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The preliminary ratings on Perstorp factor in the company's capital structure pro forma for the placement of the proposed $660 million and $430 million senior secured notes. We understand that Perstorp will use the funds to repay its existing debt.
The preliminary ratings reflect our assessment of Perstorp's business risk profile as "fair" and its financial risk profile as "highly leveraged." Funds managed by French private equity fund PAI Partners SAS (PAI; not rated) have owned Perstorp since 2005. We forecast Standard & Poor's-adjusted financial debt at year-end 2012 of SEK10.3 billion or SEK9.4 billion excluding a SEK0.9 billion shareholder loan.
In 2011, Perstorp reported SEK11.3 billion ($1.7 billion) of sales and SEK1.5 billion ($233 million) of EBITDA. The company holds leading market positions as a manufacturer of niche chemicals, notably aldehydes-driven production trees (oxo-chemical derivatives). It notably serves end markets in the resins and coatings, and plastics materials industries that in 2011 accounted for 33% and 20% of Perstorp's sales, respectively. The company operates eight plants in Europe, one in North America, and one in China. In 2011, Perstorp generated 64% of its revenues in Western Europe (mainly Sweden, Germany, The Netherlands, and the U.K.), 18% in the Americas, and 15% in Asia.
We consider one of the main rating constraints to be Perstorp's "highly leveraged" financial risk profile, with initial adjusted debt to EBITDA that we forecast at 7.7x (or 7.0x excluding the SEK0.9 billion shareholder loan) at year-end 2012. The other main constraint is the limited deleveraging we forecast under our base-case credit scenario, and the potential for negative free operating cash flow (FOCF) in view of sustained capital expenditure (capex) on expansion projects.
Partly mitigating these constraints are, however, Perstorp's "adequate" liquidity position after the proposed refinancing, with long-dated debt maturities and our calculation of sufficient headroom under the EBITDA-based maintenance covenants in the RCF and mezzanine loan documentation. We take a positive view of PAI's historically supportive stance; its EUR45 million equity injection as part of the refinancing; and its commitment to provide a further EUR30 million of additional subordinated equity to fund expansion capex, if needed. However, this commitment is still subject to board approval.
Our assessment of Perstorp's business risk profile as "fair" takes into account the company's mixed track record of profit and FOCF generation. Such generation has been weakened by unsuccessful acquisitions, such as that of highly cyclical isocyanate activities, which Perstorp has since transferred to its joint venture Vencorex. Our assessment also factors in the risks of near-term margin pressures due to weakening macroeconomic conditions in Europe, and Perstorp's exposure to this region. Other weaknesses are, in our view, the limited size and scope of Perstorp's operations compared with competitors such as BASF SE (A+/Stable/A-1) or Eastman Chemical Co. (BBB/Stable/A-2); and Perstorp's exposure to volatile feedstock prices, with 75%-80% of its raw materials based on oil (notably propylene) and natural gas.).
Business strengths include Perstorp's leading market positions in niche segments, notably its 30% global market share in oxoaldehyde (oxo) products. The company has refocused its strategy on its core chemical derivatives and expansion projects. The latter include a new butylene-based oxo reactor; the ramp-up of newly completed capacity at a caprolactones plant; and the construction of a new Neo (neopentylglycol) plant in China. We also recognize Perstorp's diversified product portfolio, and longstanding relationships with a well-diversified group of customers, of which the largest five account for only 10% of sales. Finally, we believe that Perstorp's profitability derives support from its track record of successfully passing through feedstock costs and its integrated business model, whereby it uses a significant share of production internally.
Under our base-case credit scenario, we forecast that Perstorp's EBITDA from continuing operations will decline to about SEK1.35 billion in 2012, from SEK1.5 billion in 2011. This forecast factors in EBITDA of SEK0.8 billion in the first half of 2012, but a substantial weakening in the second half, reflecting more challenging market conditions in Europe and the negative effect of the strengthening Swedish krona against the euro. Perstorp's EBITDA in the third quarter of 2012 was weak, in our view, at only SEK325 million. In 2013, we assume flat growth in EBITDA of SEK1.3 billion-SEK1.4 billion, factoring in a continued strong Swedish krona, persisting weak economic conditions, but also some contribution from Perstorp's growth projects. However, in our alternative downside scenario whereby we extrapolate Perstorp's performance in the second half of 2012, we believe that 2013 EBITDA could be lower at SEK1.2 billion-SEK1.3 billion. Our base-case assumption assumes negative growth of 0.8% in the eurozone (European Economic and Monetary Union) in 2012 and 0% GDP growth in 2013.
