Overview -- U.S.-based specialty chemical producer PQ Corp. plans to borrow $200 million in a first-lien term loan, and use proceeds to pay down an existing $200 million revolving credit facility. -- We assigned our 'B+' issue rating to the proposed term loan, with a recovery rating of '2'. -- We revised our outlook on PQ Corp. to negative from stable, and are affirming the 'B' corporate credit rating on the company. -- The negative outlook reflects our view that economic weakness in important European markets could forestall the improvement in leverage credit metrics we expect at the rating, and could potentially even weaken metrics. Rating Action On March 29, 2012, Standard & Poor's Ratings Services affirmed its ratings, including the 'B' corporate credit rating, on Malvern, Pa.-based PQ Corp. At the same time, we revised the outlook to negative from stable. We have also assigned our 'B+' issue-level and '2' recovery ratings to PQ Corp.'s proposed $200 million senior secured first-lien term loan maturing 2014. The '2' recovery rating reflects our expectation for a substantial (70% to 90%) recovery in the event of a payment default. Our rating is based on preliminary terms and conditions. We expect proceeds from the proposed term loan to repay the company's existing $200 million first-lien revolving credit facility maturing 2013, which will be terminated following this transaction. Rationale The outlook revision to negative reflects our expectation that, despite the strength of the company's business risk profile, general economic weakness in important European markets in 2012 could hurt EBITDA, resulting in flat or lower EBITDA relative to 2011. This contrasts with our previous expectation for an improvement in 2012. Deterioration in EBITDA could stall a trend of improvement in leverage to levels appropriate for the current rating, or even further weaken leverage metrics during the next several quarters. Despite EBITDA growth in 2011, the ratio of adjusted debt to EBITDA remained high at about 7.2x as of Dec. 31, 2011, higher than our expectations at the rating of adjusted debt to EBITDA of about 6x. The company's ratio of funds from operations (FFO) to adjusted debt remained well below our expectations of about 10%. In our view, the company has little cushion at the current ratings for even temporary declines in earnings that could increase leverage levels. In addition, we believe high levels of debt maturing in 2014 would be an increasing credit risk if business conditions deteriorate, despite the immediate expected improvement in the company's debt maturity profile because of the proposed transaction. Our base-case scenario assumes slightly weaker EBITDA in 2012 relative to 2011. Key elements in our base case include: -- A weak overall economic environment in 2012 in Europe, where the company derives over 40% of revenues, resulting in lower EBITDA from the company's European operations. -- Modest improvement in domestic growth prospects, but insufficient to offset earnings weakness in European markets. -- Relatively flat earnings in the company's highly profitable catalyst segment, which we view as having potential to drive EBITDA growth in future years beyond 2012. -- We believe business strengths, including the company's well-entrenched market positions, and the resultant pricing power, could potentially offset any potential volatility in input costs. Our ratings on PQ Corp. reflect the company's "highly leveraged" financial profile (as our criteria define the term), including very aggressive financial policies; and its "fair" business risk profile. PQ is a specialty chemical producer that manufactures and markets inorganic specialty chemicals and specialty catalysts. The company produces sodium silicate, magnesium sulfate, zeolites, polyolefin catalysts, and other industrial chemicals. PQ also is the parent of Potters Holdings II L.P., a maker of glass beads for various industrial applications. Following the 2011 separation of the Potters business from PQ, we focus our view of credit quality at PQ on its standalone strength, although limited support from Potters could be available in the event of distress at PQ. This includes up to $20 million in dividends through 2016, an amount which could be higher based on growth in Potter's cash flow. All financial data references in this analysis, unless explicitly stated to be consolidated data, reflect our view of PQ's standalone financial profile. PQ Corp.'s highly leveraged financial profile and ownership constrain its ratings. The Carlyle Group is the majority owner of PQ, with financial policies that we characterize as very aggressive. We expect free cash flow generation in 2012 and beyond, but do not expect the company to meaningfully reduce its debt levels. Nonetheless, our ratings assume that management will pursue financial policies including growth plans or any acquisition plans that do not further stretch the highly leveraged financial risk profile. The business risk profile is fair, characterized by well-established market positions, significant geographic diversity, a largely inorganic raw material base, and high operating margins. Although the unusual severity and global nature of the economic downturn depressed volumes and earnings, we believe PQ's business strengths have contributed to a recovery in operating performance. The company has a No. 1 market position in product lines that make up more than 85% of sales and the No. 2 position in products that comprise most of the rest. In sodium silicate, its single largest product category by sales, PQ holds a major portion of the North American market and a strong position in the European market. Significant geographic diversity further supports the fair business profile. Nearly half of the company's sales are from overseas markets, principally in Europe. PQ operates many strategically located production sites globally, which provide diversity and an advantage versus its smaller and more narrowly focused competitors. Sodium silicate solutions are expensive to transport, and competitive production necessitates a large manufacturing base. However, operations are somewhat energy intensive and subject to volatile pricing in soda ash--a key raw material for the company. Nonetheless, the raw material base for the business is relatively broad and mostly inorganic, which limits exposure to volatility in petrochemical feedstocks. Liquidity We believe PQ will maintain "adequate" liquidity (under our criteria) over the next two years. We expect sources of funds, comprised primarily of cash on the balance sheet and cash flow from operations, to exceed uses by at least 1.2x over the next year. We believe net sources would be positive even with a 15%-20% drop in EBITDA. We base our conclusions on liquidity on the following assumptions: -- The company's proposed transaction goes ahead as planned and PQ is able to extinguish its revolving credit facility maturing 2013, and replace it with term loan maturing 2014 (PQ holds about $108 million in cash on its balance sheet at Dec. 31, 2011). Still, we view large debt maturities of over $1 billion in 2014 as a credit risk and expect that management will be proactive in refinancing these maturities. -- We expect free cash flow generation to be positive after factoring in a potential for an increase in capital spending to fund growth plans. -- The company is able to maintain sufficient cushions under its senior leverage covenant and total leverage covenant; and covenant compliance would also survive a 15% to 20% drop in EBITDA. -- The company would likely absorb low-probability shocks, based on positive cash flow from operations and available liquidity. Recovery analysis For the complete recovery analysis, see our recovery report on PQ Corp. to be published on RatingsDirect following the release of this report. Outlook The negative outlook reflects the possibility that the company's first-half 2012 results could be weaker than previous expectations, and result in an absence of improvement (or even a deterioration) in leverage-related credit metrics in 2012. We could lower the ratings in the next several quarters if it becomes apparent that earnings or cash flow are likely to weaken more than anticipated, and if expectations for improving economic conditions later in 2012 fail to materialize. We could also lower ratings if liquidity weakens below current levels, debt maturities due in 2014 become an increasing concern, or EBITDA cushions under covenants decline. On the other hand, we could revise the outlook to stable later this year if unexpectedly earnings, cash flow, and liquidity strengthen, leverage improves, and the company appears well-positioned to address its large debt maturities. In such a situation we would expect the ratio of funds from operations to total debt to strengthen to around 10%. Related Criteria And Research -- Methodology And Assumptions: Standard & Poor's Standardizes Liquidity Descriptors For Global Corporate Issuers, July 2, 2010 -- Criteria Methodology: 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 Ratings List Rating Affirmed; Outlook Revised To From PQ Corp. Corporate credit rating B/Negative/-- B/Stable/-- Rating Affirmed; recovery rating unchanged PQ Corp. Senior secured First-lien B+ Recovery rating 2 Second-lien B- Recovery rating 5 Ratings assigned PQ Corp. Senior secured $200 mil. term loan due 2014 B+ Recovery rating 2 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. 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