Tue May 1, 2012 10:23am EDT
Overview -- U.S.-based ACCO Brands Corp. (ACCO) has received shareholder approval to merge with the Consumer & Office Products (Mead C&OP) division of MeadWestvaco Corp. (BBB/Stable/A-2). As part of the transaction, ACCO will pay roughly $460 million to MeadWestvaco shareholders. -- We have raised our corporate credit rating on ACCO to 'BB-' from 'B+' and removed all ratings from CreditWatch with positive implications. The 'BB+' issue-level rating on the $1.02 billion senior secured facilities are affirmed, and the '1' recovery ratings remain unchanged. We have assigned a 'B+' issue-level rating and '5' recovery rating to the $500 million senior unsecured notes. Mead Products LLC originally issued these notes, but following completion of the merger ACCO is the co-issuer. -- The outlook is stable, reflecting our view that credit measures will improve modestly over the near term as ACCO reduces debt with free operating cash flow, sustains its current operating performance, and maintains adequate liquidity. Rating Action On May 1, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Lincolnshire, Ill.-based ACCO Brands Corp. to 'BB-' from 'B+'. We removed the ratings from CreditWatch, where they had been placed with positive implications on Nov. 18, 2011, following the company's announcement that it would merge with Mead C&OP through a Reverse Morris Trust transaction. The transaction closed on May 1, 2012. At the same time, we affirmed the 'BB+' issue-level ratings on ACCO's $1.02 billion senior secured credit facilities. The recovery rating on these loans remains '1', indicating our expectation for very high (90% to 100%) recovery in the event of a payment default. We assigned a 'B+' issue-level rating to the $500 million senior unsecured notes (originally issued by Mead Products LLC, but now co-issued by ACCO following completion of the merger). The recovery rating on the notes is '5', indicating our expectation for modest (10% to 30%) recovery in the event of a payment default. ACCO used the net proceeds from the term loans and the senior unsecured notes to redeem its existing senior secured notes and subordinated notes. We withdrew the ratings on ACCO's existing 10.625% senior secured notes due 2015 and 7.625% subordinated notes due 2015, following their redemption upon close of the transaction. ACCO will also distribute shares of its common stock to MeadWestvaco shareholders as part of the consideration for the acquisition. MeadWestvaco shareholders will retain 50.5% of ACCO's outstanding shares. The outlook is stable. Pro forma for the transaction, we estimate that the company will have about $1.3 billion of reported debt outstanding. Including our adjustments for operating leases and pension obligations, we estimate ACCO will have approximately $1.4 billion total adjusted debt outstanding. Rationale The upgrade reflects our opinion that the combination of ACCO and Mead C&OP will create one of the world's largest office supply manufacturers, and that credit measures have modestly improved pro forma for the merger. We believe the company will benefit from a larger portfolio of branded products, including legacy ACCO brands (Swingline, GBC, Day-Timer, Quartet, and Kensington) and Mead C&OP's Mead, Five-Star, Day Runner, Hilroy, and At-A-Glance, among others. We view the combined company's financial risk profile as "aggressive," given its aggressive financial policy and high leverage, and its business risk profile as "weak." Key credit factors in our business risk assessment include ACCO's participation in the highly competitive branded office products industry, customer concentration, low barriers to entry, sensitivity to cyclical demand conditions, and geographical diversification. We believe the office supply industry is highly fragmented and competitive with very limited barriers to entry, and is subject to cyclicality. In addition, the industry is concentrated in a small number of major customers, principally office-products superstores, office-products distributors, and mass merchandisers, some of which have instituted private-label or direct-sourcing initiatives. Moderate customer concentration will exist following the merger, with the top 10 customers consisting of about 50% of gross sales pro forma for fiscal 2011. We believe the company's sales volume was impacted by the global recession as customers traded down to more private-label office products. We believe the merger will increase ACCO's geographic reach and distribution, while adding complementary products to its existing portfolio. Many of Mead C&OP's products target school and home office markets and are sold in more retail/mass-merchandiser locations, whereas ACCO's products tend to focus more on corporate office products. We estimate that ACCO's presence in Canada will nearly double with the inclusion of Mead C&OP's Hilroy brand of school supplies, which are exclusive to that region. Mead C&OP also has operations in Brazil under the Tilibra brand of stationery and office products. Although we believe geographic diversity benefits ACCO, with the company generating about 45% of sales outside of the U.S. in 2011, the European office-products markets are also intensely competitive and the soft economy there has affected sales. The company has taken steps to streamline costs in its International segment, which could offset EBITDA margin pressures from higher commodity costs. We estimate ACCO's credit measures have improved pro forma for the merger. We estimate the company's pro forma ratio of total debt to EBITDA is about 4.4x, as compared to about 4.7x for ACCO on a stand-alone basis for the fiscal year ended Dec. 31, 2011. On a pro forma basis, we estimate adjusted EBITDA-to-interest coverage and the ratio of funds from operations (FFO) to adjusted total