Moody's assigns Nalco Chemical Co                             Click here to return to News

Mon October 20, 2003 03:05 PM ET
(The following statement was released by the rating agency)

Approximately $3.45 Billion of Long-Term Debt Affected.

NEW YORK, Oct 20 - Moody's Investors Service assigned a B1 senior implied rating to Nalco Company. In addition, Moody's assigned the following ratings to the company's proposed debt offering: senior secured credit facility and term loans at B1, senior unsecured notes at B2, and senior subordinated notes at Caa1. Proceeds from the debt offering combined with a $1.1 billion equity capital contribution from Blackstone Group, Apollo Management, and Goldman Sachs Capital Partners ("the equity sponsors") will be used by Nalco Company (currently named Ondeo Nalco Company) to purchase the outstanding shares of capital stock from Suez for roughly $4.125 billion (representing a 7.7 times LTM EBITDA multiple). The transaction, which is not subject to Suez shareholder approval, is expected to close by December 31, 2003. The ratings outlook is stable.

This is a first time rating for the company. The following summarizes the ratings activity. Ratings Assigned: Senior Implied -- B1 Guaranteed senior secured revolver, $250 million due 2009 -- B1 Guaranteed senior secured term loan A, $300 million due 2009 -- B1 Guaranteed senior secured term loan B, $1100 million due 2010 -- B1 Guaranteed senior unsecured notes, $900 million of US dollar and Euro denominated notes due 2011 -- B2 Senior Unsecured Issuer Rating -- B2 Guaranteed senior subordinated notes, $900 million of US dollar and Euro denominated notes due 2013 -- Caa1 The ratings take into account Nalco's high leverage with pro forma debt to EBITDA, adjusted for the debt offering and certain expenses, of 6.0 times for the LTM ended June 30, 2003, negative tangible net worth, significant working capital requirements, an indenture that allows significant borrowings at subsidiary companies, a lack of multi-year historical audited financials for the combined entity, and potential exposure to exchange rates. The ratings are supported by Nalco's entrenched competitive position as a global supplier of water treatment and process chemicals for industrial and institutional applications that generates unusually strong EBITDA margins (roughly 20% excluding extraordinary items on an LTM basis), the diversity of its end-markets, raw materials and customer base, modest capital expenditure requirements, and the improvement in its operating performance over the past two years despite a weak economic environment. The ratings incorporate the strength of the new management team and the level of support, including the $1.1 billion equity investment, from the equity sponsors. The ratings also recognize significant barriers to entry, including high customer switching costs, patents, significant R&D spending, and long-term customer relationships. The notching of the senior secured credit facility (rated B1) at the level of the senior implied reflects the significant portion of secured debt in the capital structure, the substantial level of international assets that are not part of the security package, and Moody's belief that in a distress situation, the tangible collateral may not cover amounts outstanding under the secured revolver and term loans. Nalco's European subsidiaries will be co-borrowers under the revolver. The company's obligations under the secured facilities will be guaranteed by parent Nalco Holdings LLC and domestic subsidiaries while obligations of the European borrowers will be guaranteed by their subsidiaries, subject to applicable laws. The credit facility will be secured by a security interest in substantially all of the domestic tangible and intangible assets as well as a pledge of stock in international subsidiaries. The lender's position is further supported by an excess cash flow sweep provision and limitation on acquisitions and capital expenditures. The notching of the senior unsecured notes (rated B2) one level below the senior implied reflects their contractual subordination to the secured debt. The notching of the senior subordinated notes (rated Caa1) three levels below the senior implied reflects the deep subordination to a substantial amount of secured and senior unsecured debt, Nalco's limited tangible asset base, the substantial level of earnings and assets at non-guarantor subsidiaries, and the potential for additional borrowings at operating subsidiaries that could further subordinate this debt. Nalco Holdings LLC and domestic subsidiaries will guarantee the senior subordinated and senior unsecured notes. Moody's notes that the indentures for the senior unsecured and subordinated bonds contain many standard covenants. However, the level of additional indebtedness and restricted payments allowed under the indenture raises concern given the company's substantial leverage. The indentures allow for $300 million of additional indebtedness at restricted and unrestricted subsidiaries that could subordinate the notes and a $100 million basket for restricted payments and investments that could reduce cash flow available for debt reduction. This concern is somewhat offset by management's credibility and their intent to focus on debt reduction rather than the pursuit of acquisitions or other transactions. The stable outlook reflects Moody's expectation that Nalco will encounter minimal problems as it transitions to a stand-alone company, be able to maintain its market share in key end-markets, and successfully avoid aggressive price competition with its major competitors. The outlook also reflects Moody's expectation that credit metrics will improve post-2004 due to the absence of restructuring charges and other expenses tied to the transaction. The ratings could be lowered if the company fails to achieve yearly free cash flow of at least $100 -125 million adjusted for extraordinary items during the next two years, or if competitive pressures are greater than anticipated. Due to the substantial level of debt, it is unlikely that Moody's would raise the company's senior implied rating over the next two years.

