MOODY'S ASSIGNS A B3 RATING TO BORDEN CHEMICAL'S PROPOSED SR. SECURED 2ND LIEN NOTES; LOWERS SR. IMPLIED TO B2 FROM B1; OUTLOOK NEGATIVE
Approximately $1.1 Billion of Long-Term Debt Affected
New York, July 28, 2004 -- Moody's Investors Service assigned a B3 rating to Borden Chemical Inc.'s
(Borden) proposed $150 million floating rate senior secured second
lien notes, due 2010 and proposed $325 million fixed rate
senior secured second lien notes, due 2014. Moody's
also assigned a B1 rating to Borden's proposed senior secured revolving
credit facility due 2009. Commensurate with this rating action,
Moody's lowered Borden's senior implied rating and senior
unsecured issuer rating to B2 and Caa1, respectively. The
ratings downgrade considers the substantial increase in debt that will
result from Apollo Management L.P.'s (Apollo) purchase
of Borden for a price of approximately $1.2 billion (estimated
8.1 times actual EBITDA multiple). Based on actual EBITDA
of $149 million for the LTM ended June 30, 2004, pro
forma debt to EBITDA increases to 6.3 times from 3.6 times.
In light of the anticipated increase in Borden's debt, Moody's derives
some comfort from the fact that the company is emerging from a trough
in the chemical cycle and that 2004 EBITDA results should be much stronger
than the previous year. Nevertheless, Moody's is concerned
that Borden's financial profile would be stressed if it had to endure
another trough similar to 2001 to 2003 with this increased level of debt.
Moody's is also concerned that elevated feedstock prices could limit
improvements in operating margins and free cash flow. The ratings
outlook is negative. The following summarizes the ratings activity:
$150 million floating rate senior secured second lien notes due
2010 -- B3
$325 million fixed rate senior secured second lien notes due 2014
$175 million senior secured revolver due 2009 -- B1
$440 million senior unsecured notes and debentures due 2016 through
2023 -- to Caa1 from B2
$47 million senior unsecured debentures due 2019 -- to Caa1
$34 million senior unsecured industrial revenue bonds due 2009
-- to Caa1 from B2
Senior Implied -- to B2 from B1
Senior Unsecured Issuer Rating - to Caa1 from B2
In July 2004, Apollo and certain members of management entered a
definitive agreement to acquire Borden for a price of approximately $1.2
billion, including the assumption of outstanding debt. The
transaction is subject to regulatory approval and is expected to be completed
in 3Q2004. In connection with this transaction, during 2Q2004,
the company recorded a $137 million charge relating to the write-off
of its domestic deferred tax asset. The size of this charge was
unusual and certain tax code provisions could limit the company from utilizing
tax credits on its balance sheet.
The ratings reflect Borden's high pro forma high leverage with pro forma
debt to actual EBITDA of 6.3 times for the LTM ended June 30,
2004; negative book equity; modest coverage with actual EBITDA
to pro forma interest of 2.0 times; limited free cash flow
generation over the past several years; and its thin, albeit
improving, LTM EBIT margins of 6.1%. The ratings
also take into account increased production costs stemming from higher
feedstock and energy prices; higher insurance and legal expenses,
which have partially offset the benefits associated with the company's
cost reduction activities; a significantly underfunded pension plan;
material spending for environmental remediation; significant asset
write-downs during the June 2004 quarter; the uncertainty
over the strength of a recovery in the company's end-markets;
and the potential for a weakening in the new housing end-market,
which accounts for 18% of its revenue. The ratings are supported
by the company's leading market positions in resins for the forest products
industry and industrial applications, and formaldehyde; the
potential for reduced feedstock cost due to synergies with another company
owned by Apollo; the opportunity for additional cost reductions;
a favorable debt maturity profile; improvements in product volumes
and pricing; and its high proportion of sales covered by contracts
that largely pass through raw material price increases.
The negative outlook reflects Moody's concern over Borden's
ability to generate free cash flow (defined as cash from operations less
capital expenditures) given its high non-operating costs (i.e.,
pension costs and environmental and litigation expenses), and expectations
of higher interest expense and continued volatility in raw material prices.
If the company is able to reduce unadjusted leverage to below 5 times
on a sustainable basis and generate consistent free cash flow to debt
of 5 to 10%, Moody's will consider stabilizing the
outlook or upgrading the ratings. Conversely, negative ratings
pressure will be applied if a weaker than anticipated recovery or volatile
input prices result in debt to EBITDA exceeding 8.0 times or negative
free cash flow over the next twelve months.
The notching of Borden's revolving credit facility (rated B1) one-level
above the senior implied recognizes its senior position in the capital
structure and the benefit of collateral support under the borrowing base.
Availability is subject to a formula based on the sum of 85% of
receivables, 65% of inventories, 60% of eligible
PP&E, and 100% of cash. Moody's noted that certain
Canadian and U.K. subsidiaries will have access to sub facilities.
