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Rating Action:

MOODY'S RATES GRAHAM PACKAGING COMPANY, L.P.'S PROPOSED $2.675B FINANCINGS; RATINGS OUTLOOK CHANGED TO STABLE FROM POSITIVE

14 Sep 2004
MOODY'S RATES GRAHAM PACKAGING COMPANY, L.P.'S PROPOSED $2.675B FINANCINGS; RATINGS OUTLOOK CHANGED TO STABLE FROM POSITIVE

Approximately $2.7 billion debt securities affected

New York, September 14, 2004 -- Moody's Investors Service rated the proposed debt of Graham Packaging Company, L.P. ("Graham"), which arises from its definitive agreement on July 28, 2004 to purchase the Plastic Container unit ("O-I Plastics") of Owens-Illinois, Inc. ("O-I") for approximately $1.2 billion [O-I has a senior implied rating of B2 with a stable outlook]. Despite Graham more than doubling its revenue pro-forma for this sizable acquisition, Moody's affirmed Graham's existing B2 senior implied rating. Proceeds from the proposed financings are intended to finance the acquisition; to refinance Graham's existing $700 million secured credit facility (rated B2); to repay Graham's outstanding $325 million 8.75% senior subordinated notes, due 2008 (rated Caa1), as well as the outstanding $169 million 10.75% senior discount notes, due 2009 (rated Caa2), issued at Graham Packaging Holdings Company ("Holdings"); and to pay related expenses.

Pro-forma for the proposed transactions, the affirmation of the B2 senior implied rating recognizes Graham's proven ability to operate successfully throughout the recent past despite substantial financial leverage, as evidenced by its ability to maintain industry-leading margins and adequate liquidity. The rating affirmation reflects the complementary nature of the proposed acquisition and attributes value to the realization of some synergies within the near term after combination. However, the rating remains constrained by the paucity of free cash flow relative to sizable pro-forma debt, which exceeds pro-forma consolidated revenue. Moreover, Moody's has concerns about the quality of earnings, pro-forma for the proposed transactions, given the high concentration of customers (one customer is approximately 17% of consolidated revenue and the top fifteen customers account for close to 70%) and the material amount of add-backs to EBIT given the negative unadjusted pro-forma EBIT. The more significant adjustments, which represent 100% of adjusted EBIT, include goodwill and other impairment charges, write-downs of assets, legal expenses, global restructuring charges, and project start-up costs (inclusive of the O-I Plastics intended purchase). Additionally, the rating incorporates heightened concern about working capital management and the company's ability to manage timing differences between capital investment and EBIT generation.

Today, Moody's took the following ratings actions:

B2 rating assigned to the proposed $1.6 billion first lien credit facility consisting of a $250 million revolver, maturing in 6 years, and a $1.35 billion term B loan, maturing in 7 years

B3 rating assigned to the proposed $350 million second lien term C loan, maturing in 7.5 years

Caa1 rating assigned to the proposed $350 million senior unsecured note, due 2012

Caa2 rating assigned to the proposed $375 million senior subordinated note, due 2014

SGL-3 Speculative Grade Liquidity Rating affirmed

Senior implied rating of B2 affirmed and moved to Graham from Holdings

Senior unsecured issuer rating of Caa2 (non-guaranteed exposure) affirmed and moved to Graham

The ratings outlook changed to stable from positive.

The ratings are subject to the closing of the proposed transactions and review of executed documentation. Upon the closing and concurrent execution of the proposed financings, the ratings of Graham's existing debt will be withdrawn.

The change in the ratings outlook to stable from positive reflects the reversal of Graham's stated debt reduction strategy given the significant increase in financial leverage required to effect the discussed acquisition. The downward change to a stable outlook also reflects Moody's concern about integration risk, which is exacerbated by Graham's stretched financial profile. While acknowledging that the company has engaged an outside firm to assist with integration, some execution concerns linger as this is Graham's most substantial business combination. The company does not have a history of acquisitive growth.

Given the magnitude of the proposed transactions and the required revitalization of margins at the acquired O-I Plastics' business, there is minimal tolerance for operating missteps or deterioration in pro-forma credit statistics before triggering a negative ratings outlook. It will likely take several consecutive quarters of on-plan or better performance before the outlook would be considered solid enough to migrate back to positive. Specifically, financial leverage would need to be reduced to at or below pre-acquisition levels (i.e. close to 8 times debt to EBIT; 5 times debt to EBITDA); EBIT return on assets returned to mid-teens or better; and break-even to positive annual free cash flow.

