October 22, 2012 / 5:06 PM / 7 years ago

TEXT-Fitch rates Spectrum's term loans and note 'BB-'

NEW YORK, Oct 22 (Reuters) - Spectrum Brands, Inc (Spectrum) will be issuing $1.840 billion in new debt primarily to finance the acquisition of Stanley Black & Decker’s Hardware & Home Improvement Group (HHI) which was announced on Oct. 9, 2012. The acquisition’s price is approximately $1.4 billion (7.4x June 30, 2012 LTM EBITDA). The $1.840 billion in proceeds will be used to pay approximately $1.4 billion for the HHI acquisition, repay $370 million in existing term loans with the remainder for related fees and expenses.

The new facilities are expected to close within the next three months and are outlined below and are assigned the following ratings:

—$700 million seven-year senior secured term loan ‘BB-‘;

—$100 million CAD seven-year senior secured term loan ‘BB-‘;

—$1,040 million senior unsecured note ‘BB-‘.

The term loans are guaranteed by SB/RH Holdings, LLC (Spectrum’s immediate parent company) and each of Spectrum’s domestic subsidiaries. There is a first lien on substantially all assets (excluding A/R and inventory) plus a 65% pledge of equity from first-tier foreign subsidiaries. The term loans have a second lien on A/R and inventory with the $300 million asset-based loan having the first lien on these assets. There are no financial maintenance covenants on these loans which is a change from the existing term loan. There is a $350 million accordion feature subject to a senior secured leverage covenant of 3.25x. Pricing for the term loans is to be determined but is subject to a 1.25% LIBOR floor.

The terms and conditions of the senior unsecured note will mirror those of the existing $300 million, 6.75% senior unsecured notes. Pricing is to be determined.

Fitch will withdraw ratings on the existing $370 million senior secured term loan upon repayment.

Rating Rationale:

Spectrum’s ‘BB-‘ rating and Stable Outlook is supported by its solid track record of improving margins, low single-digit organic growth rates since 2009, and ample levels of free cash flow (FCF) which has been used to reduce debt. In purchasing HHI, Spectrum adds an established entity with higher EBITDA margins and with less seasonal FCF. Further, in HHI there is minimal integration risk and synergy expectations, and both companies have the same value-based product offerings and go-to-market strategy. Spectrum remains committed to deleveraging and is expected to apply the additional profits from the acquisition towards debt reduction.

Rating Outlook:

There is no room in Spectrum’s rating for any further material debt or leveraging transaction. Adding leverage in a slowing global economy sounds a note of caution with Fitch despite the expectation of marked improvements in FCF with the acquisition and management’s commitment to deleveraging. Fitch expects FCF to decline moderately in 2013 given acquisition-related fees and modest integration spending but that FCF will increase markedly over 2012’s $150 million in 2014. Leverage is also likely to trend higher at the end of 2013 without a full year of HHI’s performance but improve markedly in 2014. Spectrum generates the bulk of its FCF in the fourth quarter and much of that has been used to voluntarily reduce debt; Fitch expects this to continue.

Corporate Governance:

Spectrum is a controlled company with limited independent directors and has a 57.5% majority owner in Harbinger Group, Inc. (NYSE: HRG). HRG (rated ‘B’; Stable Outlook) is a publicly listed entity controlled by funds managed by or affiliated with Harbinger Capital Partners LLC (collectively ‘Harbinger Capital’), a hedge fund. Harbinger Capital owns approximately 93% of HRG. HRG is a holding company primarily focused on obtaining longer term, controlling equity stakes in other companies. To that end, HRG uses the value of its portfolio investments as collateral for its own debt. HRG has pledged its Spectrum shares as part of the collateral for its 10.625%, $500 million notes.

From a rating perspective the concern exists that Spectrum’s leverage could increase to fund other HRG acquisitions or its cash flows diminish through heavy share repurchases or dividends which might lessen credit protection measures. Fitch believes this is mitigated by incurrence and maintenance covenants in both Spectrum’s and HRG’s debt facilities, as well as HRG’s focus on keeping debt levels moderate at its portfolio companies in order to maintain their value as collateral. At the HRG level, in order to use a portfolio company’s values as collateral, it has to maintain certain collateral coverage levels. HRG currently has a comfortable cushion over its requirement to maintain the fair market of collateral to secured debt of at least 2.5x. Fitch monitors HRG’s covenant cushion and compliance as part of Spectrum’s rating.

To secure funds, Harbinger Capital Partners Master Fund I, Ltd., which owns 50.9% of HRG on a fully diluted basis, has also pledged all of its shares in HRG together with securities of other issuers. If there was a foreclosure or sale of the HRG shares pledged as collateral, it would be a change of control of for both HRG and Spectrum. The change would not only accelerate all of Spectrum’s and HRG’s debt and preferred stock, but would cause Spectrum to be unable to use its net operating losses, which could negatively affect cash flows. Spectrum would need a waiver on its term loan and revolver, and might also need a waiver on its notes, as it is required to offer to repurchase those instruments.

Financial Performance and Liquidity:

Today, Spectrum announced preliminary, unaudited results for its fiscal year ended Sept. 30, 2012. Revenues grew 2.1% including 2.2% of negative foreign exchange with strong growth in Global Pet Supply and Home and Garden segments. The EBITDA margin of 14.9% improved sequentially for the third year and the company ended the year with leverage of 3.4x. FCF was approximately $157 million after the special $51 million in dividends paid in the fourth quarter.

Spectrum’s liquidity is good. The $300 million ABL was undrawn and there was $158 million in cash at year end. Current debt maturities are very modest through 2015 with less than $15 million due in each of the next three years.

Rating Action Triggers:

Negative: Any change in management’s strategy to de-lever to the 2.5x to 3.5x range within 24 months after the acquisition closes or sizeable leveraging transaction that would keep leverage above the mid-4x range could have negative rating implications.

Governance Implications Potentially Negative: A change of control due to issues with the majority owner could have negative rating implications. An event of default could occur if HRG and affiliates own less than 35% of Spectrum. If there is a change of control, it would most likely be due to foreclosure on the assets (i.e. Spectrum shares) backing financings at the parent level. In this event, all of Spectrum’s debt could accelerate unless the company obtains waivers. Any event related to a potential change of control at the Harbinger Capital level will be assessed upon occurrence.

Positive:

Unlikely in the near term.

Fitch currently rates Spectrum’s existing debt as follows:

—Long-term Issuer Default Ratings (IDR) ‘BB-‘:

—$300 million senior secured revolving credit agreement ‘BB-‘;

—$370 million senior secured term loan ‘BB-‘;

—$950 million 9.5% senior secured notes ‘BB-‘; and

—$300 million 6.75% senior unsecured notes at ‘BB-‘.

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