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Global Credit Research - 23 Dec 2010
Approximately $ 275 Million of Debt Securities Affected.
Sao Paulo, December 23, 2010 -- Moody's Investors Service has downgraded the ratings of Lupatech S.A.
("Lupatech") and Lupatech Finance Ltd. to Caa1 from B2 for the
global corporate family rating. At the same time the senior unsecured
perpetual notes rating of Lupatech Finance was downgraded to Caa2 from
B3. The ratings outlook is negative.
Ratings downgraded are:
- Issuer: Lupatech S.A.
Corporate Family Rating: to Caa1 from B2 (global scale); to
Caa1.br from Ba1.br (Brazil national scale)
- Issuer: Lupatech Finance Ltd. (Cayman Islands)
- USD 275 million Senior Unsecured Guaranteed Perpetual Notes:
to Caa2 from B3 (foreign currency)
The downgrades reflect the weaker than expected results for the year-to-date
period reflected in the company's third quarter 2010 results.
The weak operating performance has again postponed the much anticipated
improvement in the company's credit profile and has resulted in
a liquidity profile and capital structure that may not sustainable in
Lupatech's current very weak liquidity position (at the end of the
third quarter ended September 30, 2010, Lupatech had cash
and cash equivalents of R$103.4 million but significant
expected cash outflows associated with debt service, working capital
and capital expenditures) is a direct result of an aggressive acquisition
spree to its expand product portfolio and manufacturing capacity in expectation
of a material increase in demand following the announcement of major oil
discoveries in Brazil. This demand suddenly collapsed in the wake
of the global financial and economic crisis and due to the need of oil
companies with operations in Brazil to speed up the exploration phase
of the development of new oil fields in order to meet deadlines of the
ANP (Brazilian Oil Agency). The latter decision had the result
of fewer investment dollars going into development activities where Lupatech
is active. These events led to a material decline in Lupatech's
operating performance. Today, we estimate that Lupatech still
operates at approximately 40% capacity which has materially depressed
its margins given its high fixed cost structure, resulting in a
material decline in cash flow which today does not cover its expected
cash needs, and a potentially untenable capital structure.
To fund its acquisitions and subsequently improve its liquidity following
the major fall-off in orders during the crisis, Lupatech
issued a total of USD275 million of perpetual notes. While this
improved the company's debt maturity profile, it also added
USD 27,1 million (or R$46.2 million at current exchange
rates) in annual interest expense and contributed to a material increase
in its leverage (at the end of 3Q10 leverage stood at an estimated 10.9
times EBITDA). Based on our current base line estimate for EBITDA
of R$70 million during fiscal 2010 and anticipating only a gradual
improvement in 2011, Lupatech's cash flow will remain stressed
given expected interest expense in excess of R$100 million,
debt amortization of an estimated R$40 million and expected working
capital and investment needs in order to accommodate an anticipated ramp-up
Operating in a very difficult environment, Lupatech has moved aggressive
this year to improve cash flow. Key components of that strategy
include reducing working capital (down to 42.3% of revenues
at end of 3Q10 as compared to 60.4% at the end 3Q08 and
49.9% at end of 3Q08) and reducing operating costs.
The latter has been particularly challenging given the high fixed cost
structure of its business.
In order to find a more permanent solution to its liquidity challenge
and capital structure, we expect Lupatech to explore various alternatives.
Those initiatives would alleviate the pressure not only on the company's
cash flow stemming from the interest payments on its convertible debentures
but also improve an unsustainable debt burden. With a current estimated
variable cost to revenues of 50%, the biggest impact on the
company's longer term performance is still expected to come from
a major boost in revenues which will allow it to benefit from its high
operating leverage and improve cash flows in a meaningful way.
We believe the company in the short term will likely opt to postpone non-essential
capital expenditures, reduce further inventories and monetize additional
receivables, potentially tap the "Progredir" Petrobras
supplier program, and work with its core banks to develop alternatives
to shore up its liquidity. While enhancing its financial flexibility
is critical for the company to meet its cash obligations over the next
six months, longer term Lupatech will need to fund growing working
capital needs and invest in new capital expenditures in order to meet
the eventual resumption in revenue growth.
