Tue Mar 27, 2012 3:17pm EDT
March 27 - Overview -- U.S. environmental services company Heckmann Corp. plans to issue $250 million of senior unsecured notes and $75 million in equity to help finance an acquisition, repay existing secured debt, and for general corporate purposes. -- We are assigning our preliminary 'B+' corporate credit rating to Heckmann and preliminary 'B-' issue-level and '6' recovery ratings to the company's proposed notes. -- The rating outlook is stable, reflecting our expectation of increasing sales and profitability in a growing market, offset by negative cash flow due to high discretionary capital expenditures. Rating Action On March 27, 2012, Standard & Poor's Ratings Services assigned its preliminary 'B+' corporate credit rating to Coraopolis, Pa.-based Heckmann Corp. The outlook is stable. At the same time, we assigned our preliminary 'B-' issue-level and '6' recovery ratings to the company's proposed $250 million senior unsecured notes. The '6' recovery rating indicates our expectation for a negligible (0% to 10%) recovery for lenders in the event of a payment default. We have assigned our ratings based on preliminary terms and conditions. The company intends to use the note proceeds, along with $75 million from an equity issuance, $17.5 million of equity held in escrow, and $63 million of existing cash to acquire Scottsdale, Ariz.-based oil recycler Thermo Fluids Inc. (TFI; unrated), a provider of used oil recycling services in the Western U.S. The company will also use the proceeds to repay its existing secured credit facilities, to pay for transaction fees and expenses, and for general corporate purposes. Rationale The preliminary ratings on Heckmann reflect the company's "weak" business risk profile and "aggressive" financial risk profile. Heckmann transports and disposes of water used in the hydraulic fracturing (fracking) process of oil and gas exploration in shale regions. Pro forma for the TFI acquisition, we expect the company's traditional water-related businesses (Heckmann Water Resources, or HWR) to account for 58% of revenues and the acquired oil-related businesses to account for 42%. The company's operations are subject to the supplies and pricing of oil and gas, since adverse commodity price movements may impact the future development and growth rates of shale fracking. The company has grown significantly during the past three years, increasing sales from less than $4 million in 2009 to $157 million in 2011. We expect sales to hit $380 million in 2012. Heckmann was founded in 2007 to make investments in various businesses. Despite favorable credit measures at the outset, we expect the company to continue to make tuck-in acquisitions from time to time, many of which may require debt financing. The company is acquiring TFI for approximately $245 million. We expect that $227.5 million of the purchase price will come in the form of cash consideration and $17.5 million as equity issued to the former owners of TFI, which include equity sponsor CIVC Partners. TFI is one of the larger oil recyclers in the U.S., with services in 18 states, predominantly in the Western U.S., and over 40% of revenues split evenly between the Mountain and South Central states. The company collects used motor oil which it recycles and reprocesses into reprocessed fuel oil. Heckmann expects TFI to generate $105 million to $115 million in revenue from April through December 2012. We do not expect significant synergies from the transaction, since TFI's 290 trucks are specialized and are not likely to be able to be used in Heckmann's core business of frack water transport and disposal. We also believe the acquisition increases the company's exposure to oil price movements. However, despite the lack of synergies and TFI's exposure to oil price movements, we believe the acquisition also increases Heckmann's service diversity and revenue stability; its operating results could benefit from the TFI acquisition if oil prices remain high while natural gas prices remain low. We also believe that the business mix will benefit from the steadier, slower growth of its oil recycling business compared than its frack water transport and disposal segment, which lacks a proven track record. Yet, despite relatively slower growth, TFI's profitability is very good, with EBITDA margins of 27% in 2011. We believe Heckmann's traditional HWR business benefits from a good market position, because the company has a large asset base in the specialized field of frack water disposal, with more than 635 trucks in service and more than 1,100 frack tanks that are available for its customers to lease. A key feature highlighting the company's competitive position is its underground pipelines around Haynesville, La., one of which is a PVC pipeline spanning 40 miles to provide fresh water used in the fracking process and another is a fiberglass pipeline that stretches for 50 miles to dispose of the produced water into its network of 21 salt water disposal (SWD) wells in the region. The company also has five SWD wells near Eagle Ford, Texas, and two SWD wells around the Tuscaloosa Marine Shale area in Louisiana and Mississippi, with a handful of SWD permits in other regions. The company's main operating regions are in the Marcellus/Utica region in Western Pennsylvania and Northeast Ohio and the Haynesville area in East Texas and Louisiana. The company also has operations in other shale plays including Eagle Ford, Tuscaloosa, and the Permian basin and Barnett regions in Texas. With persistently low natural gas prices, profitability in the dry gas Haynesville region declined and the company mobilized resources away from that area in fourth-quarter 2011 and continued to move into more-profitable oil- and wet gas-producing regions in Eagle Ford and Marcellus. Despite incurring $4 million of charges in connection with this redeployment, profitability remains good, with EBITDA margins of 18% for the year ended Dec. 31, 2011. Our 2012 performance expectations for