Under our base case, we forecast broadly flat adjusted debt to EBITDA of about 7x in 2013 (excluding the shareholder loan). Our projection of limited deleveraging over the medium term stems from a combination of projected negative FOCF due to ambitious capex plans of about SEK0.8 billion per year. We also forecast high interest costs, notably on Perstorp's SEK2.1 billion (EUR255 million) mezzanine loan.
Having said that, we believe that Perstorp's capex is relatively flexible, and that the company could generate what we would consider a reasonable amount of FOCF if it limited its investments to maintenance capex that we estimate at about SEK0.3 billion. Over the medium term, Perstorp's ability to deleverage will ultimately depend on its ability to grow EBITDA materially. In our view, this will depend in turn on improving market conditions in Europe, increased globalization of Perstorp's sales, and the successful execution of the aforementioned expansion projects.
Our adjustments to Perstorp's net financial debt pro forma the refinancing are sizable at SEK1.8 billion. These comprise SEK0.9 billion for the shareholder loan; SEK0.5 billion for unfunded pensions; SEK0.2 billion for operating leases; and SEK0.2 billion for cash that we estimate is tied to operations and therefore do not net from debt.
We assess Perstorp's liquidity as "adequate" under our criteria, pro forma for the issuance of the proposed notes. We estimate that liquidity sources should cover liquidity uses by more than 1.5x over the next 12 months.
Our liquidity assessment reflects the absence of medium-term debt maturities and our assumption of a fair degree of headroom under the maintenance covenants in both the SEK350 million RCF and mezzanine loan documentation. The RCF covenant stipulates a minimum level of EBITDA of about SEK940 million, which is about 30% below our base-case forecast. We anticipate a similar degree of headroom under the mezzanine loan covenants, which stipulate reported net debt to EBITDA of a maximum of 9.75x, and EBITDA interest coverage of a minimum of 1.20x.
Liquidity sources post refinancing over the next 12 months may include:
-- SEK350 million of availability under the proposed long-term committed RCF, due March 2017;
-- About SEK400 million of estimated surplus cash (deducting SEK200 million that we consider as tied to operations);
-- About SEK0.6 billion of funds from operations under our base case; and
-- A EUR30 million undrawn committed capex facility in the form of a subordinated equity contribution from PAI, if management needs to draw on it in the future.
Key liquidity uses over the next 12 months include:
-- No material medium-term debt maturities, with both the first- and second-lien notes maturing in 2017; and
-- About SEK0.8 billion of capex, although we believe that maintenance capex is closer to SEK0.3 billion.
We do not anticipate any acquisitions or dividends.
The preliminary issue rating on the proposed approximately $660 million first-lien senior secured notes due May 2017, to be issued by Perstorp, is 'B', one notch higher than the corporate credit rating. The preliminary recovery rating on the first-lien notes is '2', indicating our expectation of substantial (70%-90%) recovery in the event of a payment default. The first-lien notes are available in both U.S. dollars and euros.
The issue rating on the proposed $430 million second-lien senior secured notes due August 2017, to be issued by Perstorp, is 'CCC', two notches lower than the corporate credit rating. The recovery rating on the second-lien notes is '6', indicating our expectation of negligible (0%-10%) recovery in the event of a payment default.
The recovery rating of '2' on the first-lien senior secured notes derives support from our fair valuation of Perstorp as a going concern. This valuation is itself a function of Perstorp's broad and coherent business portfolio; the non-comprehensive, but in our view reasonable second-lien security package; and our view that the Swedish jurisdiction is creditor-friendly. The recovery ratings on the first-lien senior secured notes are constrained by the existence of a material amount of prior-ranking debt in the company's capital structure; the material debt baskets permitted for unsecured and secured debt; the limitations of the proposed notes' security package; and the complexity of the company's organizational and capital structure.