In our analysis we have taken into consideration BNDES' (rated A3,
outlook stable) potential support for Lupatech as evidenced by an 11.45%
equity interest in the company, its ownership of the majority of
Lupatech's R$320 million convertible debentures, and an estimated
R$150 million in Finame financing for capital expenditures and
short term working capital debt. Combined, the convertible
debentures held by BNDES and the Finame loan represent some 50%
of Lupatech's total debt.
In December 2009, Lupatech obtained a waiver from the debentures
holders for breached financial covenants and which is valid until the
end of December 2010. As we do not expect the company to be in
compliance with at least two of its three covenants under the agreement
(leverage and EBITDA margin) at the expiration of the waiver, we
believe that Lupatech will seek another waiver which will likely be announced
at a scheduled meeting with debenture holders on December 30, 2010.
The negative outlook reflects the challenges the company will face to
improve its liquidity over the near term but also to address in a meaningful
manner its capital structure which is not commensurate with its current
capacity utilization and the inherent volatility of its business model
and high reliance on one key large customer.
Given today's rating action we do not believe that there will be
upwards pressure on ratings over the near term. Longer term,
any upwards ratings action would be conditioned on the company being able
to materially improve its liquidity position, reduce its leverage
as measured by Total Adjusted Net Debt to EBITDA to below 5.0x
and generates positive free cash flow such that Free Cash Flow to Total
Adjusted Net Debt approaches 5% on a sustainable basis.
The last rating action on Lupatech was on February 9, 2010,
when we downgraded the Corporate Family Rating of Lupatech S.A.
to B2 from B1 (global scale) and to Ba1.br from Baa3.br
(Brazil national scale) and Lupatech Finance Ltd. (Cayman Islands)
USD 275 million Senior Unsecured Guaranteed Perpetual Notes to B3 from
B2 (foreign currency).
The principal methodology used in rating Lupatech was Moody's Global Oilfield
Services Industry rating methodology (December 2009), which can
be found at www.moodys.com in the Rating Methodologies sub-directory
under the Research & Ratings tab. Other methodologies and factors
that may have been considered in the process of rating this issuer can
also be found in the Rating Methodologies sub-directory on Moody's
Moody's National Scale Ratings (NSRs) are intended as relative measures
of creditworthiness among debt issues and issuers within a country,
enabling market participants to better differentiate relative risks.
NSRs differ from Moody's global scale ratings in that they are not globally
comparable with the full universe of Moody's rated entities, but
only with NSRs for other rated debt issues and issuers within the same
country. NSRs are designated by a ".nn" country
modifier signifying the relevant country, as in ".br"
for Brazil. For further information on Moody's approach to national
scale ratings, please refer to Moody's Rating Implementation Guidance
published in August 2010 entitled "Mapping Moody's National Scale
Ratings to Global Scale Ratings."
Headquartered in Caxias do Sul, Brazil, Lupatech is a leading
equipment manufacturer and service provider to the oil & gas industry
in Brazil, besides producing industrial valves and casting parts.
Lupatech reported net revenues of BRL 552.7 million (USD 325 million
using the current exchange rate) in the last twelve months ended September
Information sources used to prepare the credit rating are the following:
parties involved in the ratings, parties not involved in the ratings,
public information, and confidential and proprietary Moody's
Investors Service information.
Moody's Investors Service considers the quality of information available
on the issuer or obligation satisfactory for the purposes of maintaining
a credit rating.
Moody's adopts all necessary measures so that the information it uses
in assigning a credit rating is of sufficient quality and from sources
Moody's considers to be reliable including, when appropriate,
independent third-party sources. However, Moody's
is not an auditor and cannot in every instance independently verify or
validate information received in the rating process.
Please see ratings tab on the issuer/entity page on Moodys.com
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The date on which some Credit Ratings were first released goes back to
a time before Moody's Investors Service's Credit Ratings were fully digitized
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Please see the ratings disclosure page on our website www.moodys.com
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Senior Vice President
Corporate Finance Group
Moody's America Latina Ltda.
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
Moody's America Latina Ltda.
Moody's downgrades corporate family rating of Lupatech to Caa1; outlook negative.
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