-- ContourGlobal Power Holdings S.A. is issuing a $350 million senior secured term loan with a five-year term. The loan is supported by a guarantee from ContourGlobal L.P., the parent.
-- Loan proceeds will be used to retire some project-level debt and to acquire new projects.
-- We are assigning our preliminary 'BB-' rating to ContourGlobal Power Holdings' senior secured term loan facility based on the corporate credit rating and the impact of a preliminary recovery rating of '2'.
-- The preliminary rating on ContourGlobal and ContourGlobal Power Holdings remains 'B+', based on the guarantee provided by the parent.
-- The outlook is stable.
Rating Action On Oct. 2, 2012, Standard & Poor's Ratings Services assigned its preliminary 'BB-' rating to ContourGlobal Power Holdings S.A.'s (CGPH) proposed $350 million senior secured term loan facility due 2017. We also assigned the term loan a preliminary recovery rating of '2', indicating our expectation of substantial (70% to 90%) recovery in the event of a payment default. Assignment of a final rating hinges on our receipt and review of executed documentation. The final rating could differ if any terms change materially. The preliminary corporate credit rating on CGPH's parent, ContourGlobal L.P. (CG; a developer of electric power generation and district heating assets), remains 'B+'. The preliminary corporate credit rating on CGPH, a 100% owned subsidiary of CG that benefits from a guarantee from both CG and its project-owning subsidiaries, also remains 'B+'.
Standard & Poor's preliminary rating on CG is 'B+'. Our preliminary rating on CGPH is also 'B+', based on a parental guarantee from CG. The outlook is stable.
Standard & Poor's preliminary rating on CGPH's $350 million five-year term loan facility is 'BB-'. We assigned the term loan a '2' preliminary recovery rating, indicating our expectation of substantial (70% to 90%) recovery in the event of a payment default. The rating reflects the application of our project developer methodology. We view the financial profile to be "aggressive" and have assigned a quality of cash flow (QCF) score of 8, equating to a weak business profile.
CG had initially planned to issue a non-amortizing, seven-year, fixed-rate senior secured bond, but now plans to issue a five-year, floating-rate term loan B of the same size ($350 million). The term loan includes provisions for a 1% annual required amortization, as well as a cash sweep. Under the cash sweep, initially all residual funds (less the greater of 10% of parent cash available for debt service or $15 million) will be used to pay down debt. After 2013, if leverage at the CG level drops to less than 2 to 1, the sweep amount drops to 75%. This sweep mechanism reduces refinancing risk for the debt, with the loan fully amortizing under our base case scenario within the five-year term. The loan covenants also include a minimum interest coverage ratio of 1.5 to 1 and a maximum net leverage ratio of 5 to 1 (dropping to 4 to 1 in year three) on a nonconsolidated basis. For CG to issue additional debt, the interest ratio must exceed 2 to 1 and leverage must be less than 4.5 to 1 (dropping to 3.5 to 1). The loan covenants also allow for existing debt at subsidiaries along with some additional debt for purposes such as working capital, capital leases, capital expenditure to meet government regulation or safely requirements, permitted guarantees, hedging in the ordinary course of business, and subordinated intercompany indebtedness. Limits are imposed on most of these items as a percentage of consolidated assets.
The proceeds of the term loan will be used to repay some existing project-level debt (EUR35 million at Maritza, the anticipated largest contributor to cash flow, and approximately $15 million at Asa Branca, a wind project) and to acquire or construct new projects from CG's development pipeline. CG owners are restricted from receiving proceeds. Debt service on the term loan will come from the residual cash flow distributions of a portfolio of 21 projects, with 16 in operation and five under construction, totaling about 2.77 gigawatts (GW) of gross generation that CG either entirely or partially owns.
