MOODY'S DOWNGRADES R.R. DONNELLEY (SR. UNSEC. TO Baa2 FROM A2, SHORT-TERM TO P-2 FROM P-1); UPGRADES MOORE WALLACE (SR. UNSEC. TO Baa1 FROM B1)
Approximately $1.9 billion in debt securities affected
New York, February 23, 2004 -- Moody's Investors Service has downgraded R.R. Donnelley
& Sons' senior unsecured debt ratings to Baa2 from A2 and its
short-term debt ratings to Prime-2 from Prime-1.
At the same time, Moody's upgraded Moore Wallace North America
Finance Inc.'s senior unsecured debt ratings to Baa1 from
B1. Moody's also confirmed Moore Wallace Holdings USA Inc.'s
Ba2 senior secured bank credit facility rating pending the refinancing
of this debt and has confirmed the company's Ba3 senior implied
and B1 issuer ratings until the closing of the merger, at which
time these three ratings will be withdrawn. The proposed $850
million to $1.0 billion senior unsecured bank credit facility
of the new combined entity has been assigned a rating of Baa2.
These rating actions complete the review initiated on November 10,
2003 following the announcement by the two companies of their all-stock
merger agreement. The rating outlook is now stable.
Moore Wallace North America Finance's senior unsecured debt is rated
one notch above the senior unsecured debt of R.R. Donnelley,
reflecting the effective subordination of the R.R. Donnelley
obligations as the result of guarantees of Moore Wallace debt that will
be extended as part of the merger agreement. Upon the refinancing
of the Moore Wallace senior unsecured notes, Moody's will
equalize all of the company's senior unsecured ratings at Baa1.
The Baa1 and Prime-2 ratings reflect the combined company's
strong competitive position and broad product array, which are balanced
against increased financial risk associated with higher leverage and reduced
free cash flow. While Moody's believes there is some business
risk associated with the strategy to provide a diversified portfolio of
long- and short-run products in a cyclical industry,
there is also additional revenue potential should the company successfully
secure a bigger portion of its largest customers' print spending.
The ratings incorporate potential integration and execution risks associated
with combining two companies of this size. However, Moody's
anticipates that management will be aggressive in cutting costs in order
to stabilize, and possibly improve, operating margins,
as they have successfully done to date at Moore Wallace. Moody's
believes there is additional acquisition-related event risk in
a fragmented industry that will experience more consolidation, but
expects that management will seek smaller tuck-in acquisitions
that will only serve to strengthen, not weaken, the credit
R.R. Donnelley has experienced revenue declines and margin
pressure in many of its businesses, including financial services
printing, catalogs and forms and labels. In addition to generally
unfavorable economic conditions over the past few years, the industry
is experiencing secular pressure from electronic disintermediation,
particularly in the forms and labels business. With the drop in
demand, the competitive landscape has been shaped by printing overcapacity
and a fight for market share as the industry's largest competitors
have large fixed cost bases that are underutilized. As a result,
R.R. Donnelley's operating margins have contracted
five percentage points since 2000. However, Moore Wallace's
operating margins have expanded as management has acquired businesses
to grow revenues, while taking approximately 20% of their
printing capacity offline through plant and press closures in order to
rationalize the cost structure.
Moody's feels the merger presents an opportunity, which may
not be easy to repeat, to win additional business from the combined
companies' top customers. Moody's believes the company will
be successful in taking some additional share by providing the industry's
broadest array of high-quality, long- and short-run
print products, from magazines, telephone directories,
books, catalogs, inserts and financial documents, to
billing statements, outsourced customer communications, highly
personalized direct mail, premedia, print fulfillment,
labels, collateral materials, forms and logistic services.
Still, a business combination of this scope in the printing industry
is unprecedented, creating considerable execution risks.
The two companies' customer bases have limited overlap and the only
material business unit overlap is in their respective Direct Mail businesses
(approximately $500 million of combined revenue). In addition,
Moore just acquired Wallace last May and has yet to realize all of the
cost savings projected at the outset of that merger.
Moody's expects R.R. Donnelley will continue to be
a consolidator given the healthy acquisition appetite of Moore Wallace
management. The management of Moore Corporation has made some 60
acquisitions over the last couple of years, making it difficult
to determine how much revenue growth is organic. The combined company's
revenues represent just 5% of the US industry total of approximately
$155 billion. The industry remains fragmented, with
only 8 companies in addition to R.R. Donnelley and Moore
Wallace posting revenues of more than $1 billion, and approximately
53 companies with revenues of more than $100 million.
Despite potential acquisitions, Moody's expects the company
will keep debt-to-EBITDA financial leverage well below 2.0x
and that debt-to-free cash flow will decline to around 10.0x
by the end of 2005. Should these levels not be met and maintained,
there will be some pressure on the Baa1 ratings.
The outstanding R.R. Donnelley senior unsecured debt is
notched below the Moore Wallace North America Finance senior unsecured
debt, reflecting its effective subordination. Upon closing
the merger, R.R. Donnelley intends to provide a senior
unsecured guarantee to $403 million in Moore Wallace senior unsecured
notes until the company can refinance those notes. As a result,
the Moore Wallace note holders will enjoy a senior unsecured guarantee
from all of the company's assets, thereby disadvantaging the
current debt holders at R.R. Donnelley, who will not,
in turn, benefit from a guarantee from its wholly owned subsidiary,
As mentioned previously, upon the refinancing of the Moore Wallace
senior unsecured notes, Moody's will equalize all of the company's
senior unsecured ratings at Baa1. Should R.R. Donnelley
not refinance all of Moore Wallace's debt, then Moody's
will retain the Baa2 rating on the legacy R.R. Donnelley
debt, and will continue to evaluate how the legacy R.R.
Donnelley debt fits into the company's capital structure should
the company issue any additional debt with guarantees from the whole company.
Moody's believes the new proposed senior unsecured bank credit facility
will provide the company with sufficient alternate liquidity to backstop
its commercial paper program and support the Prime-2 short-term
R. R. Donnelley, headquartered in Chicago, IL,
is a leading printer of catalogs, magazines, books,
and direct mail in the US. With printing plants worldwide,
the company prints magazines, catalogs, inserts, books,
directories and financial information products.
Moore Wallace, headquartered in Mississauga, Ontario,
is a leading provider of print management services.
Corporate Finance Group
Moody's Investors Service
Corporate Finance Group
Moody's Investors Service