INSIGHT: Huntsman and Hexion - solvent or not?

08 September 2008 17:00  [Source: ICIS news]

You can discuss this story on ICIS Connect.

By Joseph Chang

NEW YORK (ICIS news)--As star-crossed merger partners Huntsman and Hexion Specialty Chemicals prepare for battle today in court, the $64,000 question is: would the combined company be solvent or not?

The answer depends on a slew of factors including the capital structure, financial outlook and ability to achieve synergies. But all that aside - it is going to be a close call.

Let us take a closer look.

To buy out Huntsman on the terms of the merger agreement, Hexion would be paying more than $28/share for a total of around $6.5bn (€4.6bn). The purchase price of $28/share is actually increasing by 8% on an annualised basis as of April 4, 2008, according to the merger agreement.

US-based Hexion, owned by global private equity firm Apollo Management, planned to finance the buyout with 100% debt.

Add on Huntsman’s existing net debt of $3.8bn (as of the end of the second quarter) and you get $10.3bn. Hexion is already highly leveraged, with about $3.6bn in net debt.

So adding it all up, you have a combined entity with around $14bn in debt. Now would the company be able to service that debt?

We are going to have to make some assumptions to say the least.

The leverage ratio of such a company, which is measured by debt/EBITDA (earnings before interest, tax, depreciation and amortisation), would be about 10x, based on combined trailing 12-month EBITDA (up to June 30, 2008) of around $1.4bn.

That is a very highly leveraged company, any way you slice it.

“The proposed acquisition would result in a highly leveraged and highly aggressive capital structure,” said Kyle Loughlin, team leader of the chemical group at credit ratings agency Standard & Poor’s (S&P).

“It does raise questions about whether this can be funded with all debt as originally planned, especially in today’s capital market environment.”

Hexion itself had an adjusted leverage ratio of 7.5x (including adjustments to account for unfunded employee benefit obligations and the capitalized present value of operating leases), according to S&P.

S&P has a corporate credit rating of B on Hexion and a higher BB- for Huntsman - both in the speculative or “junk” category.

S&P’s B rating on Hexion is on CreditWatch with negative implications, meaning that a combined Hexion/Huntsman with a 10x leverage ratio could be rated lower.

Despite the business profile benefits, a company with a 10x leverage ratio, all things being equal, was consistent with a rating in the “low speculative grade category”, according to S&P’s Loughlin.

Now what kind of interest rate would Hexion/Huntsman have to pay on its $14bn in debt with this type of credit rating?

Let us assume an average of 9% between floating-rate bank debt and fixed-rate senior debt, given the high leverage.

Floating-rate bank debt, based on a premium to the London Interbank Offered Rate (Libor) would likely be lower than 9% and fixed-rate senior debt would likely be higher, assuming a bond issuance can get done.

Note that US-based billboard and radio company Clear Channel Communications, which is being bought by private equity firms Thomas Lee Partners and Bain Capital after a major restructuring of the deal, is shopping a $980m bond issue with a coupon of 10.75%.

S&P rates the debt CCC+, which is two notches below Clear Channel’s corporate credit rating of B.

However, industry sources said the underwriting banks were marketing the Clear Channel bond offering at a steep discount, making the effective rate much higher - possibly 15%.

So assuming it costs 9%/year to service the $14bn in debt, that comes to $1.26bn, slightly lower than the $1.4bn in last 12-months EBITDA of the combined entity.

That does not take into account maintenance capital spending, but also does not account for benefits from cost synergies. The likelihood that lower raw material costs will lead to improved results in the coming quarters is also obviously not accounted for.

For simplicity’s sake, let us call all of that a wash.

According to John Rogers, head of the chemicals group at credit ratings agency Moody’s Investors Service: “This deal is probably technically solvent when you close it, but the concern is what happens six months or a year down the road in terms of what kind of financial covenants they would have to live up to.

“There could be terms in the financing that could impact Hexion’s borrowing cost in the future,” he added.

“Any increase in borrowing costs could greatly impact the value Apollo could extract from the combined company and increase the chance of a potential bankruptcy.”

And while it is up to the courts to decide whether Hexion is obligated to go through with the deal, even if it is unable to obtain financing, the likelihood of getting that financing is extremely low at best.

“I doubt this deal can get refinanced in today’s credit market - there is only a very, very slim chance,” said Rogers.

But the latest offer from Huntsman shareholders to backstop potential losses to Hexion to the tune of $500m in the form of a financing vehicle called Contingent Value Rights (CVRs), can only help Huntsman’s case, although it does represent a small portion of the total financing needed.

Citadel Investment Group, DE Shaw Valence Portfolios and MatlinPatterson Global Opportunities Partners as well as the Huntsman family would participate in the CVR financing to help push the deal through.

Hexion has basically said thanks, but no thanks, calling the proposal “inadequate.”

Some of these shareholders are underwater, having bought up Huntsman on the expectation that the deal would be completed at $28/share.

Since June 2008, Citadel has acquired 18.6m shares of Huntsman, representing a 7.95% stake, for a total of $356m, or an average of $19.11/share, according to a 22 July, 13-D filing with the US Securities and Exchange Commission (SEC).

Shares of Huntsman closed at under $13 last week.

Russ Stolle, senior vice-president of global public affairs and communications at Huntsman, said: “We believe that Apollo’s views on solvency are deeply flawed and that the combined Huntsman/Hexion entity will be solvent.

“If Apollo truly thinks otherwise, they should accept the proposal of the independent shareholders that was supported by the Huntsman family.”

Hexion would not comment.

Adds Moody’s Rogers: “Everyone is posturing right now. I believe that it will ultimately come down to a ruling on damages," he said.

"I can’t imagine that after the buyer says the company won’t be solvent, that the banks will go ahead and fund the transaction.”

($1 = €0.70)

To discuss this story go to ICIS Connect.

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By: Joseph Chang
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