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29 May 1997
MOODY'S RATES ICO, INC.'S SR. NOTE ISSUE B1 WITH POSITIVE OUTLOOK AND CONFIRMS CONV. PREF'S AT "b3"
New York, May 29, 1997 -- Moody's Investors Service assigned a B1 rating with positive outlook to ICO, Inc.'s proposed $100 million ten-year bullet senior unsecured notes, offered under SEC Rule 144A, and confirmed its "b3" rating on ICO's existing $32.5 million of convertible exchangeable preferred shares.
Offering proceeds will retire all domestic revolver outstandings, fund capital expenditures, and increase cash balances to over $80 million. The available cash will pre-fund ICO's intermediate term expansion strategy. Pro-forma for the offering, net debt will be under $30 million and net senior debt leverage will be low. Additionally, ICO's convertible exchangeable prefs appear to be embedded as near-equity for at least three to four years. ICO will not have room under restricted payments tests to exchange the prefs into subordinated notes during that time span. Finally, in light of relatively large pro-forma cash balances and ICO's active acquisition mode, the ratings incorporate a conservative view on successful investment of cash resources. ICO is a modestly-sized firm that is a significant distance away from the scale of operations necessary to ensure efficient funding, and viability during a 1980's style oil service depression. However, the trends are positive.
The positive outlook is assigned due to: favorable economic and technological fundamentals supporting growing demand for ICO's products and services and placing increased pricing power in ICO's hands; ICO's  attainment of moderate risk diversification by entering the petrochemicals service business; and ICO's relatively large pro-forma cash balances and record of reasonably sound acquisitions. A surge in oil and gas drilling activity is progressing and average measured depth is increasing (tubular inspection services are typically billed by the foot). A surge in directional and horizontal drilling and steerable drilling systems alone, resulting increased torque on downhole tubulars, increases the standards for tubular integrity. Oil majors have generally announced aggressive five year drilling budgets. Moody's does not anticipate a sustained crude oil or natural gas price collapse. However, if a supply-driven crude price collapse occurred that negatively impacted drilling activity, the likely negative impact on ICO's oil service's business may be balanced by its petrochemicals business. Cheaper petrochemicals and plastics prices may spur increased petrochemicals consumption and demand for ICO's petrochemicals services.
The ratings are supported by favorable sector fundamentals: key oil service revenue drivers are ascendant, with growing active domestic on and offshore drilling and workover rig counts, increased measured drilling depths, and increased average complexity and discreet value of oil producer's drilling and workover well activity. This increases the demand for services like ICO's that reduce producers long-term operating costs, reduce risks of downhole failure, and prolong the lives of downhole assets. The drilling sector witnessed a 22% rise in rig activity since early 1996, up to 948 active rigs last week. During the same period, the active workover rig count increased roughly 8% from just under 1,280 rigs to just under 1,380 rigs. Rig activity is responding to a tight global supply/demand balance for crude, major oil companies' need to grow unit volumes and reduce costs, projected strong global demand for hydrocarbons, and technological advances that are substantially improving exploration, drilling, and development economics. ICO's oil service and petrochemicals divisions jointly benefit from current sustained growth in global demand for hydrocarbons and derivative products. Additional boosts to drilling activity stem from technological improvements in exploration, development, and production economics plus oil producers' intense focus on presenting strong unit volume growth profiles to the equity market.
We also note ICO's manageable gross debt levels; promising record of acquisitions in two consolidating industry sectors; reasonably specific and disciplined acquisition criteria; and a record of using mixes of cash and equity as acquisition currencies. Further support is gained by substantial pro-forma balance sheet flexibility to absorb acquisition mistakes, unforeseen costs of or delays in merger integration, and to fund significant expansion without incurring additional debt. Though future acquisition success is not factored into our rating, any incremental EBITDA would be accretive to bondholders, assuming that neither new debt was incurred nor unforeseen liabilities were subsequently encountered.
The ratings are constrained by ICO's modest size, both in absolute terms and relative specifically to Tuboscope Vetco (currently unrated), ICO's principal competitor in the oil service sector; ICO's rapid growth by acquisitions, the number of acquisitions to assimilate, and 1996-vintage of its entry into the petrochemicals processing sector; and the fact that both of its businesses would be hurt by a global decline in hydrocarbon demand. ICO's brief experience on the petrochemicals side, and the fact that ICO will aggressively pursue consolidation in that sector, also constrain the rating. The ratings are further constrained by the historically highly cyclical oil service and petrochemicals sectors, with the former often severely impacting both unit demand and pricing, and the latter principally severely impacting pricing. The effective subordination of the notes to ICO's $25 million secured borrowing base availability and domestic subsidiaries' trade creditors, as well as to foreign subsidiaries' working capital and trade creditors, further constrains the rating.
