Agencies Take Split View On Nalco

Moody's Investors Service and Standard & Poor's have taken a highly divergent view on Nalco Co. with a couple of notches difference between the ratings for the bank debt. "During the next several years, management is expected to use virtually all discretionary cash generation for debt reduction, thus aiding the necessary strengthening of key financial ratios to appropriate levels for the initial ratings," said S&P credit analyst Wesley Chinn. S&P also highlights the company's strong competitive position in water treatment and process chemicals, solid operating margins and stable cash flows. Though Chinn notes these factors are overshadowed by very aggressive debt leverage, he gives the $1.65 billion of bank debt a BB rating.

But Moody's believes the bank debt is only worth a B1 rating. The ratings take into account Nalco's high leverage with pro forma debt to EBITDA of six times, 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, notes Moody's. John Rogers, v.p., senior credit officer for Moody's, said Nalco has shown good EBITDA levels, but it is important to look at the history of cash flow generation for the combined entity and for that there is less evidence. He said it is highly unlikely the company would have received a Ba2 rating (equivalent to BB) at this debt level.

The bank debt and $1.8 billion of bonds, combined with $1.1 billion of equity capital from The Blackstone Group, Apollo Management and Goldman Sachs Capital Partners, will be used by Nalco to purchase the outstanding shares of capital stock from Suez for roughly $4.125 billion. One banker, upon finding out about the split ratings, noted that in this market it really does not matter (see story, page 3).

Moody's expects that credit metrics will improve post-2004 due to the absence of restructuring charges and other expenses tied to the transaction, but the ratings could be lowered if the company fails to achieve yearly free cash flow of at least $100-125 million 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.