-- Private equity firm New Mountain Capital has agreed to acquire CoralSprings, Fla.-based ABB/Con-Cise Optical Group LLC.
-- We are assigning our preliminary 'B' corporate credit rating to thesoft contact lens distributor, and our preliminary 'B' issue rating to theproposed $155 million senior secured credit facilities.
-- The stable outlook reflects our forecast for a mid-single-digit profitincrease due to industry growth and new customers, continued modest free cashflow generation after tax distributions, and limited credit measureimprovement.
Rating ActionOn Oct. 10, 2012, Standard & Poor's Ratings Services assigned its preliminary'B' corporate credit rating to Coral Springs, Fla.-based ABB/Con-Cise OpticalGroup LLC. The outlook is stable.
At the same time, we assigned our preliminary 'B' issue rating, the same asthe corporate credit rating, to the proposed $155 million senior securedcredit facilities. The preliminary recovery rating on the senior securedcredit 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 toreview upon receipt of final documentation. Pro forma for the proposedtransaction, total debt outstanding is about $116 million.
The ratings on ABB/Con-Cise Optical Group LLC (ABB) reflect our assessmentthat the company has a "weak" business risk profile associated with itsparticipation in the highly competitive contact lens distribution industry;its lack of product, supplier, and geographic diversity; low barriers toentry; and the ability of customers to switch distributors fairly easily.These factors result in highly competitive pricing and low profit margins. Webelieve the ongoing competitive threat posed by mass merchants, large eye carechains, and online contact lens companies will limit growth at ABB's corecustomer base, independent eye care professionals (IECPs).
The business risk assessment also recognizes the company's vulnerability todecisions made by the four major contact lens suppliers that dominate theindustry. More importantly, we assume these suppliers will not reduce usage ofdistributors to sell product to ECPs. Loss of business with any of thesesuppliers could weaken ABB's credit quality.
In addition, the business risk assessment recognizes the modest growth andstability of the industry, which should permit ABB to sustain its profitlevels; ABB's high market share, and the potential to add customers andleverage its currently underutilized distribution centers.
Our view that ABB's financial risk profile is "highly leveraged" reflects itsmodest free cash flow generation after tax distributions, and aggressivefinancial policy, notwithstanding pro forma credit metrics, including about4.5x leverage and a 16% ratio of funds from operations (FFO) to total debt,that are currently better than levels typical for the financial risk profilecategory, including leverage above 5x. A more aggressive future financialpolicy, including the potential for a meaningful debt-financed nontaxdistribution to shareholders or sizable debt-financed acquisition, is a keyrisk factor. The proposed transaction includes a provision that would permitABB to add junior unsecured debt such that covenant leverage could increase to5x, which would equate to about 5.5x under Standard & Poor's leveragecalculation. Note that the company is privately owned and does not file itsfinancial statements publicly.
We forecast that ABB should be able to moderately increase sales andprofitability because of normal population growth, generally favorabledemographics (including the continued proliferation of computers and digitaldevices that strain eyesight), and further leveraging of the company'sdistribution centers. Specific assumptions underlying our forecast for thenext 12 to 24 months include the following:
-- Mid-single-digit organic sales and profit growth, mainly reflectingincreased contact lens shipments and modestly higher pricing.
-- A tuck-in acquisition during 2013, which costs about $6 million andadds low-single-digit inorganic sales growth. Importantly, we assume no majoracquisitions throughout the forecast period.
-- No further reduction in accounts payable days outstanding, ortightening of other working capital turnover ratios. It is our understandingthat ABB took advantage of shorter accounts payable terms this year fromcertain manufacturers to receive early pay discounts, which we believe willweaken cash flow in 2012.
-- Close to $15 million annual free cash flow generation, and $5 millionto $10 million of cash flow after tax distributions. No large debt-financednontax distributions are assumed throughout the forecast period.
Based on these assumptions, which do not include a leveraging event, weforecast over the next 12 to 24 months the following credit ratios: about 4xleverage, 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 3.1xEBITDA interest coverage as of June 30, 2012.
We view ABB's liquidity as "adequate." Pro forma for the transaction, weexpect the company to have close to full availability under the $40 millionrevolving credit facility, about $15 million of annual free cash flowgenerating ability, and minimal excess cash. Relevant aspects of the company'sliquidity 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 EBITDAfell 15%.
-- We conservatively forecast net working capital to grow by about $15million.
-- Capital expenditures of only a few million dollars annually shouldpermit close to $15 million annual free cash flow, about half of which thecompany will use to pay tax distributions to shareholders, leaving modest cashflow for debt repayment.
-- Pro forma contractual debt maturities are less than $1.5 millionannually over the next few years. However, beginning with the fiscal yearending Dec. 31, 2013, there will be an excess cash flow sweep provisionstarting at 50%, with the potential to decline if ABB reaches certaindeleveraging benchmarks.
-- It is our understanding that financial covenants (including stepdowns) will be set at about a 30% cushion to management's forecast. Based onthis assumption, we forecast at least 20% covenant cushion over the next twoyears.
ABB's liquidity descriptor is limited to "adequate" since we do not believethe company's liquidity could withstand high-impact, low-probability events,and since the company does not have access to the capital markets, though webelieve it has sound banking relationships.
Recovery analysisThe issue rating on the proposed $155 million senior secured creditfacilities, which consist of a $40 million five-year revolving credit facilityand $115 million six-year term loan facility, is preliminary 'B', the same asthe corporate credit rating. The recovery rating is preliminary '3',indicating that lenders could expect meaningful (50% to 70%) recovery in theevent of a payment default or bankruptcy.
The outlook is stable. We forecast the company will organically grow profitsat a mid-single-digit rate in 2013 due to industry growth, addition ofcustomers, and tight cost controls; generate $5 million to $10 million of freecash 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 ableto increase its geographic diversity; grow profits potentially through newIECP customer wins or increased penetration with strategic accounts and largeECP chains; and if we believe its new majority owner will maintain a financialpolicy that will result in continued adequate liquidity and credit ratiossustained around the high-end of the aggressive financial risk descriptorcategory. 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 over10%.
Alternatively, we could lower the ratings if the competitive environmentchanges, including reduced distributor usage by manufacturers or a significantloss of IECP retail share to other contact lens providers, causing ABB'sliquidity, covenant cushion, and profits to fall meaningfully; or if financialpolicy changes. We would likely lower the ratings if credit ratios deteriorateto levels at the low end of the "highly leveraged" financial risk descriptorcategory, including leverage approaching 6x and FFO to total debt of around10%. We estimate this could occur if profits fall 20%, or if ABB paid itsowners a $40 million special dividend.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For GlobalCorporate 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, 2008Ratings ListNew RatingsABB/Con-Cise Optical Group LLCCorporate 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)
Complete ratings information is available to subscribers of RatingsDirect onthe Global Credit Portal at . All ratings affectedby this rating action can be found on Standard & Poor's public Web site at. Use the Ratings search box located in the leftcolumn.
(New York Ratings Team)