TEXT - S&P raises Georgia Gulf Corp to 'BB'
Overview -- U.S. chlor-alkali, vinyls, and building products maker Georgia Gulf Corp. (Georgia Gulf) is merging with PPG Industries Inc.'s commodity chemicals segment. -- We are raising our corporate credit rating on Georgia Gulf to 'BB' from 'BB-'. -- We are raising the rating on Georgia Gulf's existing debt and assigning ratings to the new debt that will partially finance the transaction. -- The stable outlook reflects our expectation that the companies will successfully integrate their operations and generate credit metrics consistent with the ratings. Rating Action On Jan. 15, 2013, Standard & Poor's Ratings Services removed its corporate credit rating on Georgia Gulf from CreditWatch, where we had placed it on July 19, 2012, when the parties announced the merger. We then raised the rating to 'BB' from 'BB-'. At the same time, we removed our rating on Georgia Gulf's existing senior secured notes from CreditWatch, raised the issue rating to 'BBB-' (two notches above the corporate credit rating) from 'BB', and revised the recovery rating to '1' from '2'. The '1' recovery rating indicates our expectation of very high (90% to 100%) recovery in the event of a payment default. In addition, we assigned a 'BBB-' issue rating, with a recovery rating of '1', to Eagle Spinco Inc.'s (Eagle Spinco) proposed $212 million senior secured term loan due 2017. Following the merger, Eagle Spinco Inc. will be wholly owned by Georgia Gulf, which will change its name to Axiall Corp. We also assigned a 'BB' issue rating, with a recovery rating of '4', to Eagle Spinco's proposed offering of $688 million of senior unsecured notes due 2021. The '4' recovery rating indicates prospects for average (30% to 50%) recovery in the event of a payment default. The outlook is stable. Rationale The one-notch upgrade of Georgia Gulf reflects our more favorable assessment of the company's business risk profile as "fair" following the merger, together with what we consider to be the continuation of its "significant" financial risk profile. Georgia Gulf will merge with PPG Industries Inc.'s commodity chemicals business via a stock-for-stock exchange, using a Reverse Morris Trust structure. (A Reverse Morris Trust is a transaction that combines a divisive reorganization (a spin-off or split-off) with an acquisitive reorganization (statutory merger) to allow a tax-free transfer of a subsidiary under U.S. law.) At Georgia Gulf's current stock price, the transaction is valued at about $2.6 billion. It will be financed with 35.2 million shares (or about $1.6 billion) of new common stock, $900 million of new debt, and $95 million of assumed debt. In addition, Georgia Gulf is assuming certain pension, other postemployment benefit, and environmental liabilities. A favorable tax ruling has been received, Georgia Gulf shareholders have approved the merger, and the parties expect the transaction to close by the end of this month. Following the merger, Georgia Gulf's existing shareholders will own 49.5% of the company, and PPG's shareholders will own 50.5%. Pro forma combined last-12-month sales as of Sept. 30, 2012, totaled about $4.9 billion, with EBITDA of about $670 million (before synergies that management expects to total $115 million). The transaction will strengthen Georgia Gulf's business risk profile to "fair" from "weak," as it will increase the company's backward integration into chlorine production and add significant merchant chlorine and caustic soda capacity. The combined entity will be among the largest North American commodity chemical producers, and we believe its greater size and scope will increase its purchasing power and improve its operating rates. In addition, the high degree of backward integration into electricity co-generation from natural gas will improve its competitive position by leveraging its access to comparatively low-cost U.S. natural gas. We believe that the two parties' historical supplier/customer and joint-venture partner relationships and the close proximity of their respective Lake Charles, La., operations increase Georgia Gulf's familiarity with PPG's operations and reduce integration risk. Pro forma total adjusted debt will be about $1.8 billion, and total adjusted debt to EBITDA will be about 2.6x, before any synergy benefits. Our analysis adjusts debt to include about $300 million of estimated tax-effected pension, postretirement, and environmental liabilities and capitalized operating leases at the combined entity. While we expect the combined company's business to remain cyclical, we regard industry supply and demand dynamics as generally favorable. Moreover, this transaction increases industry consolidation. Although a weak global economy and capacity additions could cause demand to soften somewhat during the next year or two, the combined company should benefit considerably over the long term from a gradual recovery in the U.S. housing markets. Georgia Gulf's competitive position will improve as a result of this merger. However, we expect the cyclical, commodity nature of the combined operations, limited product diversity, and heavy reliance on key operating sites (particularly in Lake Charles) to continue to constrain its business risk profile. In addition, we believe that increasing chemical industry regulation--particularly, in connection with the transport of chlorine--is likely to result in