Given the double leverage with debt at the issuer and debt at the projects, our analysis uses the project developer methodology, under which we assign QCF scores to the different cash streams coming into CG from each project in the asset portfolio. The QCF score reflects our opinion of the dividend stream's potential volatility. Cash flow quality suffers from the more obvious reasons, such as business volatility and cash flow from operations, but is also influenced by the evaluation of each investment in a portfolio such as the project's capital requirements and the cushion available before cash flow covenant breaches such as distribution traps at the project level. This is important to the rating because the residual cash flow from each investment (dividends or distributions paid to the developer) provides the means to support parent-level debt. Standard & Poor's QCF scale ranges from '1' to '10', with '1' being the most stable. Project-level QCF scores were largely influenced by the location of projects (with respect to political risk and geography), project-level covenants that affect a projects' ability to distribute cash to sponsors, operational history, exposure (if any) to foreign exchange risk), and the terms of key project contracts such as power purchase agreements (PPAs) and fuel supply agreements.
We have assigned a QCF score of '8' to the portfolio, with currency and country exposure, relatively weak counterparties, construction and operational risk, and some technology risk (particularly at the Rwanda lake-gas project) offsetting the approximately 90% contracted revenue.
Our assessment of business risk is "weak" and our assessment of financial risk is "aggressive."
The rating on CGPH reflects our view of the following weaknesses:
-- The portfolio has significant concentration risk. If we assume no projects are added to the current portfolio, the largest two assets -- Maritza, a Bulgarian coal plant and Arrubal, a Spanish combined-cycle gas plant -- contribute 52% of forecast cash flow for debt service during the next seven years. In a scenario in which the term loan proceeds are used to expand the portfolio, we anticipate that this percentage would decline to 44%.
-- CGPH relies on substantial distributions from jurisdictions with considerable regulatory and operating uncertainties.
-- The KivuWatt project in Rwanda, which we anticipate will provide 8% of cash flow for the current portfolio, plans to use methane harvested from suspension in Lake Kivu. This technique has not yet been proven on a sustainable commercial scale, so the project has sizable operational risks.
-- The company's growth strategy is heavily dependent on smoothly working credit markets for additional debt issuances and refinancing planned at the individual project level, with the management base case including assumed debt issuance at six projects during the term of this rated debt.
-- Many regions of operations are facing political uncertainty.
-- Growth expenditure requirements are large.
-- Debt will be denominated in U.S. dollars, but more than 50% of cash flow for debt service that we project will be generated in euros.
Partly offsetting the above weaknesses, in our view, are the following strengths:
-- The debt includes a cash sweep mechanism, and is projected to fully amortize under our base case scenario within five years.
-- Exposure to merchant power markets is limited, with fewer than 90% of current revenue contracted or regulated.
-- Regional, technology, and fuel source diversification provide benefits.
-- CGPH has an experienced management team and well-developed operations team. Although the company is six years old, the core of the management team previously worked at AES Corp. (BB-/Stable) with more than 10 years of responsibility for operations of a similar portfolio during that time.
-- Political risk insurance (PRI) exists for projects in speculative-grade countries, improving potential recovery if a project is damaged, shut down, or expropriated (for reasons including failure to honor arbitration awards relating to contract breaches), and providing some incentive for counterparties to meet contractual agreements.
-- CGPH has a history of strong operations and meeting improvement targets since 2005 at its generation and distribution businesses.
-- The portfolio is tolerant to foreign exchange movements similar to the worst experienced in the past five years.
-- The portfolio can continue to support debt service with the loss of all revenue from the largest project.
CG has a current hedging program separate from the portfolio that covers much of the currency risk between project-level primary currencies and U.S. dollar-denominated debt during the next several years.
CG has 16 projects in operation and another five in various stages of construction that management anticipates will reach operational status within the next three years. Management has also provided details for a number of projects that it considers likely to launch within the next three years from the company's development pipeline. CG is in a high-growth phase and is issuing this debt with the intention of funding new projects (whether by acquisition or new construction), so we consider the company's targeted growth scenario as the most likely outcome.
At a project level, management has modeled most projects at minimum contractual PPA volume or availability thresholds, and assumes that operational performance will remain close to recent historical performance. Although many of the projects have the potential for offtake contract extensions, the current projections did not include this potential revenue, and our base case assumes none.
