MOODY'S ASSIGNS B1 RATING TO AMERICAN PACIFIC'S SR. UNSECURED NOTES
New York, 03-05-98 -- Moody's Investors Service assigned a B1 rating to American Pacific Corporation's (AMPAC) proposed offering of ten year $75mm senior unsecured notes issued under Rule 144A with registration rights. Proceeds will fund the $39mm purchase of Kerr-McGee's ammonium perchlorate (AP) inventory and operations (excluding fixed assets), repayment or defeasance of $26.2mm of existing debt, and an approximate $6.8mm increase in cash. AP is the sole oxidizing agent for solid fuel rockets, booster motors, and missiles used in launches for space exploration, national defense, intelligence, and commercial satellites. The rating outlook is stable.
The rating reflects AMPAC's pro-forma status as effectively the sole U.S. supplier of AP, its principal product, tempered by a latent risk of restricted competition by Kerr-McGee; downside EBITDA protection provided by AP purchase contracts with AMPAC's key customers, Thiokol Corporation and Alliant Techsystems; significant barriers to entry into the AP market; and the potential for reduced net leverage if AMPAC does not begin an acquisitions or expansion strategy to diversify its products line. The rating is also supported over the intermediate term by cash flows from the development and sale of commercial real estate in the Las Vegas area, as well as by certain currently favorable AP raw materials costs.
The notes may receive additional, though weak, support from the note indenture's excess cash purchase offer. This theoretically could reduce the note holder's exposure to reinvestment risk on the excess of annual cash flow over annual capex requirements. But, in any given year, permitted capex and acquisitions are not limited.
However, the rating is constrained by: AMPAC's status as a small company dependent on government funding priorities and regulations and on three customers; its mixed operating history and an evolving business strategy; dependence on one AP manufacturing facility and AP EBITDA representing 87% of total EBITDA; and AP demand trends that are dominated by government defense and space budgets, the continued use of solid fuel rocket boosters, and continued survival of the venerable Space Shuttle, and Delta and Titan rockets as preferred heavy lift launch vehicles. The Titan program appears to be winding down for military use but the issuer hopes Titan's use for commercial launches will evolve. In addition, the rating reflects the costly demise of AMPAC's second most important product, sodium azide, and the questionable outlook for its third most important product, Halotron.
The rating is also constrained by: unit cost uncertainties due to AMPAC's current renegotiation of its key 10-year electric power supply contract with Utah Power & Light; and by the unproductive, but necessary, use of $26mm of note proceeds to repay the remaining balance of the Azide notes that initially funded development of the unsuccessful sodium azide business.
AMPAC exhibits an unfortunate history of unsuccessful diversification investments away from the AP business. The sodium azide and halotron businesses do not look favorable. Foreign competition and competing airbag activation chemicals caused AMPAC to write off over $50mm of the azide business in 1997 after recently investing heavily in it. And the halotron business requires additional development and marketing efforts to ensure a long-term position in the fire retardant market. Competing products and changing environmental regulations hurt AMPAC's azide and halotron positions relatively soon after the firm made substantial commitments to those businesses.
Nevertheless, after the pending acquisition, Kerr-McGee will conditionally cease being an AP competitor. By eliminating AP competition, the acquisition will create an immediate increase in AMPAC's EBITDA and a more than doubling of capacity utilization. EBITDA will be generated under long-term contracts with Thiokol and Alliant that together consume 75% of the U.S. market for AP. The 10-year contract with Thiokol contains a key AP pricing clause that increases AP pricing when total U.S. demand for AP declines and reduces AP pricing when demand increases. The Thiokol pricing formula appears to place a floor under AMPAC's AP EBITDA for the foreseeable future.
AMPAC's pending acquisition of Kerr-McGee's AP business appears to be an essential consolidation within the AP market, likely resulting in a major increase in AMPAC's AP capacity utilization from 35% to as much as 80% according to AMPAC management. Kerr-McGee commanded 58% of the North American AP market share, including exports. When the Cold War ended, defense cutbacks shrank the AP market from 65mm pounds in 1989 to 26mm pounds in 1997, though AMPAC believes the market is stabilizing. The two AP competitors, AMPAC and Kerr-McGee, operated at progressively lower capacity utilizations, each falling below 40% utilization. After extensive negotiations with Kerr-McGee, and apparently successful efforts to gain Thiokol and Alliant approvals for the AP sale, AMPAC will assume Kerr-McGee's AP customer obligations under new sales contracts, predominantly with Thiokol and Alliant.
