TEXT-S&P assigns ABB/Con-Cise Optical Group prelim 'B' ratings
-- Private equity firm New Mountain Capital has agreed to acquire Coral Springs, Fla.-based ABB/Con-Cise Optical Group LLC.
-- We are assigning our preliminary 'B' corporate credit rating to the soft contact lens distributor, and our preliminary 'B' issue rating to the proposed $155 million senior secured credit facilities.
-- The stable outlook reflects our forecast for a mid-single-digit profit increase due to industry growth and new customers, continued modest free cash flow generation after tax distributions, and limited credit measure improvement.
Rating Action On Oct. 10, 2012, Standard & Poor's Ratings Services assigned its preliminary 'B' corporate credit rating to Coral Springs, Fla.-based ABB/Con-Cise Optical Group LLC. The outlook is stable.
At the same time, we assigned our preliminary 'B' issue rating, the same as the corporate credit rating, to the proposed $155 million senior secured credit facilities. The preliminary recovery rating on the senior secured credit facilities is '3', indicating that lenders could expect meaningful (50% to 70%) recovery in the event of a payment default or bankruptcy.
The preliminary ratings are based on the proposed terms and are subject to review upon receipt of final documentation. Pro forma for the proposed transaction, total debt outstanding is about $116 million.
The ratings on ABB/Con-Cise Optical Group LLC (ABB) reflect our assessment that the company has a "weak" business risk profile associated with its participation in the highly competitive contact lens distribution industry; its lack of product, supplier, and geographic diversity; low barriers to entry; and the ability of customers to switch distributors fairly easily. These factors result in highly competitive pricing and low profit margins. We believe the ongoing competitive threat posed by mass merchants, large eye care chains, and online contact lens companies will limit growth at ABB's core customer base, independent eye care professionals (IECPs).
The business risk assessment also recognizes the company's vulnerability to decisions made by the four major contact lens suppliers that dominate the industry. More importantly, we assume these suppliers will not reduce usage of distributors to sell product to ECPs. Loss of business with any of these suppliers could weaken ABB's credit quality.
In addition, the business risk assessment recognizes the modest growth and stability of the industry, which should permit ABB to sustain its profit levels; ABB's high market share, and the potential to add customers and leverage its currently underutilized distribution centers.
Our view that ABB's financial risk profile is "highly leveraged" reflects its modest free cash flow generation after tax distributions, and aggressive financial policy, notwithstanding pro forma credit metrics, including about 4.5x leverage and a 16% ratio of funds from operations (FFO) to total debt, that are currently better than levels typical for the financial risk profile category, including leverage above 5x. A more aggressive future financial policy, including the potential for a meaningful debt-financed nontax distribution to shareholders or sizable debt-financed acquisition, is a key risk factor. The proposed transaction includes a provision that would permit ABB to add junior unsecured debt such that covenant leverage could increase to 5x, which would equate to about 5.5x under Standard & Poor's leverage calculation. Note that the company is privately owned and does not file its financial statements publicly.
We forecast that ABB should be able to moderately increase sales and profitability because of normal population growth, generally favorable demographics (including the continued proliferation of computers and digital devices that strain eyesight), and further leveraging of the company's distribution centers. Specific assumptions underlying our forecast for the next 12 to 24 months include the following:
-- Mid-single-digit organic sales and profit growth, mainly reflecting increased contact lens shipments and modestly higher pricing.
-- A tuck-in acquisition during 2013, which costs about $6 million and adds low-single-digit inorganic sales growth. Importantly, we assume no major acquisitions throughout the forecast period.
-- No further reduction in accounts payable days outstanding, or tightening of other working capital turnover ratios. It is our understanding that ABB took advantage of shorter accounts payable terms this year from certain manufacturers to receive early pay discounts, which we believe will weaken cash flow in 2012.
-- Close to $15 million annual free cash flow generation, and $5 million to $10 million of cash flow after tax distributions. No large debt-financed nontax distributions are assumed throughout the forecast period.
