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Rating Action:

Moody's lowers Thales debt rating to A2

Global Credit Research - 12 Jul 2010

Approximately €2 Billion of Debt Securities Affected

New York, July 12, 2010 -- Moody's Investors Service lowered the long term rating of Thales to A2 from A1, and affirmed the short term rating at P-1. Moody's also revised the Baseline Credit Assessment ('BCA') to 9 (a Baa2 equivalent) from 8 (Baa1 equivalent). The rating outlook is stable.

"Near term profits are expected to be lower than Thales's historic levels, with credit metrics somewhat weaker than many of Thales's large defense-contractor peers and more consistent with the revised BCA of 9 (Baa2 equivalent)", noted Bob Jankowitz with Moody's Investors Service.

Responding to a sharp deterioration in operating performance, mostly because of cost overruns on certain aerospace contracts, Thales instituted a broad operational restructuring. The various programs under the heading of Probasis have merit in that they are designed to address Thales's principal issues of supply chain inefficiency, contract management and overhead. As the programs are process and cost-based, achieving the target objectives is mostly within management's control with little reliance on market growth.

While we expect Thales will make material progress in turning around operating results from its business, the programs will require quite some time to take hold with limited potential to assess the progress over the coming year. Thales sized the prospective benefit from Probasis at around €1.3 Billion (which is about 10% of revenue). Most of that amount is to be realized in several years with only moderate near term benefits in the next year, mostly from better control of overhead.

Thales has the flexibility to take the time to address its operational issues because debt is relatively low, when compared to the size of the company and compared to its direct peers. Thales has maintained a conservative capital structure and liquidity profile, and has usually kept cash close to the amount of reported debt. Net debt was about €91 million at the last reporting date; net debt had been around several hundred million Euros but Thales received some unexpected cash inflows at the end of the year.

Further, Thales's most problematic contracts are mostly in aerospace. The core defense business, the largest portion of Thales's revenue, is expected to continue to do well with an operating margin comparable to its large global peers. Thales is one of Europe's most important defense companies, as a principle supplier of critical technologies in avionics, surveillance and defense electronics. Among the reasons for that position is the record of research and development investment, which totaled about 20% of revenue last year and which is among the highest in the industry.

With about 27% of its shares owned by the French government, Thales is a Government Related Issuer. In addition, nearly 26% of the shares are owned by Dassault, an unrated French-based aerospace company, which is party to a shareholders agreement with the government. With that government ownership, Thales's A2 debt rating reflects three notches of ratings lift from the BCA. This ratings lift reflects the "High" probability of support from the French government (rated Aaa) during periods of strain, while the level of default dependence between the government and Thales is "Medium". Involvement of the French government in Thales was evident recently as Dassault became the new, largest industrial shareholder and party to the shareholders agreement, as well as the very considerable portion of Thales's R&D which is government funded. The highest portion of the board seats are held by the French state.

The stable outlook considers Thales's role as supplier of critical defense and civil aerospace technologies, the high barriers to entry inherent in its business model and the continuing support of the French government. The rating could be lowered following any further deterioration in cost structure from unexpected program revisions, as reflected by the inability for Thales to meet its guidance of 3-4% EBIT margin this year; by the inability to make steady progress thereafter towards an operating margin in the mid-single digit range along with sustained retained cash flow to debt over 15%; or, if cash to adjusted debt falls below 30%. Any decline in the rating of France, or change in the level of expected support could also pressure the rating down. A higher rating is not anticipated for some time, but could follow a sustained operating margin around the 9% level or better with retained cash flow to debt steadily over 20% while maintaining the backlog at around two years of revenue and strong liquidity from available cash.

Downgrades:

..Issuer: Thales

....Issuer Rating, Downgraded to A2 from A1

....Senior Unsecured Medium-Term Note Program, Downgraded to A2 from A1

....Senior Unsecured Regular Bond/Debenture, Downgraded to A2 from A1

The last rating action on Thales was an affirmation of the company's Senior Unsecured rating on April 6, 2006. The principal methodologies used in rating Thales were Moody's Aerospace and Defense Rating Methodology, published in June, 2010 and The Application of Joint Default Analysis to Government-Related Issuers, published in April, 2005 and available on 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.

Thales, based in Neuilly-sur-Seine, France, is a key global provider of integrated solutions and equipment to meet security requirements of government, institutional and private customers in the aerospace, defense and security markets.

New York
Michael J. Mulvaney
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Robert Jankowitz
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's lowers Thales debt rating to A2
No Related Data.
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