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Rating Action:

MOODY'S ASSIGNS A (P)Ba3 SENIOR IMPLIED RATING TO AVIO HOLDING S.P.A. AND A (P)B2 RATING TO ASPROPULSION CAPITAL B.V.'S PROPOSED SENIOR NOTES ISSUE; OUTLOOK STABLE.

23 Sep 2003
MOODY'S ASSIGNS A (P)Ba3 SENIOR IMPLIED RATING TO AVIO HOLDING S.P.A. AND A (P)B2 RATING TO ASPROPULSION CAPITAL B.V.'S PROPOSED SENIOR NOTES ISSUE; OUTLOOK STABLE.

Approximately Euro 200 million of Debt Securities Affected.

London, 23 September 2003 -- Moody's Investors Service today assigned a (P)Ba3 senior implied rating to Avio Holding S.p.A. ("Avio Holding") and a (P)B2 rating to the proposed issue by ASPropulsion Capital B.V. of Euro 200 million of senior notes due 2013. The proposed issue, along with Euro 749.4 million of drawings under Avio S.p.A.'s ("Avio" or "the company") senior secured credit facilities, will primarily be used to refinance existing indebtedness assumed by Avio in connection with the contribution of the Avio business by the Fiat group to Avio. New ratings assigned include:

- Senior implied rating of Avio Holding S.p.A. at (P)Ba3;

- Unsecured issuer rating of Avio Holding S.p.A. at (P)B2;

- Proposed Euro 200 million in senior notes due 2013 at ASPropulsion Capital B.V. at (P)B2.

The outlook for all ratings is stable.

SUMMARY RATING RATIONALE:

The (P)Ba3 senior implied rating reflects: (i) the company's leading position as a global supplier in the aeroengine market; (ii) the high market barriers to entry that exist in the aeronautical industry; (iii) Avio's long-term relationships with leading aircraft engine manufacturers and national governments and its experienced management team; (iv) the political and strategic importance of Avio to the Italian government; (v) the stable and predictable nature of the majority of the company's earnings and cash flow; (vi) its diverse engine portfolio; (vii) its conservative hedging policy; and (viii) Moody's expectation that Avio should maintain adequate liquidity given available cash balances, undrawn bank commitments and limited mandatory debt amortisation before 2005.

However, the rating also reflects: (i) Avio's significant exposure to the commercial airline sector; (ii) the company's high financial leverage; (iii) strong competition in both Avio's direct and end customer markets; (iv) Avio's increasing participation in risk/revenue sharing programmes which exposes the company to downside risk including cost overruns as well as negatively impacts working capital; and (v) the prevalence of large revenue programmes which, whilst customary for this industry, result in high customer concentration and large fluctuations in working capital, and can be subject to material delays or cancellations due to both technical and financial reasons which could negatively impact Avio's operating performance.

The stable outlook reflects Moody's opinion that despite the prevailing weak market conditions in the civil aerospace industry, Avio's near term earnings will be supported by its more predictable military division and that consequently Avio will remain free cash flow generative and will use its free cash flow to reduce indebtedness and will not make acquisitions that will materially impact leverage or free cash flow generation.

KEY CREDIT POSITIVES:

Avio benefits from its leadership position as a global supplier in the aeroengine market including being a leading supplier of accessory gearbox modules and low pressure turbine components, a leading independent manufacturer worldwide for power transmissions for turboprops and helicopters and the sole supplier to European space programmes of solid rocket motors for space launchers.

High market barriers to entry exist in this sector given: (i) the stringent certifications and approvals required from government regulators, aviation authorities and customers; (ii) the capital intensive nature of the business with substantial upfront investments and technological expertise required to design and produce for long life components; (iii) the necessity to develop strong customer relationships; and (iv) the reluctance of customers to change partners after products have received design approval.