Based on these assumptions, which do not include a leveraging event, we forecast over the next 12 to 24 months the following credit ratios: about 4x leverage, 18.5% FFO to total debt, and EBITDA interest coverage above 3.5x. This compares to pro forma 4.5x leverage, 16% FFO to total debt, and 3.1x EBITDA interest coverage as of June 30, 2012.
We view ABB's liquidity as "adequate." Pro forma for the transaction, we expect the company to have close to full availability under the $40 million revolving credit facility, about $15 million of annual free cash flow generating ability, and minimal excess cash. Relevant aspects of the company's liquidity profile, based on our criteria and assumptions, are as follows:
-- We forecast that cash sources will exceed cash uses by well over 1.2x. Additionally, we believe cash sources would exceed cash uses even if EBITDA fell 15%.
-- We conservatively forecast net working capital to grow by about $15 million.
-- Capital expenditures of only a few million dollars annually should permit close to $15 million annual free cash flow, about half of which the company will use to pay tax distributions to shareholders, leaving modest cash flow for debt repayment.
-- Pro forma contractual debt maturities are less than $1.5 million annually over the next few years. However, beginning with the fiscal year ending Dec. 31, 2013, there will be an excess cash flow sweep provision starting at 50%, with the potential to decline if ABB reaches certain deleveraging benchmarks.
-- It is our understanding that financial covenants (including step downs) will be set at about a 30% cushion to management's forecast. Based on this assumption, we forecast at least 20% covenant cushion over the next two years.
ABB's liquidity descriptor is limited to "adequate" since we do not believe the company's liquidity could withstand high-impact, low-probability events, and since the company does not have access to the capital markets, though we believe it has sound banking relationships.
Recovery analysis The issue rating on the proposed $155 million senior secured credit facilities, which consist of a $40 million five-year revolving credit facility and $115 million six-year term loan facility, is preliminary 'B', the same as the corporate credit rating. The recovery rating is preliminary '3', indicating that lenders could expect meaningful (50% to 70%) recovery in the event of a payment default or bankruptcy.
The outlook is stable. We forecast the company will organically grow profits at a mid-single-digit rate in 2013 due to industry growth, addition of customers, and tight cost controls; generate $5 million to $10 million of free cash flow after tax distributions; and improve credit ratios modestly, including close to 4x leverage and 18.5% FFO to total debt.
While unlikely over the next year, we could raise the ratings if ABB is able to increase its geographic diversity; grow profits potentially through new IECP customer wins or increased penetration with strategic accounts and large ECP chains; and if we believe its new majority owner will maintain a financial policy that will result in continued adequate liquidity and credit ratios sustained around the high-end of the aggressive financial risk descriptor category. This includes about 4x leverage and FFO to total debt exceeding 20% for a sustained period, which we estimate could occur if EBITDA grows by over 10%.
Alternatively, we could lower the ratings if the competitive environment changes, including reduced distributor usage by manufacturers or a significant loss of IECP retail share to other contact lens providers, causing ABB's liquidity, covenant cushion, and profits to fall meaningfully; or if financial policy changes. We would likely lower the ratings if credit ratios deteriorate to levels at the low end of the "highly leveraged" financial risk descriptor category, including leverage approaching 6x and FFO to total debt of around 10%. We estimate this could occur if profits fall 20%, or if ABB paid its owners a $40 million special dividend.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Use of CreditWatch and Outlooks, Sept. 14, 2009 -- Understanding Standard & Poor's Rating Definitions, June 3, 2009 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- Corporate Ratings Criteria 2008, April 15, 2008 Ratings List New Ratings ABB/Con-Cise Optical Group LLC Corporate credit rating B(Prelim)/Stable/-- Senior secured $40 mil. revolver due 2017 B(Prelim) Recovery rating 3(Prelim)
$115 mil. term loan due 2018 B(Prelim)
Recovery rating 3(Prelim)
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(New York Ratings Team)