In assigning the preliminary ratings, we assumed that beauty and cosmetics packaging manufacturer Albea would successfully acquire U.K.-based Rexam PLC's cosmetics business; this transaction remains subject to regulatory approvals. We expect the transaction to complete by early 2013, and understand that proceeds from the notes issuance will be placed in escrow until the acquisition closes. The preliminary ratings are also subject to our review of the final documentation and capital structure.
The preliminary rating on Albea's holding company, Albea Beauty, reflects our assessment of the combined group's financial risk profile as "aggressive" and business risk profile as "fair."
We understand that the transaction will be financed using the proceeds from a $650 million equivalent high-yield senior secured note issuance. We estimate that the group's Standard & Poor's-adjusted debt will be below $700 million when the transaction closes.
Our assessment of Albea's financial risk profile as "aggressive" reflects our view of the combined group's forecast capital structure following the completion of the acquisition. Albea is owned by private-equity firm Sun Capital Inc., and we assess Albea's financial policy as "aggressive." The ratings are further constrained by limited audited historical financial data and track record. We forecast that Albea's adjusted pro forma debt-to-EBITDA ratio will be less than 5x at acquisition closing. We expect this ratio to improve to less than 4.5x as of Dec. 31, 2013, based on forecast improvements in operating performance.
Our assessment of Albea's business risk profile as "fair" reflects the combined group's position as a global leader in the niche beauty and cosmetics packaging market--combined sales are expected to total about $1.5 billion. The combined group is likely to benefit from economies of scale, an enhanced product portfolio and stronger market positions, (especially in higher-growth emerging markets, which we understand will represent 30% of total sales). The group benefits from long-standing relationships with blue-chip customers such as L'Oreal and Estee Lauder. It has improved its ability to pass on volatile raw material costs to customers--almost three-quarters of Albea's sales contracts included price-adjustment clauses in 2011.
The beauty and cosmetics packaging market has higher barriers to entry than some packaging industries (e.g., plastic film packaging), as industry expertise and innovative production is supported by ongoing research and development efforts. Beauty packaging remains an integral part of the end product, and is a key part of the customer purchasing decision and therefore marketing efforts.
These strengths are somewhat offset by the weak macroeconomic outlook in key European markets (which represent about 50% of combined group sales), exposure to more cyclical end markets where spend is somewhat discretionary in nature, and weak--if improving--EBITDA margins versus peers (we calculate an adjusted EBITDA margin of 8.4% for the 12 months to June 30, 2012, for Albea on a stand-alone basis). The group also suffers from some customer concentration--more than half of combined sales are expected to be to its top 10 customers.
Furthermore, the usual acquisition risks are inherent to the transaction, including uncertainty regarding the ability of Rexam's cosmetics business to function without the support of Rexam PLC.
We view Albea's liquidity as "adequate" under our criteria. We anticipate that liquidity sources will exceed liquidity uses by about 2x over the 12 months following the acquisition, which is estimated to complete by early 2013. During this 12-month period, our forecast liquidity sources comprise:
-- Cash on balance sheet of about $140 million; and
-- Funds from operations (FFO) of about $75 million.
We estimate that Albea's liquidity uses for the 12-month period, will include:
-- Capital spending of over $100 million; and
-- A modest working capital outflow.
Albea's up to EUR100 million European factoring and up to $60 million North American asset-based lending facilities support local liquidity. These facilities are subject to certain borrowing base limitations; as of June 30, 2012, $88 million would have been available under the European factoring facility and $48 million under the North American asset-based lending facility. The group has a degree of flexibility in curbing capital expenditure, which in turn could become a potential source of additional liquidity.
Once the notes have been issued, the group's liquidity position will benefit from its long-term debt maturity profile.
The issue rating on the proposed $650 million equivalent senior secured notes (due 2019) to be issued by Albea Beauty is 'B+', in line with the corporate credit rating. The recovery rating is '4', indicating our expectation of average (30%-50%) recovery in the event of a payment default.
The recovery rating is supported by our view of Albea's valuation as a going concern, its leading market position and the synergies expected to be achieved through the Rexam acquisition. The recovery rating on the proposed notes is constrained at the '4' level by:
-- The existence of material prior-ranking debt in the group's capital structure;
-- The limitation of the notes' guarantee and security package;
-- The existence of material debt allowance in the notes' documentation; and
-- France's relatively unfavorable jurisdiction for creditors.