Through Thiokol, NASA's Space Shuttle program consumes roughly 40% of annual AP production. Each Shuttle flight consumes 1.6mm pounds of AP or 11.2mm pounds for the typical 7 flights per year schedule. Through Alliant, the Delta and Titan rocket programs each consume 4mm pounds per year. Through Thiokol, Alliant, Atlantic Research, and Aerojet, U.S. defense requirements for AP consume over 4mm pounds of AP a year. Exports to the French Ariane rocket program consume 1.5mm pounds and the U.S. Navy, United Technologies, Talley Industries, and Bristol Aerospace consume 2mm pounds per year. After Kerr-McGee's 40mm pounds of AP capacity exits the market, only AMPAC's 30mm pound facility will serve the North American market as well as some foreign markets. In need, AMPAC states it can expand its plant to 40mm pounds. The only other world capacity appears to be an 11mm pounds/year French facility and an apparently dormant 8mm pound Japanese facility.
Currently, NASA budgets a continued 7 shuttle flights per year through 2004 and indicates the Shuttle will be operated through 2012 or longer at probably lower launch rates. Construction of the International Space Station will reportedly require at least 12 Shuttle flights to complete the first phase and 35 flights to complete the project. The U.S. Congress has voted in favor of the Space Station. On the other hand, research continues on the X-33 program, the eventual successor to the Space Shuttle. Increased defense consumption of AP may commence in 2003 with Thiokol's contract to refuel the Minuteman rocket (4.5mm pounds annually).
Notably, AMPAC is not acquiring Kerr-McGee's AP operating assets. This simplifies AMPAC's job of assimilating Kerr-McGee's customer and volume obligations. But it also leaves the assets in Kerr-McGee's or a subsequent owner's hands as a latent competitor should AMPAC stumble in consistently meeting defense and NASA volume requirements. AMPAC will need to sustain production from its single plant by supplying AP at more than a 25mm pound/year rate.
After actual calendar 1997 EBITDA of $10mm on $47mm of revenues, AMPAC believes its pro-forma calendar 1997 EBITDA would have been $29mm on $72mm of revenues, after assumption of the Kerr-McGee AP business and under the new AP contracts with Thiokol and Alliant. A key assumption is the fact that the acquisition adds $25mm of revenues on just $5.2mm and $0.9mm increases in variable and fixed cash production and distribution costs, respectively. This may be reasonable since the acquisition entails a somewhat more than doubling AMPAC's current AP production at its existing plant and distributing the great bulk of such production to current customers Thiokol and Alliant. Additionally, the new plant was built in the late 1980's with current safety and technology enhancements (following the 1988 explosion at AMPAC's original Henderson, Nevada site). Additionally, AMPAC previously has sustained production at over 20mm pounds per year.
Future earnings will be shielded by a $48mm net operating loss carryforward that the company believes it will fully utilize by 2001.
An analysis of leverage should include as debt $3.6mm of warrants, attached to the Azide notes and booked in proportion to the original note amount. The warrants include a right (exercisable only on 12/31/99) by the warrant holder to under certain circumstances put exercised shares back to AMPAC. AMPAC's maximum exposure to this put right is $5mm. For purposes of this analysis, the issuer's gross debt totals $79.7mm.
Though 1998 will not benefit from a full year of pro-forma production, pro-forma $29mm 1997 EBITDA renders Gross Debt/EBITDA of 2.7x and EBITDA/Gross Interest Expense of 3.6x. Pro-forma Net Debt/EBITDA would be 2.1x and EBITDA/Net Interest Expense would be 4x. The pro-forma capital structure exhibits net and gross Debt/Total Capital of 49% and 65%, respectively. The Kerr-McGee acquisition will generate $39mm of goodwill, rendering an extremely high Gross Debt/Tangible Capital of 95%.
AMPAC believes its balance sheet is strengthened by a commercial real estate development portfolio that it believes is worth $40mm compared to a book value of $25.5mm. In support of this view, AMPAC commissioned a third party market appraisal, which may support the company's claim. AMPAC believes the real estate business will generate between $3mm and $5mm of EBITDA per year through 2001.
American Pacific Corporation is headquartered in Las Vegas, Nevada. The company was formed in 1956 to manufacture AP. Its principal manufacturing complex is located in Cedar City, Utah, in southwestern Utah.
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