Nalco Company (Nalco) is a global producer of water treatment and process chemicals for a variety of industries. Water treatment chemicals address boiler water, cooling water, and wastewater applications while process chemicals address the performance and efficiency of a customer's production process. Process chemicals tend to carry higher gross margins than those of water treatment; however, the overhead cost required to serve this business is higher. Nalco's products and services represent a relatively small portion of a customer's cost, but are a critical component of a customer's operations. When it was acquired by Suez in 2000, Nalco was combined with Suez's smaller Aquazur and Calgon water treatment businesses. In 2001, Nalco acquired the remaining equity interest (40%) in an energy services joint venture with Exxon. Nalco's business is divided into three divisions: Industrial and Institutional Services (I&IS -- 47% of 2002 revenues), Energy Services (27% of revenues), and Paper Services (26% of revenues). I&IS derived 79% of its 2002 revenues from water treatment chemicals for a variety of industries, including food and beverage, metals and mining, manufacturing, and institutions (remainder of revenues are from process chemicals).

Energy Services generated 77% from process chemicals for the natural gas, petroleum, and petrochemical industries and Paper Services derived 87% of its revenues from process chemicals for the pulp and paper industry. Key strategic initiatives include expanding within its increasingly consolidating customer base, expanding with customers internationally, and continued integration of technical staff into its customer's operations and process planning. The ratings also recognize that Nalco is well positioned to benefit from the trend of customers out-sourcing process and water management due to its geographic scale, technical capabilities, and ability to address all aspects of a customer's water management system. Additionally, the company should continue to benefit from continuing government regulation on water quality and increased monitoring by public and private entities monitoring pathogens in food and water.

Nalco's primary competitors are GE Water Technologies (formerly BetzDearborn) in I&IS and Hercules in Paper Services. Most other water treatment competitors are much smaller private companies that lack scale and geographic diversity of Nalco and GE. Most large specialty chemical companies do not compete directly with Nalco in its end-markets. The ratings are supported by the stability of Nalco's operating margins despite weak economic conditions. More specifically, the company has consistently maintained 18% to 20% pro forma EBITDA margins (adjusted for restructuring expenses) despite soft demand within its primary end-markets and significant pricing pressure in its Paper Services division due to substantial consolidation among its customer base. Revenues have also remained relatively stable over the period. This stability is primarily attributed to the positive trends driving growth in water treatment and energy services demand, which have more than offset raw material cost pressure and pricing pressure in paper. However, Moody's notes that although margins have been stable, cash flow has been volatile due to restructuring expenses and pension payments. For example, although pro forma adjusted EBITDA increased to $517 million in 2002 from $471 million in 2001, cash from operations decreased to $337 million from $406 million over the same period. The reduction in cash flow is primarily due to a voluntary $90 million contribution to the company's US pension plan. The company's US pension will be under-funded by roughly $220 million at closing. However, management does not anticipate any required contributions to the pension plan over the next three years due to the contribution made in 2002. Moody's also noted that cash flows in 2004 will be negatively impacted by roughly $40 million of cash restructuring expenses. The ratings also take into account Nalco's substantial pro forma leverage. Adjusted for the transaction, the company would have total debt of $3.25 billion, which would have represented 1.2 times LTM revenues of $2.7 billion. LTM debt to EBITDA of 6.0 times (pro forma LTM EBITDA of $546 million excludes $30 million of unrealized cost savings). Pro forma free cash flow (cash from operations less capital expenditures) to debt is approximately 2.8%. Additionally, at June 30, 2003, the company had goodwill and intangibles of $4.25 billion (69% of assets) and tangible net worth of a negative $3.2 billion. Adjusted for the transaction, Moody's views Nalco's liquidity as good. The company will have pro forma cash of $40 million and revolving credit facility availability of $228 million. Term loan amortization will be $37 million in year 1, $41 million in year 2, and $56 million in year 3. Furthermore, financial covenants in the bank agreement appear to be set well below projected operating performance over the next several years. Nalco Company, headquartered in Naperville, Illinois, is a global producer of water treatment and process chemicals for industrial and institutional applications. Revenues were $2.7 billion for LTM ended June 30, 2003.

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