debt to be about 4.5x and 12%, respectively, for the 12 months ended Dec. 31, 2011. Both leverage and FFO-to-debt metrics are currently within the ranges of indicative ratios for an aggressive financial risk profile, which include leverage between 4x and 5x and FFO/debt between 12% and 20%. We expect ACCO's credit measures to continue to improve over fiscal year 2012 and 2013 as the company expands its products into more channels and new geographies. Our base-case scenario assumptions include: -- EBITDA margins of roughly 15% in fiscal 2012 and 2013, which is essentially unchanged from our estimated pro forma EBITDA margin at the end of fiscal 2011. Our EBITDA margin expectation reflects the likelihood that commodity costs could remain elevated through fiscal 2012, partially offset by cost savings initiatives and potential synergies. -- We estimate that net sales will increase by a low-single-digit percent over the next year as consumer spending remains soft. -- No further acquisition activity in the next 12 months. -- Based on our assumptions, we estimate that the company will generate at least $100 million in discretionary cash flows in 2012 and will likely generate at least that level annually during the next two years. -- We believe the company will use a significant portion of its excess cash to reduce debt by the end of 2012. As a result, we estimate the ratio of FFO to total adjusted debt will increase slightly over the next 12 months to about 13%, and adjusted interest coverage will increase to near 4.5x. We estimate leverage will further decline to slightly below 4x by year-end 2012. -- Our estimate assumes no dividends or share repurchases during this period. -- More importantly, we expect the company's liquidity will remain adequate. We believe the company's credit metrics will improve over 2013 closer to those in the indicative ratio ranges for a "significant" financial risk profile. Indicative ratios for a significant financial risk profile include leverage below 4x and FFO to total adjusted debt of around 20%. Liquidity We believe ACCO will have "adequate" liquidity. This includes our anticipation that liquidity sources (including cash, FFO, and availability under the revolving credit facility) will exceed uses by more than 1.2x during the next 12 to 24 months. Liquidity sources will likely continue to exceed uses, even if EBITDA were to decline by 15%. This is based on the following information and assumptions: -- Pro forma for the acquisition, we expect the company to have about $142 million of cash and full availability of its $250 million revolving credit facility due 2017. -- No near-term debt maturities until December 2017. -- No further acquisition activity in the next 12 months. -- The company will be subject to maximum leverage and minimum interest coverage covenants beginning in the fourth quarter 2012. These covenants become more restrictive over time, but we believe the company will have at least 15% cushion on each during fiscal 2012. -- We expect the company to have modest capital expenditures of about $40 million in 2012 and 2013. -- We assume the company will be cash-flow-positive over the next 12-24 months, and generate cash flow from operations of at least $150 million for 2012 and 2013. -- We believe the company has sound relationships with banks and a generally satisfactory standing in credit markets. Recovery analysis The issue-level ratings on the $1.02 billion senior secured facilities are 'BB+', with a recovery of '1'. The issue-level rating on the $500 million senior unsecured notes is 'B+'. The recovery rating is '5'. For the complete recovery analysis, please see our recovery report to be published following this report on RatingsDirect. Outlook The outlook is stable, reflecting our view that credit measures will improve modestly over the very near term as ACCO reduces debt with free operating cash flow, sustains its current operating performance, and maintains adequate liquidity. This includes reducing leverage below 4x and improving FFO-to-debt closer to 20% by fiscal 2013. Although unlikely in the near term, we could raise our ratings if the company reduces leverage and sustains debt-to-EBITDA below 3x, which would primarily result from EBITDA expansion from stronger operating performance. We estimate this scenario could occur if pro forma EBITDA were to increase by 40%, assuming constant pro forma debt levels. However, we could lower the ratings if operating performance weakens materially, possibly due to lower consumer/corporate account spending and rising production costs, resulting in deteriorating credit protection measures, including leverage well over 4.5x, or if FFO-to-total adjusted debt does not improve as expected. We estimate the company's leverage could exceed 4.5x if pro forma debt remained constant and EBITDA were to decline more than 10% from the pro forma EBITDA for the 12 months ended Dec. 31, 2011. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011. -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009. -- Key Credit Factors: Business And Financial Risks in the Branded Consumer Products Industry, Sept. 10, 2008. -- Corporate Ratings Criteria 2008, April 15, 2008. Ratings List Upgraded; Ratings Off CreditWatch To From ACCO Brands Corp. Corporate credit rating BB-/Stable/-- B+/Watch Pos/-- Ratings Withdrawn ACCO Brands Corp. Senior secured 10.625% notes due 2015 N.R. BB-/Watch Pos Recovery rating N.R. 2 Subordinated 7.625% notes due 2015 N.R. B-/Watch Pos Recovery rating N.R. 6 Rating Affirmed; Recovery Ratings Unchanged ACCO Brands Corp. Senior secured BB+ Recovery rating 1 New Ratings ACCO Brands Corp. Mead Products LLC Senior unsecured $500 million notes B+ Recovery rating 5 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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