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Rating Action:

Moody's downgrades corporate family rating of Lupatech to Caa1; outlook negative.

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 longer term.

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 in production..

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 website.

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 30, 2010.

REGULATORY DISCLOSURES

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 for the last rating action and the rating history.

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 and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Sao Paulo
Filippe Goossens
Senior Vice President
Corporate Finance Group
Moody's America Latina Ltda.
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New York
Brian Oak
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
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Moody's downgrades corporate family rating of Lupatech to Caa1; outlook negative.
No Related Data.
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