At the portfolio level, we focused on three primary scenarios: management's anticipated growth scenario; our base case, which also assumes portfolio growth; and a "no-growth" scenario, which has the same assumptions as our base case but assumes that projects in construction will be completed and that no additional projects will be added to the portfolio. We have also run a number of scenarios on top of these base cases to examine volatility of cash flow under various stress scenarios. The default management case also assumes a refinancing of the debt issuance at the same rate and tenor after seven years.
Our base case varies from the management base case with assumptions that:
-- The yield on cash is zero.
-- None of the assumed recapitalizations occur (and thus do not provide incremental cash flow to the parent from the recapitalization proceeds).
-- Corporate expenses are 20% higher than management's case because of the complexity of managing such a disparate set of assets.
We tested portfolio volatility in two phases: individual projects and the portfolio as a whole.
In the individual projects phase, we examined each project in turn and adjusted inputs based on the actual contracts for energy offtake, fuel supply, operations and maintenance, and other items that are material to the project. We converted the cash flow from local currency into U.S. dollars, as that matches the currency of the debt obligation. Foreign exchange rates and inflation rate assumptions were also stressed. We then established QCF numbers for each project based on volatility together, with an assessment of transfer and convertibility risk and country risk in a number of the less developed areas. These stresses were made as consistent as possible across the portfolio.
For the portfolio as a whole, we ran a number of different scenarios to test the strength of cash flow across the portfolio in aggregate, and these are detailed in a later section. Maritza, a coal plant in Bulgaria, is the largest project within the portfolio, and even in the growth scenario this project is forecast to contribute more than 20% of cash flow to the debt issuer. We tested the impact of losing some or all revenue from this project, and also ran a scenario in which revenue was lost from the projects in the lowest-rated jurisdictions. Other scenarios include no under-construction projects reaching completion, the impact of a South American IPO, inflation and foreign exchange stress, unsuccessful expansion of the KivuWatt plant, and a combined stress that includes operational underperformance at key plants along with inflation and foreign exchange stress.
Overall, cash flow strength under all sensitivities exhibits a degree of robustness commensurate with a 'B+' corporate credit rating. We also note that the management base case scenario includes what we consider achievable assumptions for PPA revenue (including only minimum amounts under PPAs).
Debt per kilowatt (kW) at the issuer level is $166 per kW for the term debt, or $181 per kW including the revolving facility. Consolidated debt per kW is about $985 per kW in 2012 for the 2.5-megawatt current portfolio, in terms of net ownership of generation, and $1,002 per kW assuming the revolving facility is fully drawn. This higher level of debt is associated more with the speculative-grade rating category. On a consolidated basis, the debt at the parent and all subsidiaries is about 50% of capital.
For both a static portfolio and the growth portfolio, we project that the $350 million term loan will be paid off by the end of the debt term. A large number of existing PPAs have contractual revenue that extends beyond the 2018 refinancing date, providing CG with the opportunity to possibly refinance another loan at the maturity of this one, should any principal be left outstanding.
However, without such refinancing, our base case scenario predicts that consolidated debt will decline to $770 per kW for the static portfolio and $645 per kW for the growth portfolio by the end of 2017.
In the non-growth case, a discounted cash flow of future contracted revenue from 2017 onward (excluding any anticipated non-contracted revenue, using a 15% discount rate) from existing projects results in a present value of $585 million, about 167% of the initial debt balance. In the non-growth scenario, the issuer has retained bond proceeds on the balance sheet and can also use this liquidity to pay off debt (another approximately 95% of debt principal). The company is unlikely to retain this cash (with its associated holding costs) for five years, but the non-growth scenario is a useful extreme case.
In our base case growth scenario, the bond proceeds are spent, and the resultant larger portfolio has future revenue of $912 million (including contracted revenue at current projects and anticipated revenue from finalized contracts at growth projects from the development pipeline). This is approximately 260% of the value of the initial debt balance. In both cases, future revenue provides solid coverage of $350 million of debt and increases the chance of successful refinancing.