Pro-forma for the proposed transactions, Graham's financial profile is weak in the near-term. However in Moody's opinion, the realization of some synergies should be captured fairly rapidly thereby bolstering the bottom line and taking some of the stress off Graham's stretched credit statistics during the first year of combination. Financial leverage is substantial at over 11 times pro-forma pre-synergies EBIT (slightly over 6 times pro-forma EBITDA). There is minimal free cash flow as pro-forma capital expenditures increase to the $200 million and above level, well over the approximately $90 million spent during fiscal 2003. Graham is likely to continue to reinvest at levels that exceed depreciation throughout the intermediate term. EBITDA less capital expenditures coverage of pro-forma interest expense is thin at virtually one-to-one.

The B2 rating assigned to the proposed first lien credit facility reflects the priority position in the pro-forma capital structure and the expectation of collateral coverage. Moody's does not rate the credit facility better than the senior implied rating of B2 given the magnitude of committed first lien facilities (roughly 65% of total pro-forma debt), and the substantial leverage at approximately 7 times pro-forma consolidated pre-synergies EBIT (approximately 4 times EBITDA). Moody's notes that documentation provides for an uncommitted increase of up to $50 million to the proposed $250 million revolver, subject to conditions detailed in the Credit Agreement.

The proposed $1.6 billion facility, consisting of the $250 million revolver plus a $1.35 billion term B loan, is intended to be secured by a first priority perfected lien on the assets, intercompany notes, and stock of the borrower, Graham, and each of its direct and indirect subsidiaries, except non-US subsidiaries for which the lien on stock is limited to 65%. Unconditional guarantees by Holdings and each of the borrower's wholly-owned direct and indirect domestic subsidiaries support the facility. At closing, no advances under the proposed revolver are anticipated. Approximately $2 million letters of credit will be outstanding. Financial covenants are intended to address maximum total leverage, minimum interest coverage, and maximum capital expenditures.

Pro-forma liquidity, while expected to remain adequate, will be reviewed when the transactions have been completed and documentation has been executed and reviewed (refer to the Speculative Grade Liquidity Assessment published on September 2, 2004 for Graham).

The B3 rating assigned to the proposed $350 million second lien term C loan reflects the benefits and limitations of the collateral. The rating, one notch below the B2 senior implied rating, reflects the contractual subordination to a sizable amount of first lien debt. The rating expresses the expectation of collateral coverage. The loan is to be secured by a second priority perfected lien on the same collateral securing the first lien debt. An Intercreditor Agreement is expected to be in place. Guarantees by the same entities as the first lien facility support the term C loan.

The Caa1 rating assigned to the proposed senior unsecured note reflects the effective subordination to a substantial amount of secured debt at Graham and gives consideration to the effective subordination to liabilities at the non-guarantee subsidiaries. Based upon the significance of those two, the loss severity on the note would likely exceed that of secured debt thus resulting in a rating that is two notches down from the senior implied rating. The note, issued by Graham, is to be guaranteed on a senior unsecured basis by the same entities supporting the first and second lien debt.

The Caa2 rating assigned to the proposed senior subordinated note reflects the contractual subordination to a substantial amount of senior debt at Graham (approximately $2.07 billion of funded debt - inclusive of approximately $20 million in assumed debt- plus a large level of trade payables and accrued expenses) and effective subordination to all obligations of Graham's subsidiaries. The rating would represent a downgrade from the existing senior subordinated notes' rating of Caa1 (to be withdrawn upon repayment from the proceeds of the proposed transactions) due to the sizable increase in senior indebtedness. The note, issued by Graham, is to be guaranteed on a senior unsecured basis by the same entities supporting the senior unsecured note.

Based in York, Pennsylvania, Graham Packaging Company, L.P. is a leading global designer and manufacturer of customized blow-molded plastic containers for branded food and beverages, household and personal care products, and automotive lubricants. Blackstone Capital Partners of New York is the majority owner. Pro-forma for the intended acquisition of O-I Plastics, which is also a manufacturer of technology-based value-added custom plastic packaging, consolidated annual revenue would be approximately $2 billion.

New York
Andris G. Kalnins
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Kendra M. Smith
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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