Maintenance of the ratings rests on management's use of proceeds, specifically acquisitions within current business lines and reasonable acquisition multiples. Moody's will assess management's skill in delivering accretive growth through its acquisition strategy and to navigate its businesses through inevitable cycles. We note that one-time write-offs, merger costs, amortisation of goodwill, and high levels of acquisition-inflated depreciation slow ICO's progress in establishing GAAP earnings and ROA track records and accumulating positive retained earnings. Given the competition for growth capital, we believe these factors can potentially narrow a growing firm's access to capital during times of general financial market distress.
The ratings are further supported by ICO's strong domestic niche position in a duopoly segment of the oil services industry, management's skill in generating six consecutive years of revenue and EBITDA growth, and six years of widening margins resulting from consolidation and increasing scale economies. ICO believes it has the majority of the domestic sucker rod inspection market and 30% to 40% of the tubular goods inspection and coatings business. ICO reports long-standing customer relationships with the international oil majors, steel, and chemical companies, including Amoco, Shell, Mobil, Exxon, Phillips, Quantum Chemical, Borealis, and U.S.Steel and recently won quality awards from Exxon and Union Carbide. Having qualified to serve major oil companies, ICO believes such oil services relationships will assist in winning contracts with the petrochemicals arms of those same firms. ICO recently signed chemicals distribution contracts and/or alliances with Exxon and Borealis.
Two key acquisitions, of a total of 16 completed since 1992, gave ICO relative critical mass in oil services and petrochemicals processing. In 1992, the company bought Baker Hughes' domestic Tubular Services business; in 1996, ICO bought Wedco Technology, Inc., whose principal business is grinding/size reduction of plastic pellets into plastic powders and related processing services. Additional acquisitions intensified ICO's position in oilfield services and in processing services for the petrochemicals/plastics sector through a series of small acquisitions of regional/niche firms hubbed around major customers. The petrochemicals/plastics processing business serves clients downstream from their commodity petrochemicals and plastic pellet manufacturing units. Management has completed 9 oil services acquisitions and 6 petrochemicals/plastics acquisitions. In 1992, Baker-Hughes also sold its international tubulars inspection business to Tuboscope, now ICO's principal competitor worldwide.
In oilfield services, ICO provides electromagnetic and ultrasonic tubulars inspection services and corrosion protection services for tubular goods and sucker rods that reduce producer's operating costs and prolong the life of increasingly sophisticated/valuable downhole production assets. ICO inspects new tubular goods for flaws before being placed downhole, existing tubular goods and sucker rods are inspected and reconditioned during well workovers, and new and used tubulars and sucker rods are treated with corrosion prevention coatings. Deeper and more sophisticated wells, drilled into prolific but harsher subsurface environments, lead producers to invest in inspection and corrosion protection services rather than risk expensive premature remedial action after completion. Inspection can avoid future catastrophic pipe and well failure for only some $20,000-plus per well. Tubular coatings extend the life of tubulars by a factor of some 4X, at a cost of $20,000-plus per well, and can increase flow rates of high-paraffin wells by reducing paraffin build-up on tubular sidewalls.
In the petrochemicals/plastics sector, ICO serves two basic functions. Both on contract and as principal, ICO grinds (reduces) major petrochemical firms' plastic resin pellet production to meet downstream customers' specific size and quality requirements. This enables large capital intensive chemical majors to focus on producing standard products in large batches and at maximum output and efficiency. Downstream customization can be handled by ICO. ICO also manufactures concentrates that are added to plastic resins to alter color, texture, and other properties of final products.
Pro-forma for the bond issue, approximately $113 million of gross debt and $128 million of equity support approximately $85 million of cash and approximately $270 million of assets. Pro-forma for recent acquisitions, management cites normalized FYE 9/30/96 EBITDA of $21 million and $12.3 million of pro-forma six-months 3/31/97 EBITDA. Actual FYE9/30/96 EBITDA was $14 million, prior to one-time write-offs. Pro-forma FY 1997 EBITDA/Gross Interest Expense exceeds 3x and EBITDA/average Net Interest Expense exceeds 4x. Pro-forma Gross Debt/EBITDA is would be below 4.0x and Net Debt/EBITDA would be 1.0x. Similarly, pro-forma Gross Total Debt/Cap would be 40% while Net Debt/Cap would be a low 10%. The company will have over $80 million in cash to grow the business prior to incurring additional debt. While ICO's gross margins appear to be comparable to its prime oil services competitor, Tuboscope Vetco, ICO's EBITDA, EBIT, and pre-tax margins are less than one-half of Tuboscope's margins. This may partially be due to ICO's significantly smaller size relative to Tuboscope, to ICO's higher proportion of acquisition-led growth, and to ICO's management team assembled in anticipation of substantial global growth and acquisition activity over which those cost would be spread.
ICO is a public firm headquartered in Houston, Texas pursuing consolidation in the international petrochemicals processing and international oil services inspection and protective coatings sectors.
No Related Data.
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