Borden's U.S. borrowings under the revolver are secured
by substantially all capital stock of the borrower and subsidiary guarantors,
as well as substantially all domestic tangible and intangible assets,
excluding manufacturing and processing plants. International borrowings
will be secured by substantially all the tangible and intangible assets
of the Canadian and U.K. borrower as well as a pledge of
stock in certain of their subsidiaries. Domestic borrowings will
be guaranteed by Borden's U.S. subsidiaries while international
borrowings will be guaranteed by certain U.S. and international
subsidiaries. The notching of the senior secured second lien notes,
at one-level below the senior implied, reflects their contractual
subordination to the senior secured credit facility and a weak collateral
package due to the absence of US and other international manufacturing
assets. The notes are secured by second liens on the same domestic
assets that secure the revolving credit facility. However,
Moody's believe that asset coverage is severely limited for the
note holders, given the size of the revolving facility and the limited
collateral package. The notes will benefit from guarantees from
domestic subsidiaries. Covenants under the indenture will allow
for restricted payments based on a percentage of consolidated net income.
The downgrade of Borden's existing senior unsecured notes and debentures
(now rated Caa1) to two-notches below the senior implied reflects
their contractual and structural subordination to the new senior secured
credit facility and senior 2nd lien notes. Moody's notes
that Borden Chemical, Inc. is an operating company,
which holds substantially all of the domestic assets of the company.
The downgrade recognizes the substantial increase in debt that will result
from Apollo's purchase of Borden. The company's pro
forma debt increases 73%, to roughly $940 million
from $543 million as of June 30, 2004, as it is expected
that only a small portion of existing debt will be redeemed in the transaction.
This level of debt is a concern for Moody's given the cyclical nature
of the company's formaldehyde-based products. The
company's EBITDA last peaked at $176 million in 1999 and
has just begun to recover in 2004. Nevertheless, the ratings
recognize the $280 million in additional equity provided by Apollo
for the transaction.
The ratings are supported by Moody's belief that credit metrics
will improve from initial pro forma levels over the next twelve to eighteen
months as the company benefits from the chemical commodities upcycle.
Since deteriorating from peak 1999 levels, EBITDA began to recover
in 2003, and has further improved in 2004. For instance,
EBITDA increased to $76 million in 1H2004 from $55 million
in 1H2003, and is expected to exhibit improvements in 2H2004 as
stronger industrial demand should continue to translate into higher volumes.
Moreover, an increase in North American gas drilling activity has
been the impetus behind a 43% increase in oil product sales for
2003. Borden is also pursuing international opportunities and has
recently expanded its presence in China through the formation of two separate
joint venture companies that will produce formaldehyde, resins and
UV-curable materials. However, Moody's is concerned
that a significant slow down in housing market could derail recovery in
US demand and margins. The company has benefited from a strong
housing market and a shift to production of OSB (oriented strand board)
The ratings also incorporate Moody's concern over Borden's exposure
to elevated feedstock costs primarily methanol, urea and phenol.
Methanol and urea prices increased 42% and 50%, respectively,
in 2003 and have remained high in 2004. Phenol prices, which
have increased significantly in 2004, are likely to increase further
due to the recent run-up in benzene prices to historic levels of
over $4 per gallon on the spot market. While the majority
of North American Forest Products sales are based on contracts that allow
the pass through of raw material costs, Performance Resins and International
sales are not protected to the same degree. In addition,
Forest Product contracts typically adjust quarterly, potentially
creating problems if prices are volatile. Moody's also anticipates
that feedstock costs will remain elevated over at least the next 12-18
months, which could increase working capital and pressure free cash
flow. Offsetting these feedstock issues is the potential benefit
from combining Borden's feedstock purchasing with another Apollo
portfolio company. Combined, these two companies will likely
be the largest single purchaser of phenol in North America. The
ratings also recognize that Borden has had some success passing through
raw material price increases, as evidenced by gross margins increasing
to 20.2% in 1H2004 from 19.2% in 1H2003.
The ratings further reflect that Borden's historical free cash flow
has been very limited. Although free cash flow was positive $48
million in 2001, it was negative $28 million in 2002 and
negative $8 million in 2003. Moody's noted that the company's
ability to improve cash flow will be challenged by several factors.
Besides the potential for weaker free cash flow due to higher feedstock
costs and working capital investments, capital expenditures are
expected to be around $40 million in 2004 (which is well above
maintenance levels) and could increase in 2005, depending on the
company's international expansion plans. Furthermore,
administrative cost increases could pressure cash flow as well.
For instance, legal and insurance expenses increased $13
million in 2003. Moody's also noted that the company's pension
was under funded by $70 million as of December 31, 2003.
Pension funding requirements are expected to be close to $25 million
in 2005. The company also has significant environmental liabilities,
which could range from $24 million to $74 million ($39
million was accrued on the balance sheet as of December 2003).
Offsetting these concerns to a limited degree are recent steps the company
is taking to reduce costs and the recent improvements in cash flow.
Cash from operations improved to positive $27 million in 1H2004
from breakeven levels the same period last year. Plans to improve
cash flow include amending its post-retirement medical benefits
in April 2003, which reduced annual cash requirements by $10
million. The company will also benefit from the previously mentioned
raw material arrangements as well as other anticipated cost reduction
activities and productivity initiatives.
Borden Chemical, Inc., based in Columbus, Ohio,
is a chemical producer of resins, formaldehyde, and coatings.
The company reported revenues of $1.51 billion for the LTM
ended June 30, 2004.
Corporate Finance Group
Moody's Investors Service
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service