Overview -- U.S.-based steel mill services company Phoenix Services International LLC intends to raise new bank debt to refinance existing loans and fund expansion capital expenditures. -- We expect leverage to increase to about 4.5x EBITDA, which we view to be indicative of an "aggressive" financial risk profile. -- We lowered our corporate credit rating on the company to 'B' from 'B+' and we assigned a 'B' issue-level rating to the proposed $305 million first-lien bank loans. -- The stable outlook reflects our view that EBITDA from new contracts will offset losses related to a recent customer bankruptcy, supporting leverage in the 4x to 5x EBITDA range over the next 12 months. Rating Action On Nov.12, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Phoenix Services International LLC to 'B' from 'B+'. The rating outlook is stable. At the same time, we assigned a 'B' (same as the corporate credit rating) issue-level rating to its subsidiary Metal Services LLC's proposed $275 million first-lien loan due 2017 and its proposed $30 million first-lien revolving credit facility due 2016. The 'B' issue-level rating and the '3' recovery rating indicate our expectation for meaningful (50%-70%) recovery in the event of default. Rationale The lower rating on Phoenix Services reflects our expectation that leverage will increase to about 4.5x EBITDA from about 3.5x due to higher absolute debt levels associated with the company's proposed financing. We view this level to be indicative of an "aggressive" financial risk profile and more in line with the lower rating. The corporate credit rating on Pennsylvania-based Phoenix Services reflects our view of the company's financial risk as "aggressive" and its business risk as "vulnerable." Risks include the company's high customer concentration, as well as our view that the outsourced steel services industry is very competitive and that the variable component of Phoenix's service contracts could expose the company's cash flow to cyclical swings. Our expectation for weak global steel production in 2013 reinforces these risks. Still, Phoenix Services continues to win new contracts from new and existing customers and it maintains good EBITDA margins relative to peers. We believe margins have been good, in part, because of the company's success in recovering valuable iron during its slag processing operations. Phoenix Services is privately owned and does not file public financial statements. Our 2013 baseline scenario for Phoenix Services assumes the company closes its proposed financings as currently contemplated, its debt climbs to about $340 million (with adjustments), and leverage initially increases by one full turn to about 4.5x. Leverage should recede closer to 4x by the end of 2013 if external growth offsets some expected diminution in organic cash flow, and if the company's relatively strong EBITDA margins (not disclosed) hold up. We further expect funds from operation (FFO)-to-debt to be in the 12% to 20%, which is consistent with an aggressive financial risk profile. We expect 2013 revenue and EBITDA to grow 5% to 15% despite weak industry conditions. Phoenix Services continues to win new contracts, including recent agreements with new customer Nucor Corp. (A/Stable/A-1) and existing customer ArcelorMittal (BB+/Negative/B). We expect this external growth to offset a loss of cash flow related to the 2012 bankruptcy filing by former customer RG Steel LLC (not rated). That said, we expect global steel production to be weak in 2013. Domestic capacity utilization is currently below 70% (according to the American Iron and Steel Institute) and we expect utilization to remain below the industry's 80% historical average next year. We also expect overseas production to remain weak given stagnant European economies and less-robust demand in emerging markets. We expect these conditions to particularly weigh on Phoenix Services' recently acquired French operations. Phoenix Services was founded in 2006 to provide steel mill services including the handling and processing of slag, a byproduct of steel production. We view this business to be highly fragmented and very competitive, with its major competitors including Tube City IMS Corp, (BB-/Stable/--) and Harsco Corp. (BBB/Negative/A-2). Phoenix Services' operations are geographically diverse: the company derives roughly half of pro forma revenues from the U.S. and the balance from France, Romania, South Africa and (beginning in 2013) Belgium. Its customer concentration is high, as ArcelorMittal accounts for a significant amount of revenues. Liquidity In our opinion, Phoenix Services has an "adequate" liquidity position pro forma for the proposed credit facilities and based on the following observations and estimates: -- We expect sources of liquidity, including $30 million of revolving borrowing capacity and $45 million of excess proceeds from the proposed bank loan, to cover estimated uses by more than 1.2x over the next 12 months; and -- We expect the leverage covenant under the proposed bank loans will initially be set with a 25% EBITDA cushion. We expect Phoenix Services to retain $45 million of excess cash (pro forma for the proposed financing transaction). We also expect the company to have full availability under its new $30 million revolving credit facility due 2016. We expect related covenants to be set with a 25% EBITDA cushion. Other sources of liquidity include our estimate for between $40 million and $60 million of FFO annually. Uses of liquidity are expected to include between $60 million and $70 million of maintenance and expansion capital expenditures, up to $10 million in working capital needs, and about $3 million in mandatory principal amortization. Phoenix Services will have no bullet maturities until the proposed term loan matures in 2017. Recovery analysis The 'B' issue-level ratings and '3' recovery ratings on subsidiary Metal Services LLC's proposed $275 million first-lien loan due 2017 and proposed $30 million first-lien revolving credit facility due 2016 indicate our expectation for meaningful (50%-70%) recovery in the event of default. This recovery estimate reflects our distressed gross valuation of $200 million that applies a 5x multiple to $40 million of distressed EBITDA. Our simulated default scenario assumes a global economic downturn in 2015 that severely constrains demand for steel and causes Phoenix Services' customers to shut mills and renegotiate contracts on terms that are less favorable to Phoenix Services. Outlook The stable outlook reflects our baseline view that leverage is unlikely to continue to rise above 4.5x and is more likely to recede gradually, near to 4x by the end of 2013. This is driven by new contracts with steel producers including Nucor Corp. and cash flow from other operations that ramped up in 2012 that we expect to support modest improvement in 2013 EBITDA. An upgrade is unlikely in the next 12 months because we don't expect leverage to return to recent lower levels given the company's higher absolute debt levels (following the proposed debt transactions) and our expectation for only moderate EBITDA growth next year. We would raise our ratings over the longer term if the company uses its free cash flow to pay down term debt over time, such that leverage falls and is maintained more comfortably in the 3x to 4x range. We would lower our rating if leverage increased above 5x, which we would view to be indicative of a highly leveraged financial profile. This could occur if the company raised additional debt to fund new capital projects or pay distributions to its private equity owner or if another large tenant filed for bankruptcy protection. We view the latter scenario to be less likely given that the company's largest tenants (including ArcelorMittal and Nucor) are rated in the 'BB' category or higher. Temporary phone numbers: James Fielding (917-734-3477); Megan Johnston (917-715-3892). Related Criteria And Research -- Industry Report Card: U.S. Natural Resources Split As Housing Boosts Building Products Companies While A Tough Market Puts Coal Miners Deeper In The Hole, Oct. 8, 2012 -- Issuer Ranking: U.S. Metals And Mining Companies, Strongest To Weakest, Oct. 2, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- Credit FAQ: Knowing The Investors In A Company's Debt And Equity, April 4, 2006 Ratings List Downgraded; Outlook Action To From Phoenix Services International LLC Corporate Credit Rating B/Stable/-- B+/Negative/-- Downgraded To From Phoenix Services International LLC Senior Secured B BB- Recovery Rating 3 2 New Rating Metal Services LLC Senior Secured US$275 mil bank ln due 06/30/2017 B Recovery Rating 3 US$30 mil revolving credit fac bank B ln due 12/31/2016 Recovery Rating 3 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 column.