(The following statement was released by the rating agency)
Oct 10 - Fitch Ratings has affirmed Spectrum Brands Inc.'s
(Spectrum) ratings following yesterday's announcement that the company will acquire Stanley Black & Decker's Hardware & Home Improvement Group (HHI) for $1.4 billion in cash. The acquisition is expected to be debt financed and finalized by the end of the company's second quarter subject to customary closing conditions.
Fitch affirms Spectrum's rating as follows:
--Long-term Issuer Default Ratings (IDR) 'BB-':
--$300 million senior secured revolving credit agreement 'BB-'; --$370 million senior secured term loan 'BB-'; --$950 million 9.5% senior secured notes 'BB-'; --$300 million 6.75% senior unsecured notes at 'BB-'. The Rating Outlook is Stable. Rating Rationale:
This is clearly a leveraging transaction with opening day debt/adjusted EBIDTA increasing to 4.6x from an estimated 3.4x at the fiscal year ended Sept. 30, 2012. Nonetheless, the affirmation is supported by Spectrum's solid track record of improving margins, low single digit organic growth rates since 2009, ample levels of free cash flow and higher margins and additional FCF to be garnered from HHI.
The acquisition is accretive and fits from a financial perspective, particularly as HHI is reported to have strong and stable FCF. The acquisition also allows the company to further diversify its customer base. In purchasing HHI, Spectrum adds an established entity with higher EBITDA margins and less seasonal FCF. There are minimal integration risk and synergy expectations. Both companies have the same marketing strategy based on value with similar performance to premium priced products.
The Outlook is Stable based on Fitch's expectation of improving FCF and management's ability to de-lever to well below 4.0x within an 18-24 month period after closing. However, there is no room in Spectrum's rating for any leveraging transaction. Adding leverage in a slowing global economy could pose some risk despite our expectation of marked improvements in FCF. Fitch anticipates that FCF will decline moderately in 2013 given acquisition related fees and modest integration spending. However FCF should increase markedly in 2014 to more than the $150 million expected in 2012. Spectrum generates the bulk of its FCF in the fourth quarter, and much of that has been used to voluntarily reduce debt. Fitch expects this to continue. Leverage is also likely to trend higher at the end of 2013 without a full year of HHI's performance but then improve markedly in 2014.
Spectrum is a controlled company with limited independent directors and has a 57.5% majority owner in Harbinger Group, Inc. (NYSE: HRG; rated 'B', Outlook Stable). HRG is a publicly listed entity controlled by funds managed by or affiliated with Harbinger Capital Partners LLC (collectively 'Harbinger Capital'), a hedge fund. Harbinger Capital owns approximately 93% of HRG. HRG is a holding company primarily focused on obtaining longer-term, controlling equity stakes in other companies.
HRG uses the value of its portfolio investments as collateral for its own debt. HRG has pledged its Spectrum shares as part of the collateral for its 10.625%, $500 million notes. The collateral is valued at approximately $1.2 billion. Debt incurrence and maintenance covenants in both Spectrum's and HRG's debt facilities helps to support credit protection measures. Additionally, HRG has to maintain certain collateral coverage levels. HRG has a comfortable collateral cushion. Fitch monitors HRG's covenant cushion and compliance as part of Spectrum's rating.
Harbinger Capital Partners Master Fund I, Ltd., (an affiliate of Harbinger Capital) owns 50.9% of HRG on a fully diluted basis and has also pledged all of its shares in HRG together with securities of other issuers. If there was a foreclosure or sale of the HRG shares pledged as collateral, it would be a change of control of HRG and Spectrum, respectively. The change would not only accelerate all of Spectrum's and HRG's debt and preferred stock, but would cause Spectrum to be unable to use its net operating losses, which could negatively affect cash flows. Spectrum would need a waiver on its term loan and revolver, and might also need a waiver on its notes, as it is required to offer to repurchase those instruments.
Financial Performance and Liquidity:
For the first nine months ended July 1, 2011, Spectrum's revenues increased almost 2.6% due primarily to increased volumes of 3%, acquisitions of 1.5% and partially offset by (1.9%) of negative foreign exchange translation. The EBITDA margin of 14.7x at the LTM continues to increase with slow but steady sales growth and cost containment efforts. Leverage was 3.8X but is expected to be 3.4x at year end with $150 million of prepayments made in the fourth quarter.
FCF continues its typical path of being negative in the first quarter but improving sequentially each quarter and was $120 million at the LTM. Spectrum's fourth quarter 2012 FCF is estimated to be at least $253 million, a 12% increase from fourth-quarter 2011. Fitch estimates Spectrum's 2012's FCF to be at least $150 million, which would be the third year in a row of positive free cash flow. If the special one-time dividend last month was excluded, FCF would have improved sequentially in each of the past three years.
Spectrum's liquidity is good. It had $195 million in borrowing availability at the end of June 2012 under its secured revolving credit agreement and $62 million in cash. Current debt maturities are very modest through 2015 with less than $15 million due in each of the next three years.
Rating Action Triggers:
Negative: Any change in management's strategy to de-lever to the 2.5x to 3.5x level within 24 months after the acquisition closes would have negative rating implications. A new and sizeable leveraging transaction that would keep leverage above the mid 4x range could also have negative rating implications.
Governance Implications Potentially Negative: A change of control due to issues with the majority owner could have negative rating implications. An event of default could occur if HRG and affiliates own less than 35% of Spectrum. If there is a change of control, it would most likely be due to foreclosure on the assets (Spectrum shares) backing financings at the parent level. In this event, all of Spectrum's debt could accelerate unless the company obtains waivers. Any event related to a potential change of control at the Harbinger Capital level will be assessed upon occurrence.
Positive: Unlikely in the near term given the acquisition announcement and the expected increase in leverage.
(Caryn Trokie, New York Ratings Unit)