MOODY'S ASSIGNS B1 RATING TO COVANTA ENERGY'S FIRST LIEN CREDIT FACILITIES AND B2 RATING TO SECOND LIEN FACILITIES; UPGRADES SENIOR IMPLIED RATING TO Ba3 AND SPECULATIVE GRADE LIQUIDITY RATING TO SGL-2; OUTLOOK STABLE
Approximately $1.1 Billion of Credit Facilities Rated
New York, April 28, 2005 -- Moody's Investors Service has assigned a B1 rating to Covanta Energy
Corporation's (Covanta) proposed $690 million new First Lien
Credit Facilities, including its $250 million First Lien
Term Loan, $100 million First Lien Revolving Credit Facility,
and $340 million First Lien Synthetic Letter of Credit Facility.
Moody's assigned a B2 rating to Covanta's proposed $425
million new Second Lien Term Loan Facility. Moody's upgraded
Covanta's Senior Implied rating to Ba3 from B3, Issuer Rating
to B2 from Caa1, and speculative grade liquidity rating to SGL-2
from SGL-3. The rating outlook is stable. Moody's
also upgraded the rating on Covanta's outstanding Third Lien 8.25%
Senior Secured Notes to B3 from Caa1. This rating will be withdrawn
when the Notes are repaid with the proceeds of the new credit facilities.
The new credit facilities are being issued to refinance existing debt
at Covanta and finance Covanta's pending acquisition of American
Ref-Fuel Holdings Corp., which owns MSW Energy Holdings
LLC, MSW Energy Holdings II LLC, and American Ref-Fuel
Company, LLC. These ratings are assigned subject to the acquisition
closing under terms and conditions which are in accordance with Moody's
current understanding, including the sizing and terms of the financing.
The upgrades reflect the following credit strengths:
The substantial improvement that is expected in Covanta's consolidated
financial measures as a result of the acquisition, the stability
of ARC's cash flows, and the diversification benefits from
deriving operating cash flow from a larger number of underlying operating
Covanta is expected to generate significant cost savings and economies
of scale by managing and operating the six ARC facilities in conjunction
with its existing 25 facilities.
Debt at the project level amortizes relatively quickly, which will
lower consolidated leverage over the next several years.
The underlying waste-to-energy projects generate relatively
stable cash flow and Covanta management has exhibited a strong track record
with regard to operating performance, with availability factors
consistently at 90% or above over the past several years.
Many of the waste-to-energy projects are located in the
attractive Northeast region of the country, which is characterized
by dense population and limited waste disposal alternatives.
Covanta derives two-thirds of its revenues from the waste side
of its business, for the most part from long-term contracts
with a diverse group of municipalities, with the remaining one-third
derived from power sales, most of which are under long-term
Covanta received an unqualified audit opinion on its 2004 financial statements,
in contrast to the "going concern" audit opinion that was
issued with its 2003 financial statements.
The ratings also reflect the following credit risks:
Deep structural subordination of the credit facilities to $1.7
billion of debt at the waste-to-energy projects held by
a number of operating subsidiaries, and debt at several intermediate
holding companies. The debt at intermediate holding companies includes
$240 million of debt at American Ref-Fuel Company,
LLC, $200 million of debt at MSW Energy Holdings LLC,
and $225 million of debt at MSW Energy Holdings II LLC.
High consolidated leverage with approximately $3.4 billion
of total debt throughout the Covanta organization following the acquisition,
with $2 billion of recourse corporate debt, including $440
million of undrawn credit facilities.
Limited financial flexibility, and interest coverage ratios that
are thin unless Covanta is able to utilize a significant portion of parent
company Danielson Holding Company's net operating loss carry forwards
Uncertainty related to the availability of these NOLs, which will
be relied upon to offset taxable income at Covanta. These NOLs
could be substantially reduced or eliminated should there be an ownership
change at Danielson, if taxable income is generated by any future
Danielson subsidiaries, or if their validity was to be successfully
challenged by the Internal Revenue Service.
Although debt at the project level amortizes relatively quickly,
most of the recourse corporate debt at Covanta and at American Ref-Fuel
Holdings Corp. is nonamortizing with bullet maturities, exposing
the company to refinancing risk beginning in 2010.
Approximately 12% of Covanta's cash flow is derived from
a portfolio of higher risk international power projects, the largest
being the Quezon project in the Philippines.
Although the overall business is highly contracted, the risk exists
that contracts could be modified or abrogated. Some contracts begin
to roll off as early as 2007, exposing the company to recontracting
risk at that time, including a number of above-market power
Covanta faces the ongoing challenge of changes in environmental laws or
regulation, or the failure to comply with existing regulations,
and the need to renew environmental permits on an ongoing basis.
However, during the term of the service agreements, costs
associated with a change in environmental law or regulation are generally
passed through to the client community.
Moody's notes that Covanta has historically pursued an acquisitive
business strategy which continues with the American Ref-Fuel Holdings
Corp. acquisition. While Covanta's senior management has
changed since bankruptcy and the credit agreement contains restrictions
on acquisitions, additional acquisitions are possible going forward,
increasing event risk for the company.
The upgrade of Covanta's speculative grade liquidity rating to SGL-2
from SGL-3 reflects relatively good liquidity for the next twelve
months and the risks inherent in Covanta maintaining this liquidity,
including: limited financial flexibility and free cash flow,
a dependence on parent company Danielson's NOLs to provide adequate
coverage of long-term debt obligations, and newly increased
alternative liquidity sources including a new $100 million revolving
credit for working capital needs and a $340 million synthetic letter
of credit facilities for letter of credit needs, neither which are
expected to be drawn. There are few hard assets at the Covanta
parent company level or at American Ref-Fuel Holdings Corp.
and most of the assets at the subsidiaries are pledged to $1.7
billion of project level debt. Covanta also operates in a very
specialized industry niche, with a limited market for assets to
be sold in a timely manner if needed for liquidity reasons. Offsetting
these risk factors is Covanta's relatively robust current cash position,
which has increased from $44 million immediately following its
exit from bankruptcy to approximately $78 million as of December
The stable outlook on Covanta's rating reflects Moody's expectation
that: (i) the waste-to-energy projects' contracts
with the respective municipalities and utilities will remain in place
through their current maturities; (ii) Covanta management will continue
to operate the plants at high availability levels and maintain stability
with regard to administrative, operating, and maintenance
expenses; (iii) Covanta will de-lever over the next several
years at the subsidiary project level; (iv) Covanta will be able
to utilize a significant portion of Danielson's NOLs that are available
as of December 31, 2004; and (v) there will be no incremental
debt issued or acquisitions made by Covanta over the near term.
Covanta Energy Corporation, headquartered in Fairfield, New
Jersey, is an energy company with operations in waste-to-energy,
independent power production, and water. Parent company Danielson
Holding Corporation, also headquartered in Fairfield, has
operations in insurance services in addition to Covanta.
Corporate Finance Group
Moody's Investors Service
Michael G. Haggarty
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service