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At the same time, we assigned a 'B-' issue rating to KraussMaffei's EUR325 million proposed eight-year bond. The recovery rating of '5' indicates our expectation of modest (10% to 30%) recovery for the bondholders in the event of a payment default.
The ratings on KraussMaffei reflect our view of the company's weak business risk profile and highly leveraged financial risk profile.
The business risk profile is restricted by KraussMaffei's operations in the highly competitive and cyclical plastics-processing machinery industry, as well as the company's weak and volatile, although improving, operating profitability. The business risk assessment is also restricted by KraussMaffei's relatively low share of aftermarket operations compared with industry peers'. A higher share of such operations could offset some of the cyclicality in new machinery sales, in our view.
On the positive side, we see that the company has well-established market positions in Europe and a broad product offering. Our assessment is also supported by the broad geographic diversity of the company's revenue generation. This is particularly because we expect growth prospects in emerging markets to remain relatively better than in KraussMaffei's domestic European market over the next two years. However, we believe the group would find it difficult to achieve similar diversification of its production operations, which are mainly in Europe.
KraussMaffei was hit particularly hard by the financial and economic crisis in 2009, when its revenues and order intake levels declined by 30% and 41%, respectively. These declines were high in comparison with peers' in the capital goods sector, but somewhat better than those of direct competitor Milacron Holdings Inc. (B+/Stable/--) in that year.
KraussMaffei's EBITDA turned to negative EUR55 million in 2009, owing to fairly high operating leverage and significant restructuring charges. Over the past few years, the company has implemented several restructuring programs aimed at improving its operating profitability, which coupled with volume growth allowed the group to return to its precrisis EBITDA margin of about 8%. We believe that the highly competitive nature of the industry will likely limit the scope of significant further margin expansion.
For our base case we assume flat revenue growth in 2013, followed by single-digit-percentage growth in 2014. We also assume steady improvements in the group's operating margin to an adjusted EBITDA margin of about 9% in 2014 from 8.5% for the fiscal year ended Sept. 30, 2012, despite a continuously difficult economic environment in Europe (see "Economic Research: The Eurozone's New Recession-Confirmed," published on Sept. 25, 2012). This is because we assume that demand trends will be more favorable in other regions, most notably emerging markets.
In 2012, KraussMaffei generated about 60% of its revenues outside Western Europe. We note that KraussMaffei's operating profitability is likely to be under pressure should the economic environment became more difficult. Our economic stress case assumes a decline in the eurozone (European Economic and Monetary Union) of close to 2%, which could lead to pressure on the rating. This compares with flat growth for 2013 as assumed under our base case. We view KraussMaffei's management and governance as fair.
Our financial risk profile assessment is based on the leveraged buyout by Onex Capital Partner, the private-equity sponsor. We assume that the current financial structure will be replaced by a EUR325 million secured bond, a EUR75 million revolving credit facility (RCF; which is drawn by about EUR60 million at closing) to be used for guarantees, cash balances of about EUR77 million, of which some EUR27 are expected to be restricted, and EUR281 million of common equity. This will translate into a debt-to-EBITDA ratio at closing, after our adjustments, of about 5.9x, which we assume will go down to 5.3x in 2013 and to 4.7x in 2014 under our base case. Funds from operations (FFO) to debt will remain between 9% and 12% over the next two years, in line with our assessment of the financial risk profile as highly leveraged.
We view KraussMaffei's liquidity as "adequate" as defined in our criteria. We estimate the ratio of liquidity sources to uses to exceed 1.2x for the next 24 months. We assume that, after successful refinancing in line with the proposed issuances, liquidity sources will consist of:
-- EUR50 million in unrestricted cash on closing the transaction. This includes about EUR25 million of cash that we assume will be needed to run the ongoing operations; and
-- Moderate annual free operating cash flows (FOCF) of about EUR10 million to EUR15 million in 2013 and 2014.
Liquidity uses will include some moderate seasonal swings in working capital that we expect the group to adequately cover with cash on the balance sheet. We assume no debt amortizations, dividends, or bolt-on acquisitions exceeding the size of the group's free cash flow generation.
We also assume headroom under the EUR75 million RCF facility of about EUR14 million for working capital funding. The RCF is subject to one financial covenant that stipulates net debt to EBITDA of less than 3.5x. This would be tested only if the company were to use the RCF materially (by more than 15% at the end of each quarter) for revolving loans, instead of letters of credit or bank guarantees.
The 'B-' issue rating on KraussMaffei's proposed EUR325 million senior secured bond due 2020 is one notch below the corporate credit rating. The recovery rating of '5' indicates our expectation of modest (10%-30%) recovery in the event of a payment default, reflecting our valuation of the company as a going concern and the favorable jurisdiction of Germany.