The company has a well established record of working in the aeronautical industry and benefits from the long-term relationships it has developed with a number of leading aircraft engine manufacturers, e.g. General Electric, Rolls-Royce and Pratt & Whitney, as well as partnerships with national governments and their ministries, e.g. the Italian military and the UK, German and Saudi air forces, as well as certain national and domestic airlines, e.g. Alitalia. In addition, the management team is highly experienced and has an established track record in running its business. Whilst the buy-out will introduce new challenges to management, including operating in a leveraged environment, management will benefit from the guidance and support of its experienced shareholders.

As one of only two Italian-controlled companies operating in the Aerospace & Defence industry, Moody's believes that the company is of significant political and strategic importance to the Italian government and is therefore likely to benefit going forward from political backing within Italy as well as government support e.g. through continued Law 808/85 financing, whereby the Italian government provides funding to Avio and other Italian companies operating in the aerospace industry in order to encourage research and development activities. Such financing is long term and interest free, with payback linked to the commercial success of the related programme.

The majority of the company's earnings and cash flow are derived from its stable and long-term military, space and spares businesses. The company therefore benefits from long term visibility of earnings for a significant percentage of its business. While 2002 and H1 2003 operating performance has been weak due to the difficulties in the civil divisions, order backlog is currently Euro 2.6 billion (up from Euro 2.4 billion in December 2002) and the company is expected to remain free cash flow positive going forward.

Historically the profitability of civil and military engine programmes has varied significantly during their life cycles, which involves development, production and aftermarket phases. Avio benefits from a diverse engine portfolio which includes a significant proportion of young commercial engines that are currently entering the more profitable mature phase of the engine life cycle, which should help to support margins in the civil division over the medium term.

Pro-forma for the close of the transaction, the company will have cash balances of Euro 13.5 million as well as access to a Euro 150 million revolving credit facility (which is projected to be undrawn at close) and a Euro 200 million performance guarantee facility. Drawdown under the revolver is subject to certain conditions including compliance with financial covenants (including inter alia a total debt/EBITDA test, a senior debt/EBITDA test and certain interest cover tests) and the facility also contains a material adverse change clause. However mandatory amortisation under the bank facilities is low in the first two years and headroom under the financial covenants appears reasonable. Liquidity is therefore believed to be adequate. In addition, whilst Avio is exposed to fluctuations in foreign exchange given that the majority of Avio's manufacturing costs are in Euros whereas a substantial amount of revenue is generated in other currencies (particularly US$), the company is putting in place a comprehensive foreign exchange hedging strategy, which should reduce future earnings volatility.

KEY CREDIT RISKS:

The senior implied rating also reflects Avio's significant exposure to the commercial airline sector, which is a highly cyclical industry and currently suffering a severe downturn with no expectation of improvements in the near term. In light of this and pro-forma credit metrics, with Total Debt/EBITDA of 4.6x and EBITDA/cash interest expense of 3.2x, the company is viewed as highly leveraged. In addition, Moody's has taken into consideration the high level of performance guarantees given by the company to customers (expected to be in the region of Euro 130 million going forward), albeit that there have been no significant warranty claims in the past, as well as unsecured non-trade payables relating to employee severance indemnities and Law 808/85 funding (currently approximately Euro 425 million).

Avio also faces strong competition in both its direct market, i.e. the provision of components and assemblies to aeroengine manufacturing customers, as well as its end customer market where aeroengine manufacturing customers compete for business from airlines and governments. As a consequence, the company is increasingly participating in risk/revenue sharing programmes with original equipment manufacturers and major suppliers, particularly for civil projects. Whilst this benefits Avio to the extent that it participates in the upside of the project and is locked in to long term new engine sales and spare parts sales over the life of the programme, it also exposes Avio to downside risk including cost overruns and negatively impacts working capital since Avio must fund a portion of the associated development costs, which includes an upfront cash entry fee.

In addition, given that a significant proportion of Avio's revenues are generated from large projects, customer concentration is high, e.g. General Electric represented 32% of 2002 revenues whilst Avio's top eight customers represented 76% of 2002 revenues, and working capital can be subject to large variations depending on the timing of programmes. Also, such projects can be subject to material delays or cancellations due to both technical and financial reasons which could negatively impact Avio's operating performance.

