Moody's puts Graeme Hart firm's junk credit rating on review for downgrade after latest US$4.5b leveraged buy-out

International credit rating agency Moody's Investors Service has put its B2 junk grade rating on Graeme Hart's packaging group Reynolds Group Holdings on review for possible downgrade after Reynolds reached agreement to acquire US group Graham Packaging for about US$4.5 billion in a leveraged buy-out.

In a statement entitled Approximately US$15.7 billion (NZ$19.4 billion) of rated debt securities affected, Moody's noted Reynolds' unadjusted debt would increase by about US$4.8 billion as a result of the deal. As of March 31 Reynolds had borrowings of US$12.547 billion and US$279.9 million of net financial expenses in the March quarter..

The agreed deal, announced on Friday US time, will see Reynolds pay Graham's shareholders US$25.50 a share in cash. That's US50 cents a share, or about US$33 million, more than an earlier bid. and is the equivalent of about US$4.5 billion including the assumption of Graham’s debt of about US$2.8 billion. See our story on the deal from last week here.

Reynolds, the world’s second biggest food and drink packaging maker after Sweden's Tetra Laval with annual sales of about US$10 billion, says the deal will be financed with cash and up to US$5 billion of new debt. Hart's firm, adding to more than US$13 billion worth of packaging acquisitions made within just five years, is paying about nine times Graham’s earnings before interest, tax, depreciation and amortisation (ebitda).

The York, Pennsylvania-based Graham is 61% owned by private equity giant Blackstone Group. The deal is expected to close in the second half of this year and is subject to "customary" regulatory approvals and closing conditions.

Although specific details of Reynolds' financing for the deal haven't been disclosed, Reynolds has said the deal will be financed with debt and cash on hand and that it has committed financing.

"Reynolds has also not disclosed the value of synergies it expects to achieve,' Moody's said.

"Pro-forma for the transaction and previous acquisitions and excluding unrealized synergies, Reynold's debt to EBITDA is well above six times. Unadjusted debt will increase by approximately US$4.8 billion, depending upon how much cash the company applies to the deal, as Reynolds assumes or refinances approximately US$2.8 billion of existing Graham debt and another approximately US$2 billion of debt to help finance the transaction including fees and expense."

As of March 31, Reynolds had about US$1.2 billion of cash and Graham US$172 million.

Moody's says it had specified last September, following the announcement of the debt financing for Reynold's US$6.5 billion buy of Hefty trash bag maker Pactiv, that maintenance of around six times debt to ebitda was necessary for Reynolds to avoid a downgrade from B2, a rating already regarded as speculative and subject to high credit risk.

"Currently, Moody's is unable to determine the extent of the potential downgrade, if any. Moody's review will focus on the final capital structure, credit metrics of the combined entity, potential synergies, the integration plan, and the plan for deleveraging."

'No room for another leveraged buy-out', says S&P

Moody's threatened downgrade comes after its rival Standard & Poor's (S&P) last week effectively said it would downgrade its B+ junk grade rating on Reynolds if the Graham deal was completed.

"Reynold's debt leverage is already high, in our opinion, following its mostly debt-financed US$6.5 billion acquisition of Pactiv Corp. in November 2010," S&P said.

"Although management has a good track record of achieving targeted cost reductions and lowering debt following acquisitions, the purchase of Pactiv, Reynolds' largest to date, stretched the company's financial risk profile and left no room for another large debt-financed acquisition."

"We believe that for the next year, the company's ratio of pro-forma funds from operations to total adjusted debt likely will stay less than 10%, a measurement that we previously indicated would be key to maintaining the B+ ratings," S&P added.

"We also recognize that Reynolds may face integration risks if it acquires Graham's operations. However, the additional product line and geographic diversity could improve Reynolds' already strong business risk profile, as should operational cost consolidation post-acquisition. Therefore, and given our assumption that liquidity and covenant headroom will remain adequate, we would expect a potential downgrade to be limited to one notch."

Once the deal closes, Reynolds will pay Blackstone and the Graham family US$245 million in cash due to income-tax receivable agreements. This is compensation for previous operating losses Graham’s owners can use to reduce future tax liabilities.

Graham Packaging supplies plastic containers for the likes of juice, sports drinks, smoothies, condiments and beer. Its customers include Procter & Gamble's Gain detergent, H.J. Heinz’s ketchup, and Coca-Cola’s Minute Maid juice. The company had pro-forma net sales, taking into account its September 2010 acquisition of Liquid Container, of about US$2.8 billion. Graham employs more than 8,300 staff in 15 countries and has 97 manufacturing facilities.

Reynolds includes SIG, a maker of aseptic beverage carton packaging that allows the likes of juice, milk, soups and sauces to be stored for extended periods without refrigeration, Reynolds Consumer Products which is the dominant US maker of foil, wraps and bags used for food storage and preparation, and Closures, the leading global provider of plastic bottle caps used for soft drinks and bottled water. It also incorporates Evergreen, formed through Hart’s acquisition of the United States domiciled Evergreen Packaging and Blue Ridge Paper Products in 2007, and Pactiv.

Hart started assembling his packaging empire after completing his NZ$3.3 billion Carter Holt Harvey acquisition and delisting that company from the NZX in 2006.

See Reynolds' announcement here and here's Graham's announcement.