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Rating Action:

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

28 Jul 2004
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:

Ratings Assigned:

$150 million floating rate senior secured second lien notes due 2010 -- B3

$325 million fixed rate senior secured second lien notes due 2014 -- B3

$175 million senior secured revolver due 2009 -- B1

Ratings Downgraded:

$440 million senior unsecured notes and debentures due 2016 through 2023 -- to Caa1 from B2

$47 million senior unsecured debentures due 2019 -- to Caa1 from B2

$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) from plywood.

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.

New York
Mark Gray
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
John Rogers
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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