Nevertheless, the recovery rating is constrained by the marked cyclicality of KraussMaffei's business and its sizable priority liabilities (pensions and some factoring). Further constraints, in our view, are the EUR75 million RCF--which contains an option for an increase to EUR100 million and is secured with a first lien on receivables and inventories and a second lien on tangible fixed assets, intangibles, and share pledges--and the significant amount we assume to be outstanding under the proposed bond.
The net proceeds of the proposed bond, along with cash equity of EUR282 million, will be used to acquire KraussMaffei Group, refinance existing debt, and pay related fees. After issuance, the company's capital structure will comprise the new bond and an RCF of up to EUR100 million. The bondholders will benefit from a guarantee from KraussMaffei's operating companies, representing 91.5% of the group's aggregate EBITDA for the fiscal year ended Sept. 30, 2012.
According to the documentation, the bond has a security package comprising a first-ranking pledge on the shares of the issuers and guarantors and a first-ranking lien on all the intangible assets and tangible assets, excluding receivables and inventories. The RCF will be secured by a first lien on the receivables and inventories, which will be further encumbered by a second lien in favor of the bond via an intercreditor agreement.
The bond documentation contains some limitations on additional debt incurrence, including a minimum consolidated fixed-charge coverage ratio of 2x, excluding permitted debt, such as debt under any credit agreement not exceeding EUR100 million and 25% of consolidated net current assets (pro forma the transaction, there is no headroom under this clause for additional debt incurrence). Excluded debt also comprises nonguarantor debt of up to EUR15 million and an undefined amount under the receivables financing facility on a nonrecourse basis.
The documentation includes restrictions on liens, except for pari passu liens or junior liens on permitted debt relative to the bond, subject to a maximum consolidated senior secured leverage ratio of 2.25x. The senior secured leverage ratio pro forma the transaction is 3.3x, which does not give the group flexibility to incur additional secured debt at current ratio levels.
To calculate recoveries, we simulate a default scenario, in which we assume a decline in KraussMaffei's earnings, primarily from its manufacturing business. As part of our default scenario, we assume that the group would utilize EUR100 million under the RCF. We assume a hypothetical payment default in 2014, triggered by the group's inability to meet interest payments in that year, by which time we anticipate that EBITDA will have declined to about EUR52 million.
Given KraussMaffei's good market position in plastics-processing machinery solutions, we have valued the company as a going concern at the hypothetical point of default, using a multiple of proxy EBITDA. We have used a multiple of 5.0x taking into account the company's business risk profile and that of peers, resulting in a gross enterprise value of about EUR260 million at the hypothetical point of default.
We then deduct administrative costs, priority claims in the form of 50% unfunded pension liabilities, and part of the factoring facilities. We also consider that EUR100 million of the RCF would have been used, partly as letters of credit for third-party guarantees provided to the customers and for liquidity purposes. We assume that the advance-payment guarantees for customers would crystallize in the event of a default. This results in residual value of about EUR70 million for the EUR340 million bond (including six months of prepetition interest), leaving 10%-30% recovery for the bondholders, consistent with a recovery rating of '5' under our criteria.
The stable outlook incorporates our expectation of flat revenue growth in fiscal year ending Sept. 30, 2013, followed by growth of about 2% in 2014. In addition, we also anticipate the company posting an adjusted EBITDA margin of 8%-9%, minimally positive FOCF, no dividend payments, and no acquisition payouts exceeding FOCF generation. Our leverage parameter for the 'B' rating is debt to EBITDA lower than 6x.
We could lower the ratings if weakening operating performance were to lead to negative free cash flow, adversely affecting the group's liquidity, or a significant deterioration of credit measures, for example, if revenues declined by more than 10% and margins deteriorated by more than 200 basis points. A severe economic recession in Europe could significantly erode the company's revenue and lead to a negative rating action. We could likewise lower the ratings if KraussMaffei failed to refinance its current financial structure by the end of the second quarter of 2013, when part of the group's existing debt becomes short term.
Rating upside could stem from KraussMaffei continuing to deleverage and successfully improve its credit-protection measures on a sustainable basis. We could raise the rating if stronger-than-expected EBITDA generation led to leverage lower than 4.0x and FFO to debt of about 20%.
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
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Munich Holdings Corporation II S.a.r.l.
Corporate Credit Rating B/Stable/--
KM Germany Holdings GmbH
KM US Holdings II Inc.
Senior Secured* B-
Recovery Rating 5
*Guaranteed by Munich Holdings Corporation II S.a.r.l.