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25 Apr 2005
MOODY'S REVIEWS VALERO ENERGY'S RATINGS FOR POSSIBLE DOWNGRADE; CONTINUES REVIEW OF PREMCOR'S RATINGS FOR POSSIBLE UPGRADE
Approximately $5.8 Billion of Securities Affected
New York, April 25, 2005 -- Moody's Investors Service placed Valero Energy Corporation's ratings
under review for possible downgrade in response to Valero's announcement
earlier today that it plans to acquire Premcor Inc. for approximately
$8 billion, including the assumption of about $1.8
billion of debt. Premcor's ratings remain on review for possible
upgrade, continuing a review initiated on February 23, 2005.
The equity portion of the purchase will be funded with 50% cash
and 50% Valero stock. Valero expects to fund the cash portion
with a combination of cash on hand and debt. The transaction is
subject to the approval of Premcor's shareholders and customary
regulatory reviews and is expected to close by December 31, 2005.
Ratings under review for possible downgrade are Valero Energy Corporation's
Baa3 rated senior unsecured notes, debentures, medium-term
notes, and bank debt, its Ba1 rated subordinated debentures,
its shelf registration for senior unsecured debt/subordinated debt/preferred
stock rated (P)Baa3/(P)Ba1/(P)Ba2, and its Ba2 rated mandatory convertible
Ratings under review for possible upgrade are Premcor Inc.'s Ba3
senior implied and B1 non-guaranteed senior unsecured issuer ratings,
Premcor Refining Group's (PRG) Ba2 senior secured rating of a $1
billion bank facility, PRG's Ba3 rated senior unsecured notes,
PRG's B2 rated senior subordinated notes, and Port Arthur Finance
Corporation's Ba3 rated senior secured notes.
Moody's decision to review Valero's ratings for possible downgrade
reflects the potential for a substantial increase in Valero's financial
leverage as a result of the acquisition in the event that refining margins,
which tend to be highly unpredictable, were to decline from today's
lofty levels. The review also considers the relatively rich purchase
price of the transaction. Based on Moody's estimate of the
acquisition cost at approximately $1,016 per complexity barrel,
the transaction appears expensive when compared to other recent refinery
acquisitions. Furthermore, debt could account for 60%
of the total acquisition cost if cash builds by year-end are less
than anticipated. The combined entity's pro-forma
financial leverage (net of cash) at 12/31/04 is approximately $408
per complexity barrel (including the debt of Valero L.P.,
a master limited partnership for which Valero is the general partner),
the highest among the investment grade refining company peers.
Management expects large cash balances at the end of 2005 as a result
of high refining margins to reduce the amount of debt required to finance
the acquisition at closing, which Moody's would view as a
key aspect of the ratings review. If Valero is unable to reduce
the leverage impact of the transaction through sufficient cash builds,
Moody's believes a one notch downgrade of Valero's Baa3 senior
unsecured debt rating is possible.
During the review process, Moody's will focus on: (1)
the benefits to Valero of the acquisition, including a significant
increase in refining capacity, greater geographic diversification,
certain operating synergies, and increased exposure to heavy sour
crudes, (2) management's track record with prior acquisitions
in improving refining operating performance and realizing synergies,
(3) FTC divestitures, if any, and their impact on the company's
operations and financial position, (4) the likelihood that Valero
and Premcor will build up cash balances at least in line with management's
expectations prior to closing in order minimize the debt required to finance
the acquisition, (5) Valero's and Premcor's heavy capital
requirements, including substantial environmental capital expenditures,
(6) the post-merger capital structure, including upstream
and downstream guarantees, (7) management's financial policies
with respect to share buybacks and dividends, and (8) management's
future growth strategy for the combined company and for Valero L.P.
The equity portion of the purchase consideration has been fixed at approximately
$3.5 billion as of April 22, 2005. The ultimate
increase in Valero's financial leverage to finance the cash portion
of the acquisition, as well as management's plan to reduce
post-merger debt with free cash flow, are highly dependent
on refining margins remaining reasonably strong over the next two years.
On a pro-forma basis, assuming the acquisition closed on
March 31, 2005, Moody's estimates that Valero's
gross balance sheet debt would increase by about $5.7 billion
to $9.8 billion, and its off-balance sheet
debt would increase by $0.6 billion. However,
if refining margins remain robust in 2005, Valero anticipates a
substantial cash build by year-end (approximately $2.0
billion, including Premcor's cash), which would reduce
the net amount of additional debt to approximately $1.4
billion. Despite recent strength in U.S. refining
margins, Moody's believes margins will continue to be volatile and
cyclical, which could affect earnings and levels of internal cash
generation and possibly result in higher debt levels.
Moody's believes that debt levels could be also negatively impacted
by higher than anticipated investment needs associated with the Premcor
assets in order to comply with environmental regulations and improve refinery
performance. Premcor has heavy environmental capital needs through
2006, has suffered from relatively low utilization rates at its
Memphis and Lima refineries, and remains challenged to improve operating
performance at the Delaware City Refinery.
Valero Energy Corporation is the largest independent refining and marketing
company in the United States and is headquartered in San Antonio,
Premcor Inc. is an independent refining and marketing company headquartered
in Old Greenwich, Connecticut.
Alexandra S. Parker
Senior Vice President
Corporate Finance Group
Moody's Investors Service
Thomas S. Coleman
Senior Vice President
Corporate Finance Group
Moody's Investors Service
No Related Data.
© 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.
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