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Rating Action:

Moody's rates K2 Pure Solutions NoCal's senior debt at B1 with a stable outlook

21 Jul 2010

Approximately $115 million of debt affected

New York, July 21, 2010 -- Moody's Investors Service has assigned a B1 rating to K2 Pure Solutions NoCal, L.P's (K2 Pittsburg or Project) proposed $115 million senior secured term loan due 2015. The rating outlook is stable.

K2 Pittsburg owns a chlor-alkali project under construction that is located inside Dow's Pittsburg manufacturing site in Pittsburg, CA . The Project is designed to produce up to 296.5 tons per day of ECUs and up to 200 tons per day of bleach. The Project's ECU facility primarily utilizes salt, water and electricity to produce chlorine, caustic soda and hydrogen, commonly referred to as electrochemical units ("ECU") via electrolysis. The Project is able to further produce bleach by processing the chlorine and caustic soda produced by its ECU facility. The Project is currently under construction and is being built by DPR Construction Inc (DPR) under a design-build contract (DB Contract). The expected construction completion date is in April 2011 and completion of all commissioning activities is expected by mid July 2011. Once in operation, the Project will supply approximately 96 million pounds of ECUs to Dow Chemical Company ("Dow", rated Baa3) under a 20-year agreement and the remaining output will be sold into the wholesale market. A third party marketer will serve as the Project's marketing agent for sales into the wholesale market with certain exclusions.

The proceeds from the $115 million term loan and approximately $78 million of equity will be used to fund the construction of the Project, pay interest during construction, fund reserves and pay transaction costs. The Project sponsor will also provide a $14.6 million of contingent equity to backstop a $14.6 construction contingency. The Sponsor's unfunded equity commitment is expected to be backed by a letter of credit.

The B1 rating for K2 Pittsburg considers the following credit strengths:

• Nearly 50% of total revenues under the base case are provided under a 20 year "tolling" type agreement with Dow for the ECU plant

• The Project should be able to meet its minimum delivery obligations to Dow since approximately half of the Project's capacity is merchant.

• The Project benefits from location in a destination market and benefits from rising transportation costs for chlorine.

• The Project utilizes membrane technology which is more efficient than the older diaphragm and mercury based production methods.

• The Project will utilize mature technology and construction while operating risks of chlor-alkali facilities are generally lower relative to other types of projects such as gas-fired power plants.

• Project is located inside to an existing Dow facility and the Project benefits from an environmental indemnity for any direct costs incurred due to environmental conditions not caused by the Project.

• The Project is able to service debt under conservative cases considered by Moody's while the Project's base case forecasts 3-year average metrics at 31% FFO/Debt and 4.1 times DSCR

• The Project benefits from $14.6 million of contingent equity (8.7% of construction costs), DPR's internal contingency of $3.7 million, approximately 9% retainage on payments to DPR, OEM performance guarantees for major pieces of equipment, relatively short construction with COD around Q2 2011 and large portion of equipment costs fixed.

• The lenders will benefit from a 1st lien on the underlying contracts and non-leased assets, a cash flow waterfall, a major maintenance reserve, a 6-month debt service reserve and ring fencing provisions.

• K2 Solutions's management and staff have extensive experience in the chlor-alkali and bleach industry.

Key Credit Weaknesses

• The DB Contract's low liquidated damage and liability cap, lack of overall performance guarantees and various exceptions to the guaranteed maximum price result in limited construction protection.

• The lack of an all-encompassing EPC contract creates potential for conflict between DPR, project and equipment provider especially if problems arise during construction.

• The construction schedule is aggressive which provides little cushion for delays or problems during construction and several permits will be outstanding at financial close.

• Moody's considers DPR to have speculative grade credit characteristics and DPR does not have experience in building chlor-alkali plants.

• The Project derives approximately half of the revenues under the base case from the sale of basic chemicals into the wholesale market.

• The distribution of bleach in the region is dominated by a few major entities which could negatively affect the Project's merchant sales.

• The industry has experienced significant capacity reductions and 2010 & 2011 are expected to be trough years for the chlor-alkali industry.

• The Project's total production capacity is expected to be a large portion of local and regional consumption.

• The Project's cost of raw inputs are generally not correlated with the wholesale price of end products sold into the wholesale market.

• The Dow contracts have various weaknesses including Dow's ability to terminate the agreement in year 11 subject to a scheduled termination payment starting at $32.5 million, various penalties and adjustments for under performance and no explicit penalties on Dow for non-delivery of raw materials.

• The Project could incur inefficiencies at partial operations of any individual electrolytic cell trains though the ECU facility's 3 electrolytic cell trains provides some flexibility to minimize this risk.

• Project has not conducted an environmental site assessment and Dow's environmental indemnity does not cover indirect costs such as debt service which indirectly exposes the Project to existing environmental risks.

• The Project's location near various fault lines around the San Francisco area increases earthquake risk while the earthquake insurance coverage during construction incorporates a large deductible.

• Sizeable refinancing risk exists since up to 85% of the debt could be outstanding at maturity under conservative cases considered by Moody's though the base case has about 47% outstanding at maturity.

The stable outlook reflects Moody's expectation that the Project will achieve full commissioning in the third quarter of 2011, the Project will be able to meet its performance obligations under the Dow contracts and the Project will achieve FFO/Debt of at least 6% and DSCR of at least 1.6 times.

The rating could be negatively affected if the Project incurs significant delays or cost overruns during construction, the Project is unable to meet its performance obligations under the Dow contracts, if the Project is unable to achieve the expected financial metrics including debt amortization. The rating could also be negatively affected if a major earthquake occurs near the Project's location and the Project incurs significant damage.

The rating could be positively affected if the Project reaches full construction completion according to budget, demonstrates consistently strong operations and achieves sustained financial performance commensurate with the base case.

K2 Pittsburg's rating were assigned by evaluating factors we believe are relevant to the credit profile of the issuer, such as i) the business risk and competitive position of the company versus others within its industry, ii) the capital structure and financial risk of the company, iii) the projected performance of the company over the near to intermediate term, and iv) management's track record and tolerance for risk. These attributes were compared against other issuers both within and outside of K2 Pittsburg's core industry and K2 Pittsburg's ratings are believed to be comparable to those of other issuers of similar credit risk.

K2 Pittsburg owns and is constructing a chlor-alkali project located in Pittsburg, CA and is designed to produce up to 296.5 tons per day of ECUs and up to 200 tons per day of bleach. The Project is being built by DPR and mechanical completion is expected by April 2011. Once in operations, the Project will sell approximately half its output to Dow under a long-term 20-year contract. The Project is indirectly owned by K2 Pure Solutions (K2 Solutions). K2 Solutions is indirectly owned by K2 Solutions's management and Centre Capital Investors IV LP and related parties.

New York
Clifford J Kim
Asst Vice President - Analyst
Project & Infrastructure Finance
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Chee Mee Hu
MD - Project Finance
Project & Infrastructure Finance
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's rates K2 Pure Solutions NoCal's senior debt at B1 with a stable outlook
No Related Data.
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