Heckmann include: -- Sales growth of 142%, reflecting its proposed acquisition of TFI., the full-year effect of acquisitions made in 2011 and 2012, as well as organic growth arising from relocation and expansion into faster growing liquids and oil rich shale regions, partially offset by contraction in the lower-growth dry gas Haynesville region; -- Consolidated EBITDA margins of 25%, largely on the factors listed above; and -- Adjusted EBITDA of $96 million--within the company's stated guidance of $95 million to $105 million. We characterize Heckmann's financial risk profile as "aggressive". Despite its public ownership, Heckmann is still a relatively new and growing company without an established track record of prudent financial policies. Because the fracking industry is in a high-growth stage, the company has had to fund large capital expenditures in order to build the infrastructure necessary to capitalize on this trend. We still anticipate high capital expenditures during the next year, though we note that these expenditures are largely discretionary as opposed to mandatory, and should ease over time. In addition, we expect the company to engage in tuck-in acquisitions from time to time, which could involve additional borrowings. However, the ratings are based on the expectation that the company will successfully execute the equity offering to help fund the TFI acquisition, which we expect will keep credit measures appropriate for the rating. For the current rating, we expect funds from operations (FFO) to debt of roughly 20%. As of Dec. 31, 2011, the pro forma amount (excluding the full-year impact of acquisitions) was 16%; however, when incorporating the full-year effect of Heckmann's acquisitions in 2011 and 2012, along with the combined company's organic growth prospects, we expect this figure to increase to the target expected for the rating. Heckmann does not have any environmental liabilities, and indicates that the produced water it transports and disposes of is exempt from the U.S. Clean Water Act. Heckmann owns and operates 25 salt water disposal wells, which are not required to be capped. As such, the company carries no asset retirement obligations on its financial statements. Liquidity We view Heckmann's liquidity as "adequate". Pro forma for the transactions, we expect the company to have sufficient availability under the proposed unrated $150 million revolving credit facility due 2017, because we expect no borrowings under the facility at first. The facility includes a $10 million sublimit for letters of credit. Proposed financial covenants at the outset include a minimum interest coverage ratio of 2.75x, a maximum senior leverage ratio of 2.50x, and a maximum total leverage ratio of 4.50x. The total leverage ratio is applicable until the quarter ended Sept. 30, 2012. Based on our scenario forecasts, we expect the company to be able to maintain sufficient headroom over the next year. Our liquidity assessment incorporates the following assumptions and observations: -- We anticipate $15 million to $20 million of revolver usage for working capital needs, with most of the usage occurring in the summer due to seasonality in the water transportation and oil recycling businesses; -- High capital expenditures of more than $90 million in 2012, roughly 80% for capital spending and about 20% for maintenance; -- We expect sources of liquidity to exceed uses by 1.2x over the next 12 months; -- We expect that net sources would be positive, even with a 20% drop in EBITDA; and -- Debt maturities are benign, with the earliest meaningful maturity in 2017. Recovery analysis For the complete recovery analysis, see our recovery report on Heckmann, to be published later on RatingsDirect. Outlook The stable outlook reflects our expectation that hydraulic fracturing activity will remain favorable to support solid sales and profitability over the next couple of years, while reductions in discretionary capital spending will improve the company's free cash flow generation. Our base case assumes that, over the next year, Heckmann will be able to maintain adjusted EBITDA margins of around 25%, with FFO to debt of 25% as well. We could lower the ratings if downside risks to our forecast were to materialize, such as insufficient proceeds from the pending equity offering, greater-than-expected debt incurrence to fund the TFI acquisition, unfavorable economic trends that reduce the profitability of hydraulic fracturing, environmental-related regulations that curtail drilling activity and investment, a disruption in water pipelines, other operating problems that could constrain liquidity, or significant debt incurrence to fund a shareholder distribution. Based on our scenario forecasts, we could take a negative rating action if the company's sales growth in 2012 were to fail to meet expectations and its EBITDA margins decreased to 21%. If this were to happen, Heckmann's FFO to total adjusted debt would likely fall to the 15% area. We could raise the ratings modestly within the next 12 months if the company establishes and maintains a track record of reliable operating performance and its business prospects remain robust. While the hydraulic fracturing industry appears to be strong at present, changes in oil and gas prices could affect profitability in certain regions, forcing some service providers to incur unexpected costs as they move manpower and equipment to other regions. Another important factor in our consideration of a higher rating is whether Heckmann maintains adequate liquidity levels despite high capital spending and seasonal working capital-related borrowings. Related Criteria And Research Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 Ratings List New Rating; Outlook Stable Heckmann Corp. Corporate Credit Rating B+ (prelim)/Stable/-- New Rating Heckmann Corp. $250 mil senior unsec notes B- (prelim) Recovery Rating 6 (prelim) Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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