-- U.S.-based diversified industrial company Eaton Corp.
announced in May 2012 its plans to acquire electrical equipment maker Cooper
Industries PLC for about $11.8 billion in cash, debt, and an equity
-- We are assigning our 'A-' issue rating to Eaton's proposed senior
unsecured debt issues to fund the acquisition.
-- Our 'A-' long-term and 'A-2' short-term corporate credit ratings on
Eaton remain unchanged.
-- The negative outlook reflects our belief that credit metrics will be
stretched for the rating following the partly debt-financed acquisition, and
we could lower the rating if they do not improve.
On Nov. 14, 2012, Standard & Poor's Ratings Services' ratings on
Cleveland-based Eaton Corp., including the 'A-' long-term corporate credit and
senior unsecured debt, and 'A-2' short-term ratings, remain unchanged. The
outlook is negative. At the same time, we are assigning our 'A-' senior
unsecured debt ratings to Eaton Corp.'s proposed senior unsecured debt issues.
The senior unsecured notes will be guaranteed by its material domestic
subsidiaries. There is also a change of control provision in the notes.
The rating reflects our expectation that Eaton is likely to sustain its
operating prospects and that its planned contribution of equity to fund a
considerable portion of the Cooper Industries PLC (A/Watch Neg/A-1)
acquisition is sufficient to maintain the rating. However, the negative
outlook recognizes the potential for a lower rating if weak market conditions,
deterioration in operating performance, or a less conservative financial
policy delays expected improvements.
The rating also reflects our view that Cooper represents a good strategic fit
for Eaton because it expands the company's product offerings, presents synergy
opportunities, and adds a business that carries good operating margins (before
depreciation and amortization) in the mid-teen percent area. Eaton and Cooper
shareholders approved the transaction, and we expect the Cooper acquisition to
close by the end of this year.
Eaton's credit quality measures are currently somewhat subpar compared with
ratios we expect for the rating. Eaton is acquisitive and demonstrates a
growth strategy that can stretch credit metrics. We expect the partly
debt-financed acquisition of Cooper to weaken credit measures further on the
close of the acquisition. Still, we expect these measures to recover to
appropriate levels in 2014--including adjusted funds from operations (FFO) to
total adjusted debt of about 40%-45%--as the company pays down debt and
benefits from some medium-term improvement in economic conditions and an
improved cost structure largely because of recent and future cost cutting.
Eaton is a globally diversified power management company, with several large
segments that cover the gamut of early-, mid-, and late-cycle businesses. We
believe Eaton's operating performance in the next one to two years will depend
on both broad macroeconomic indicators, such as global and U.S. GDP growth,
and more specific indicators including U.S. nonresidential construction
spending and industrial production. We forecast mid-single-digit revenue
growth in our forecast through 2014 for the combined company.
Eaton's global electrical businesses--which will account for more than half of
its sales--provides power distribution, power quality equipment, and service
solutions to the electrical industry, including the utility, industrial,
commercial, light commercial, government, institutional, and residential end
markets. The addition of Cooper's business and products will complement
Eaton's. We expect the markets, primarily nonresidential construction markets
in the U.S., to expand modestly in 2013 and 2014.
The company has a "strong" business risk profile, in our assessment. Factors
supporting our view include the company's strong competitive business position
in the cyclical global industrial equipment market, its strong cash flow
generation, and our expectation that it will perform acceptably even in the
currently weak economy. We expect gradual global economic growth to support
continued increases in demand for Eaton products. We believe the pro forma
combined business profile will benefit from very good geographic and
end-market diversity. However, the company will remain exposed to some
cyclical and competitive markets.
Although end markets are currently somewhat mixed, we expect the company to
use free cash flow to improve credit measures after the acquisition closes.
The company generates meaningful free cash flow, and we expect this to
increase with the addition of Cooper's operations. We adjust total debt for
capitalized operating leases and pension and postretirement obligations in our
calculation of credit ratios. We also regard Eaton's postretirement benefit
liabilities as sizable, but manageable, because we expect Eaton to make any
necessary voluntary cash contributions.
Our short-term rating on Eaton is 'A-2'. We consider the company to have
"strong" liquidity that can more than cover its needs for the foreseeable
future, even if EBITDA declines sharply. Our assessment of Eaton's liquidity
profile incorporates the following expectations and assumptions:
-- We expect the company's sources of liquidity, including cash and
facility availability, to exceed its uses by more than 1.5x over the next 12
-- We expect net sources to remain positive, even if EBITDA declines more
-- Because of the company's good conversion of EBITDA to discretionary
cash flow, we believe it could absorb low-probability, high-impact shocks and
that it has good access to capital markets.
Liquidity sources for Eaton currently include about $1 billion in cash and
short-term investments as of Sept. 30, 2012. The company has $2 billion in
credit facilities that back up commercial paper. We expect Eaton to generate
strong operating cash flow following the transaction.
Eaton made discretionary contributions to its pension and post retirement
plans in January 2012. Other uses of cash (excluding the pending funding for
Cooper) include the company's dividend payment (which we estimate at more than
$500 million for 2012) and capital expenditures, which we expect to be about
$500 million in 2012. Eaton does not have material near-term debt maturities.
We expect the combined company's ratios of capital expenditures to sales and
dividends to net income will remain consistent with current ratios. The
company has a 20 million share repurchase program and historically has engaged
in moderate share repurchase activity. We do not expect any sizable share
repurchases after the transaction.
The outlook is negative. We expect credit measures to improve to levels
consistent with the 'A-' rating. We could lower the rating if weaker market
conditions delay this expected improvement, and FFO to total adjusted debt
remains less than 35% through 2014. We do not expect Eaton to make any further
meaningful acquisitions nor any share repurchases that would further
deteriorate credit measures. We could revise the outlook to stable if Eaton is
on track to meet expectations in 2014.
Related Criteria And Research
-- Methodology: Short-Term/Long-Term Ratings Linkage Criteria For
Corporate And Sovereign Issuers, May 15, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Corporate Credit Rating A-/Negative/A-2
Sr. unsecured notes due 2017 A-
Sr. unsecured notes due 2022 A-
Sr. unsecured notes due 2032 A-
Sr. unsecured notes due 2042 A-