financial sponsor. -- We are assigning Calceus our preliminary 'B' corporate credit rating. In addition, we are assigning a preliminary 'B' issue-level rating to the company's proposed $270 million senior secured term loan maturing in 2020, and a preliminary '3' recovery rating. -- The stable outlook reflects our view that Calceus' credit metrics will strengthen over the next 12 months as profitability improves, benefiting from some cost savings, and as debt levels are modestly reduced with cash flow from operations. Rating Action On Jan. 11, 2013, Standard & Poor's Ratings Services assigned its preliminary 'B' corporate credit rating to Calceus Acquisition Inc. The outlook is stable. At the same time, we assigned Calceus' proposed $270 million senior secured term loan our preliminary 'B' issue-level rating (the same as the corporate credit rating) with a preliminary recovery rating of '3', indicating our expectation for meaningful (50% to 70%) recovery for the lenders in the event of a payment default. Rationale Our ratings on Calceus reflect our view that the company's financial profile is "highly leveraged," given the high debt levels following its acquisition by financial sponsor Apax Partners resulting in pro forma adjusted debt-to-EBITDA leverage in excess of 7x. Though the company's financial sponsor will be making a meaningful equity contribution (about 50% of the purchase price), we believe the company's post-transaction leverage is indicative of an aggressive financial policy. Our ratings further reflect our view of Calceus' "weak" business risk profile, underpinned by the company's strong positions in the U.S. premium footwear market and good diversification by product category and distribution channel. The business risk assessment is constrained by our view of the highly competitive market in which Calceus operates, as well as by its limited geographic diversification and reliance on a single brand. The company will have high debt levels after the transaction. We estimate pro forma debt-to-EBITDA leverage will initially be in the low-7x area, adjusting for operating lease obligations and nonrecurring expenses, including expenses related to its prior corporate parent (NIKE Inc.; A+/Stable/A-1) related expenses. We believe this should decline to about 6x within the next 12 months, particularly as the company achieves additional cost savings for the stand-alone company and modest debt reduction with cash flow from operations. As such, we believe credit measures are in line with indicative ratios for a financial risk profile that we characterize to be highly leveraged, which includes debt-to-EBITDA leverage of over 5x. (Calceus is a privately held corporation and does not publicly disclose its financial statements.) Our base-case forecast for the next 12 months incorporates the following assumptions: -- Organic revenue growth in the mid-single-digit area for fiscal 2013 (ending May 31) and low-single-digits for fiscal 2014. We expect fiscal 2014 growth to be lower as the company closes unprofitable retail locations. -- EBITDA margins will improve to the 10% area from the company's currently low level of about 8.5%. In particular, we expect the company to benefit from implementation of a portion of the cost savings management has identified related to operating efficiencies across the organization. -- We estimate capital expenditures of in the low-$20 million area for the next 12 months. -- We expect the company's cash flow from operations to fully fund all capital expenditures and fixed charges. -- We assume no shareholder distributions or acquisition activity for the next roughly 12 to 24 months. We expect the company to use internally generated cash to reduce debt. We believe Cole Haan's business is narrowly focused in the highly competitive premium footwear sector. The company, with a little over $500 million in sales, will be a relatively small player as compared to other rated footwear and apparel companies, including Wolverine World Wide Inc. and Jones Group Inc. (both BB-/Stable/--). In addition, the company's geographic diversification is somewhat limited, with about 15% of combined sales generated outside of North America. Still, we believe the Cole Haan brand will continue to hold top market positions across the various men's and women's footwear categories in which it competes. In addition, the company's products are diversified across many categories, ranging from casual to more formal wear, and are distributed across various retail channels, including company-operated retail stores (about 40% of EBITDA) and wholesale channels (60%). Liquidity We view Calceus' liquidity as "adequate," with sources of cash that are likely to exceed uses for the next 12 months. We expect funds from operations for 2013 to fully cover all capital expenditures and fixed charges. Our assessment of Calceus' liquidity incorporates the following expectations, assumptions, and factors: -- We forecast sources of liquidity to exceed uses of liquidity by more than 1.2x over the next 12 months. -- We estimate net sources would be positive even if EBITDA fell 15%. -- Calceus will have a $100 million five-year asset-based revolving credit facility maturing in 2018, which will have substantial availability upon completion of the transaction. -- The proposed secured term loan will be covenant lite. In addition, the company's asset-based credit facility will only be subject to a fixed charge covenant if availability declines to less than 10% of its borrowing base availability. We estimate availability will be well in excess of this level during the company's peak seasonal period. -- The company has no term debt maturities beyond principal amortization until 2020. Recovery analysis The issue-level rating on Calceus' proposed $270 million senior secured term loan is 'B', same as the corporate credit rating. The recovery rating on the facility is '3', reflecting our expectation for moderate (50% to 70%) recovery for the lenders in the event of a payment default. For the complete recovery analysis, please see Standard & Poor's recovery report on Calceus, to be published on RatingsDirect following the publication of this report. Outlook The stable outlook reflects our view that Calceus' profitability will improve over the next 12 months thanks to cost reductions, and the company will be able to maintain its strong market positions in the U.S. premium footwear market. We expect credit metrics to strengthen modestly such that the company's debt-to-EBITDA leverage declines to 6x area in the next 12 months. However, if debt-to-EBITDA leverage were to increase to over 7.5x on a sustained basis (possibly from lower-than-anticipated cost savings or weak sales performance), or if there is a meaningful operational stumble in connection with the company's spin-off from Nike, we could lower the ratings. Conversely, if we believe leverage is sustainable below 5x (which would be commensurate with a "aggressive" financial risk profile), we could raise the rating. This could result from greater-than-anticipated sales or cost savings, leading to about a 200 basis points of improvement in margins versus our base case. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Assigned Calceus Acquisition Inc. Corporate credit rating B(prelim)/Stable/-- Senior secured $270 mil. term loan due 2020 B(prelim) Recovery rating 3(prelim) Temporary telephone contact number: Linda Phelps (917-583-1997) Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.