somewhat higher operating costs in the future. Following the transaction, Georgia Gulf should see a substantial increase in its EBITDA margins and return on capital, along with reduced volatility in its operating earnings. We expect EBITDA margins will be at or above 13% (subject to some variation) and its pretax return on capital about 13%. Our base case scenario assumes a continued U.S. economic recovery and a gradual increase in U.S. residential construction during the next few years. On a global basis, we expect subdued economic growth in 2013. However, Georgia Gulf's operating profitability could exceed our expectations if the U.S. housing market recovery is stronger than we currently anticipate. Despite some capacity additions, we expect chlor-alkali and vinyl resin supply and demand trends to remain relatively favorable, and we anticipate that North American vinyl resin producers will continue exporting a substantial percentage of production because of a continued favorable cost position. However, we note that longer term, these conditions could cause North American vinyl resin capacity to increase. We consider the company's goal of 2x reported debt to midcycle EBITDA and 3x trough EBITDA interest coverage consistent with our expectations at the current ratings. Our assessment of Georgia Gulf's financial policy as "aggressive" reflects the growth and investment objectives of its management team, including the potential for additional large capital investments. We expect Georgia Gulf to generate funds from operations to total adjusted debt of about 25%, appropriate for the ratings. Under our base-case assumptions, EBITDA interest coverage is about 7x. Liquidity We expect liquidity to be adequate as defined in our criteria. Immediately following the merger, we expect Georgia Gulf to have about $140 million of cash. In addition, the company plans to enter into a new, unrated $500 million five-year asset-based lending (ABL) revolving credit facility, which we expect to be fully available at closing except for modest letter of credit usage. The ABL facility contains a minimum fixed-charge coverage ratio of 1.1x if excess availability falls below 12.5% of the facility size for three consecutive business days, which we do not expect to occur. We expect the term loan to contain a maximum 3.5x senior secured leverage covenant, under which the company should have ample cushion. Liquidity should be sufficient for the company to comfortably meet ongoing operating and capital requirements, including seasonal and other fluctuations in working capital and capital spending of about $175 million per year as well as outlays that management expects to total about $55 million to achieve merger-related synergies. We expect dividends to be modest--about $22 million per year if the company maintains its current quarterly dividend of $0.08 per share. Beginning in 2014, we expect the company to generate discretionary cash flow of more than $250 million per year. Relevant aspects of our assessment of the company's liquidity profile include our expectations as follows: -- Sources of liquidity will exceed uses by 1.2x or more during the next 12-24 months; -- Net sources would be positive even with a 15% drop in EBITDA; -- The company's sound relationships with banks and a generally satisfactory standing in credit markets; and -- The company should be able to absorb low-probability shocks because of available liquidity. Recovery analysis The senior secured debt rating is 'BBB-' (two notches above the corporate credit rating) with a recovery rating of '1', indicating our expectation of very high (90% to 100%) recovery in the event of a payment default. The senior unsecured debt rating is 'BB' (the same as the corporate credit rating) with a recovery rating of '4', denoting prospects for average (30% to 50%) recovery. For the complete recovery analysis, see our recovery report on Georgia Gulf to be published shortly on RatingsDirect on the Global Credit Portal. Outlook The outlook is stable. Despite industry cyclicality, we expect the company to achieve funds from operations to total adjusted debt of 25% or more. Post-merger, it should benefit from increased scale and, to an even greater degree than at present, low natural gas costs. In addition, during the next few years, we believe the company stands to benefit from an expected recovery in U.S. housing markets. There is some capacity at the current rating level for a moderate-size investment to increase vertical integration into ethylene production. Nevertheless, we could lower the ratings if economic conditions or other factors cause operating results to be weaker than we expect such that FFO to debt drops below 20% without prospects for near-term improvement. We believe this could occur if revenues remain flat at pro forma combined levels, debt is unchanged, and EBITDA drops about two percentage points to about 11%. Longer term, we could raise the ratings slightly if the company reduces debt and consistently generates FFO to debt above 30%. Ratings List Upgraded/Recovery Rating Revised; CreditWatch/Outlook Action To From Georgia Gulf Corp. Corporate Credit Rating BB/Stable/-- BB-/Watch Pos/-- Georgia Gulf Corp. Senior Secured BBB- BB/Watch Pos Recovery Rating 1 2 New Rating Eagle Spinco Inc. $212 mil. term loan due 2017 Senior Secured BBB- Recovery Rating 1 $688 mil. notes due 2021 Senior Unsecured BB Recovery Rating 4