The proposed notes will be contractually subordinated to the working capital assets pledged to the $60 million North American Asset-Based Lending (ABL) and the EUR100 million European factoring facilities, as well as structurally subordinated to debt raised at operating subsidiaries (currently about $16 million is available at subsidiaries).
The notes' guarantee and security package will have some important limitations, as they will exclude the contributions from French operating subsidiaries--these account for 33% of combined group sales and 22% of its EBITDA. As such, the proposed guarantee package will only comprise Twist Beauty Packaging S.a.r.l. (Luxembourg) and material subsidiaries, which are expected to represent 50%, 58%, and 69% of the combined group's revenue, EBITDA and net assets, respectively, as of the 12 months to June 30, 2012. This is a relatively low coverage level by market standards.
The collateral package (comprised of most of the guarantors' tangible and intangibles assets) also fails to capture French assets. The proposed notes' documentation will provide partial protection regarding Albea Beauty's ability to incur or guarantee additional indebtedness. An incurrence fixed-charge coverage ratio of at least 2.0x (on a pro forma basis) must be maintained if the company incurs additional unsecured debt. However, on a pro forma basis Albea would be able to assume significant additional indebtedness (about $300 million). Secured debt will also be subject to incurrence consolidated senior secured leverage test of maximum 3.75x (on a pro forma basis), which would currently leave no headroom for additional senior secured debt. In addition, there is no hard cap regarding Albea Beauty's ability to raise a qualified securitization facility.
In line with our criteria, to calculate potential recoveries, we simulate a hypothetical default scenario, that would be triggered by a combination of top line deflation (due to intensified competition, slowing demand from challenging European markets), margin pressure (inflation in raw material costs, delays in synergies from Rexam integration), and an increase in variable interest rates. This scenario would lead to a default in 2015 due to the Company's incapacity to service interest, with EBITDA declining to $117 million at the point of hypothetical default.
We envisage a stressed enterprise value of about $585 million at the point of hypothetical default, which is equivalent to 5.0 times the stressed EBITDA multiple. After deducting priority liabilities, mainly comprising of enforcement costs, 50% of the unfunded pension deficit and finance leases, we arrive at a net enterprise value of about $494 million. We envisage $222 million first-lien debt (including a fully drawn North American ABL, the European factoring facility, local lending facilities at subsidiary level, and six months prepetition interests). This would leave about $272 million residual value available for the proposed $650 million senior secured notes, resulting in average (30%-50%) recovery prospects for noteholders.
Albea reports under International Financial Reporting Standards. As part of our analysis, we have adjusted some of Albea's audited annual reported figures for 2011. The main adjustments are:
-- The addition of $40 million of postretirement benefit liabilities to debt.
-- The addition of $25 million of capitalized operating lease to debt.
-- The addition $18.5 million of preferred equity certificates (PEC) to debt; these were recognized as equity in Albea's accounts. We note that $2.6 million of PECs have already been recognized as debt in Albea's accounts. We understand that there is no further debt, or debt-like instruments (e.g., shareholder loans or preferred equity) above the reporting entity Twist Beauty S.a.r.l. & Partners S.C.A. in the group's structure.
-- The deduction of $8 million of what we consider to be available cash from debt. According to management, $20 million in cash is needed for the company's daily operations. We deducted this amount from Albea's reported cash of $28 million.
-- We also added back certain one-off restructuring costs to EBITDA.
The stable outlook reflects our opinion that Albea has the capacity to reduce its debt leverage steadily over the medium term through an improved operating performance and robust cash generation. We anticipate that following the acquisition pro forma credit metrics should be at levels commensurate with the 'B+' rating. Specifically, this means adjusted debt-to-EBITDA of less than 5.0x, and adjusted FFO-to-debt of more than 12% on a pro forma basis.
We could lower the ratings if Albea's operating performance and cash generation does not improve enough to allow the group to delever and credit metrics weaken to levels that we consider commensurate with a "highly leveraged" financial risk profile.
If Albea materially reduces its debt leverage, we could consider raising the rating.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Key Credit Factors: Methodology And Assumptions On Risks In The Packaging Industry, Dec. 4, 2008
-- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- Credit FAQ: Knowing The Investors In A Company's Debt And Equity, April 4, 2006
Preliminary Rating; CreditWatch/Outlook Action
Albea Beauty Holdings S.A.
Corporate Credit Rating B+/Stable/--
Senior Secured B+
Senior Secured 4