Moody's notes that the company may pursue potential acquisitions in the future but cautions that any acquisition that materially impacts leverage or free cash flow generation is likely to put downward pressure on the ratings.

TRANSACTION OVERVIEW:

On 1 July 2003, Avio Holding, a newly incorporated Italian company ultimately controlled by The Carlyle Group ("Carlyle") and Finmeccanica S.p.A. ("Finmeccanica") and certain of their affiliates, entered into an agreement to purchase the entire share capital of Avio from Fiat S.p.A. for a total consideration of approximately Euro 1.5 billion (including the assumption of debt). Avio is a newly incorporated company containing substantially all of the assets and liabilities related to the aviation business previously contained in FiatAvio S.p.A., with the exception of certain assets and liabilities related to businesses discontinued by FiatAvio S.p.A. in the past or other businesses not aviation related.

It is proposed that the acquisition will be funded through Euro 625 million of equity (comprising Euro 475 million cash equity contributed by Carlyle and Finmeccanica and a Euro 150 million vendor loan note from Fiat), Euro 200 million of senior notes and drawings under the Euro 899.4 million of senior secured credit facilities (Euro 749.4 million drawn at closing), with Euro 25.6 million of existing indebtedness remaining in place. Post closing, Carlyle will own approximately 70% of the company, whilst Finmeccanica will own the remaining stake. Management will hold stock options on 6% of the company subject to certain return targets being met.

The Euro 899.4 million of senior secured facilities and a Euro 200 million senior performance bond facility will both be contractually and effectively senior to the proposed notes. The vendor loan note will be both structurally and contractually subordinated to both the senior facilities and the proposed notes, will have a tenor of twelve years and six months, i.e. two and a half years longer than the notes, and will be non cash pay for life. In addition, the holders of the vendor loan notes will not benefit from any acceleration rights whilst the notes are outstanding.

STRUCTURAL CONSIDERATIONS:

The (P)B2 rating on the senior notes reflects the fact that the proposed issuer is a special purpose vehicle, hence the claims of note holders are removed from the main operating company (Avio), as well as the fact that the notes are contractually subordinated to a significant amount of priority debt at Avio, including both secured creditors, i.e. Euro 749.40 million of drawn credit facilities, a Euro 150 million revolver and a Euro 200 million performance bond facility, and unsecured creditors including, inter alia, approximately Euro 100 million of employee severance indemnities and Euro 325 million of Law 808/85 payables.

However, Moody's acknowledges the benefit to note holders of the Euro 200 million indirect claim at Avio, albeit subordinated, which exists by virtue of the second secured inter-company loans in place between ASPropulsion Capital B.V., ASPropulsion International B.V. and Avio as well as the senior guarantee from Aero Invest 2 S.a.r.l., the senior subordinated guarantees from Avio Holding, Avio and certain of its subsidiaries and the second secured lien over the stock of Avio.

The proposed notes will be sold in a privately negotiated transaction without registration under the United States Securities Act of 1933 ("the Act") under circumstances reasonably designed to preclude a distribution thereof in violation of the Act. The issuance will be designed to permit resale under Rule 144A and Regulation S of the Act.

The assigned ratings assume there will be no material variations to the draft legal documentation reviewed by Moody's and assume that these agreements are legally valid, binding and enforceable.

COMPANY SUMMARY:

Registered in Italy, Avio is a leading designer and manufacturer of subsystems and components for military and civil aircraft engines and a producer of propulsion systems for space launch vehicles and tactical missile applications. For the last twelve months ended 30 June 2003, Avio generated revenues of Euro 1,350.3 million and EBITDA of Euro 208.4 million.

Paris
Eric de Bodard
Managing Director
Corporate Finance Group
Moody's France S.A.
JOURNALISTS: 33 1 53 43 93 78 SUBSCRIBERS: 44 20 7772 5454

London
Nicole Guest
Asst Vice President - Analyst
Corporate Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454

No Related Data.
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