The recovery rating of '6' on the second-lien notes reflects these notes' contractual subordination to a significant amount of debt, including the RCF of SEK 350 million and the first-lien senior secured notes of $660 million.
The proposed debt structure is multi-layered. Perstorp will issue all the debt instruments, including the SEK350 million RCF, the $660 million first-lien notes, and the $430 million second-lien notes. The three categories of debt will share the same security package, but an intercreditor agreement will establish their first, second, and third pledges, respectively, on the security. The security consists mainly of tangible assets from Perstorp's subsidiaries in Sweden, Germany, the U.S., and the U.K., and other share pledges. We understand that these assets account for about 50% of the company's total assets. The proposed notes will also benefit from a guarantee from subsidiaries representing about 85% of the company's EBITDA.
The documentation for the super senior RCF provides lenders with fairly typical credit protections. However, atypically, its documentation only includes one maintenance financial covenant, specifying a minimum SEK940 million of EBITDA, regardless of the level of outstanding debt. This amount of EBITDA is equivalent to 60% of the SEK1.6 billion reported in the 12 months to June 30, 2012.
In our view, the documentation for the first- and second-lien notes has relatively weak terms and conditions, and significantly weaker credit protection than for the RCF, with additional debt only limited by incurrence-based covenants, and significant permitted debt and permitted collateral liens. In particular, the documentation allows for the establishment of a securitization facility of an unlimited amount. In light of the non-debt-related covenant on the RCF, we will monitor in particular the level of debt that the company incurs to assess whether the recovery prospects for the first-lien noteholders remain in the 70%-90% range.
Furthermore, atypically, the mezzanine loan includes the two maintenance financial covenants outlined above. A breach of this covenant would trigger a cross-default on the first- and second-lien notes after different cure periods for each note type. While the cross-default clauses provide protection for the noteholders, we note that the presence of this type of covenant in a contractually subordinated debt instrument is unusual and in our view provides the mezzanine lenders with some power to adversely influence negotiations on the path to a default.
In line with our criteria, to calculate potential recoveries, we simulate a hypothetical default scenario. The trigger for default is a combination of revenue deflation (due to intensified competition and slowing demand from European markets); margin pressure (due to inflation in raw material costs); and an increase in variable interest rates. This scenario would lead to a default in 2015 due to the company's inability to pay interests, with EBITDA declining to about SEK1.05 billion.
We envisage a stressed enterprise value of about SEK5.4 billion at the point of hypothetical default, which is equivalent to 5.0x stressed EBITDA. After deducting priority liabilities, mainly comprising enforcement costs, 50% of the unfunded pension deficit, and finance leases, we arrive at a net enterprise value of about SEK4.6 billion. We consider that the RCF would be fully drawn, leaving about SEK4.2 billion of value available for the proposed first-lien senior secured notes. This results in substantial (70%-90%) recovery prospects for the first-lien noteholders, but negligible (0%-10%) value for the second-lien noteholders.
The stable outlook reflects our view of Perstorp's "adequate" liquidity and our projection that its EBITDA and EBITDA margin will show a degree of resilience to the likely difficult European macroeconomic environment in 2013. This also assumes that the negative FOCF we forecast will remain limited, with the company managing expansion capex or otherwise receiving support from a EUR30 million undrawn committed capex facility from PAI in the form of a subordinated equity contribution.
We view a ratio of adjusted debt to EBITDA (excluding the shareholder loan) of about 6x-7x through the cycle as commensurate with the current rating. Including the shareholder loan, this ratio would be closer to 7x-8x.
Rating downside could occur if Perstorp's covenant headroom or liquidity deteriorated materially. A material deviation from our base case, such as EBITDA dropping to SEK1.2 billion-SEK1.3 billion in 2013 could also result in rating pressure.
Rating upside is unlikely over the coming years, in our view, as it would require substantial EBITDA growth from expansion projects and a more supportive macroeconomic environment, such that adjusted debt to EBITDA (excluding the mezzanine loan) improved to 5.5x or less on sustainable basis.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Criteria Guidelines For Recovery Ratings On Global Industrial Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008