May 29 - Overview
-- U.S.-based diversified chemical producer Eastman Chemical Co.
plans to issue approximately $2.3 billion of senior unsecured notes to partly
finance its planned acquisition of U.S.-based specialty chemical maker Solutia
-- We are assigning a 'BBB' to the new notes.
-- All our other ratings on Eastman, including the 'BBB' corporate credit
rating, remain unchanged.
-- The stable outlook reflects our belief in Eastman's ability and intent
to strengthen its financial profile to levels appropriate for the ratings
within two years.
On May 29, 2012, Standard & Poor's Ratings Services assigned its 'BBB' senior
unsecured debt rating to Eastman Chemical Co.'s proposed offering of
approximately $2.3 billion of senior unsecured notes with five-, 10-, and
30-year maturities. The company plans to use the proceeds, along with proceeds
from a $1.2 billion five-year unsecured term loan, up to 15.8 million shares
of Eastman common stock (valued at about $780 million at the current share
price), and cash on hand to finance its approximately $5 billion acquisition
of Solutia Inc. (BB/Watch Pos/--). This amount includes funds to refinance
Solutia's outstanding debt and estimated transaction costs. The parties expect
the transaction, which is subject to Solutia shareholder approval and
customary closing conditions, to close by mid-2012.
All our other ratings on Eastman, including the 'BBB' corporate credit rating,
remain unchanged. The outlook is stable.
The acquisition of Solutia would strengthen Eastman's business risk profile to
"strong" from "satisfactory." The purchase, the price of which represents
about 10x Solutia's last-12-month EBITDA (excluding expected cost and tax
benefits), would add a substantial specialty chemical business with high and
relatively stable operating margins to Eastman's portfolio. We believe it
should enhance Eastman's competitive position by adding some complementary
technologies and accelerating access to high-growth markets, particularly in
Asia. We also believe that it would improve manufacturing site, product,
geographic, and end-market diversity. Moreover, Eastman should benefit from
increased overall size and scale, and lower capital intensity. Finally, the
acquisition appears to offer the opportunity for meaningful tax and cost
synergies. The integration has a high probability of success given Eastman's
experienced management team and recent track record with smaller transactions
and because its plans do not call for major operational restructuring.
Solutia's businesses consist of:
-- Technical Specialties (43% of 2011 revenues) includes insoluble sulfur
(a vulcanizing agent for tires), heat-transfer fluids, aviation hydraulic
fluids, and rubber chemicals;
-- Advanced Interlayers (43%) includes PVB (polyvinyl butyral)
interlayers and resins (the former increase the functionality of glass by
enhancing strength, flexibility, and safety); and
-- Performance Films (14%) includes specialty films for use in windows,
touch screens, and handheld electronic devices.
Eastman's primary products include:
-- Acetate fibers used in cigarette filters and other filters and
-- Coatings, additives, solvents, and resins used in paints and adhesives;
-- Performance chemicals and intermediates used in a wide variety of
-- Specialty plastics.
Although Eastman's operating profitability remains subject to industry
cyclicality and raw material cost swings, in recent years management has
increased the level and stability of operating profits through various actions
including acquisitions and divestitures, new product development, product line
extensions, and raw material sourcing. The acquisition of Solutia should
further increase margins and enhance stability. As a result, we expect
Eastman's operating profitability to become more typical of a specialty,
rather than commodity, chemical producer, with EBITDA margins averaging about
20%. Although the cost of the acquisition initially depresses return on
capital somewhat, we think pretax return on capital is likely to gradually
strengthen from approximately 15%, pro forma for the acquisition.
Despite these credit strengths, the transaction increases debt leverage and
weakens cash flow protection measures. Following the transaction, we expect
debt (which we adjust to include unfunded postretirement and environmental
liabilities and capitalized operating leases) to total about $6.6 billion, and
pro forma debt to EBITDA (before synergies) to be about 3.5x. However, the
improved business risk assessment, coupled with the issuance of about $780
million of equity (at Eastman's current share price) and the use of $500
million to $600 million in cash on hand to partially finance the transaction,
is sufficient to maintain the ratings and outlook. The company's
cash-generating ability and our expectation that management will make debt
reduction a high priority in the years immediately following the acquisition
are critical to maintaining the ratings. One year following the acquisition,
we expect the ratio of funds from operations (FFO) to total adjusted debt to
be in the low-20% area, and we expect this ratio to strengthen to about 25% by
the end of year two. Given Eastman's strong business risk profile following
the transaction, we expect this ratio to be 25% to 30% after those two years.
We continue to view Eastman's financial policy as moderate. In addition to
management's commitment to credit quality, we factor in its track record of
prudent financial policies. These include substantial actions to conserve cash
during the 2008-2009 recession and the strengthening of the financial profile
in advance of the Solutia acquisition beyond what is required for the current
We regard Eastman's liquidity as "adequate" (as defined by our criteria). At
closing of the Solutia acquisition, we expect Eastman's liquidity to consist
primarily of full or nearly full availability under its $750 million revolving
credit facility maturing in 2016 and a $250 million accounts receivable
securitization program maturing in 2015. Headroom under the 3.5x maximum debt
to EBITDA covenant in the company's credit facilities will decline but remain
adequate, in our view.
By the second year following the transaction, we expect Eastman to generate
more than $400 million of annual discretionary cash flow. This is after
midsize pension contributions, meaningful investment in working capital to
support sales growth, capital spending we estimate will average roughly $600
million in each of the next few years, and dividends that could increase
modestly from a pro forma level of about $160 million.
Until credit measures have strengthened to the appropriate levels for the
ratings, we expect Eastman to direct discretionary cash flow primarily to debt
reduction, including term loan amortization and scheduled note maturities in
The stable outlook reflects moderate financial policies that should support
our investment-grade ratings on the company. In the years immediately
following Eastman's acquisition of Solutia, we expect share repurchases to be
minimal and additional debt-financed acquisitions to be very limited. Credit
measures should meet our expectations even in the face of only modest global
economic growth this year. Nevertheless, we could lower the ratings if FFO to
total adjusted debt were to drop below 20% with limited near-term prospects
for recovery. We believe this could occur if revenue growth slowed to 1.5%
from expected pro forma 2012 levels and EBITDA margins dropped to about 17%
from roughly 20%.
Related Criteria And Research
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Key Credit Factors: Business And Financial Risks In The Commodity And
Specialty Chemical Industry, Nov. 20, 2008
Eastman Chemical Co.
Corporate Credit Rating BBB/Stable/A-2
Eastman Chemical Co.
Senior Unsecured notes due 2017 BBB
Senior Unsecured notes due 2022 BBB
Senior Unsecured notes due 2042 BBB
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