We do not consider CG separate from its private equity owners. Although CG includes separateness provisions, we do not anticipate receiving a non-consolidation opinion from the partnership owners of CG, and thus CG does not meet our criteria definition of a bankruptcy-remote special-purpose entity. Although the credit documents include some leverage and interest coverage covenants, the lack of separation from the parents means that we did not assess CG completely separately from the credit risk of its parents. The private equity owners have the ability to leverage up themselves, and this may affect CG's continued operation. Therefore, the CG rating is limited to the 'B' category even before the assessment of the portfolio QCF score.
Recovery Scenario Our recovery scenario is based on liquidity stress on the portfolio. We assume the term loan proceeds are spent on new projects, not all of which are successful. In this scenario, a number of key projects operationally underperform. Liquidity from the revolving facility, term loan proceeds, and project distributions is exhausted in 2015, and our recovery assessment is based on a present value of future contractual revenue at remaining operating plants. The outcome is a recovery of 71% and a recovery score of '2'.
We consider CG's liquidity "adequate" given anticipated sources and uses during the next 12 months. We anticipate a $35 million revolving facility to be issued concurrently with the $350 million term loans. Apart from loan proceeds and existing cash, the revolving facility is the only source of liquidity. The bond proceeds will be held by the issuer (CGPH), and can be used in equity investment or loans to other subsidiaries of CG.
Given the planned debt issuance and the gradual deployment of proceeds, liquidity at the issuer level is initially high. In the no-growth scenario, this liquidity will remain with the issuer. In the growth scenario, we anticipate $38 million of term loan proceeds to be used in the first year, with projects generating $104 million of cash available for debt service, and first-year interest and required principal amortization of $38.5 million under the five-year term loan facility.
CG provides additional liquidity in the form of operational cash flow and reserves built into the financings at the individual project level (with this liquidity accessible through the guarantees provided to the issuer from these project companies.) At the current rating, the underlying projects are adequately financed by their own debt service and maintenance reserves. We anticipate debt service coverage (DSC) of more than 2.0x in 2012 and an average of more than 2.5x during the term of the debt, providing a buffer of cash generated from operations. The minimum DSC is 2.28x for one year in the no-growth scenario. If any project experiences a major operational issue that requires an equity infusion, bond proceeds would be available unless already disbursed for growth projects. The company could also choose to refinance existing project-level debt. Judging by recent operational performance figures, we think the risk of major operational issues is low in most projects (with KivuWatt being one exception because of technology risk and lack of historical precedent).
The stable outlook reflects our view of the portfolio's diversified nature in terms of geography, technology, and counterparty exposure. It also reflects the high level of contracted revenue under offtake agreements and the exclusion of potential contract extensions in the corporate projections. It also reflects the amortizing nature of the loan. Although the portfolio is exposed to country risk in a number of emerging markets, the anticipated distributions to CG offer substantial DSC, and CG can continue to pay debt service even with the loss of revenue from a number of key projects.
We are unlikely to raise the rating because of exposure to emerging markets and construction risk at some projects. We could lower the rating if operating costs escalate well above projections, if construction on new projects is substantially delayed, or if planned acquisition targets are not met. On a consolidated basis, the debt to capital ratio is around 50%. If CG issues additional debt at the parent level, we would likely lower the rating.
Related Criteria And Research
-- Rating Criteria for Project Developers, Sept. 30, 2004
-- Credit FAQ: Knowing The Investors In A Company's Debt And Equity, April 4, 2006
-- Criteria For Special-Purpose Entities In Project Finance Transactions, Nov. 20, 2000
Ratings List ContourGlobal L.P. ContourGlobal Power Holdings S.A. Corporate credit rating B+(prelim)/Stable New Rating
ContourGlobal Power Holdings S.A.
$350 mil sr sec term ln due 2017 BB-(prelim)
Recovery rating 2(prelim)
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