Fitch Rates Tyco International's Planned Sr Unsecured Notes 'A-'; Outlook Stable
Proceeds from the new notes will be available for general corporate purposes, including funding the pending acquisition of Industrial Safety Technologies (IST) for approximately \$330 million expected to close in the second quarter of fiscal 2015. The new debt will also increase Tyco's liquidity prior to the scheduled maturity of \$258 million of 3.375% notes due October 2015.
KEY RATING DRIVERS
Acquisitions represent Tyco's first priority for cash deployment, and the pending IST transaction could be followed by other acquisitions. Acquisitions are a key part of Tyco's strategy to expand its presence globally and in higher-growth emerging regions.
Debt-funded acquisitions would increase Tyco's leverage, including total adjusted debt/EBITDAR of 2x at Dec. 26, 2014. Fitch estimates pro forma leverage was nearly 2.3x including the new debt. Fitch would view total adjusted debt/EBITDA near 2.5x or higher as a rating concern that could lead to a negative rating action. However, Fitch expects Tyco to maintain a strong balance sheet over the long term.
Other cash deployment has been concentrated on share repurchases, partly reflecting modest acquisition activity. Tyco repurchased \$1.8 billion of shares in 2014 and \$417 million in the first quarter of fiscal 2015. Share repurchases were partly funded by proceeds from significant divestitures of non-core assets totaling more than \$2 billion, primarily ADT Korea and Atkore.
Tyco expects to make cash payments of \$600 million during 2015 to fund the company's asbestos liabilities. A portion of this amount (approximately \$278 million) was funded early in the second quarter of fiscal 2015. The amounts are substantially higher than Tyco's original estimates but Fitch believes the company has sufficient liquidity and free cash flow (FCF) to make payments to a bankruptcy trust and a qualified settlement fund over the next 12 months while maintaining total adjusted debt/EBITDAR below 2.5x. Cash balances of \$473 million at Dec. 26, 2014 were down materially from previous high levels as a result of share repurchases, but the reduced cash level should be sufficient to fund operations.
More than 90% of Tyco's asbestos cases involve the company's Yarway Corporation and Grinnell LLC subsidiaries. Tyco recognized a \$465 million charge in the fourth quarter of fiscal 2014, net of certain adjustments, following a recent agreement in principal with Yarway's claimants and a revised estimate of asbestos liabilities at Grinnell and other non-Yarway businesses. Tyco plans to fund future payments for Yarway's asbestos liabilities by contributing \$325 million to a section 524(g) trust, including approximately \$100 million of an intercompany amount claimed by Yarway. The agreement in principal pertaining to Yarway is subject to various approvals and would expire if not finalized by certain dates in 2015 or 2016. In addition, Tyco contributed \$278 million in January 2015 to a qualified settlement fund (QSF), in coordination with insurers, that will be used to fund future payments related to non-Yarway asbestos liabilities.
There is a risk that the revised estimate of Tyco's asbestos liability is low and Tyco will be required to make claim payments in addition to its planned or completed contributions of approximately \$600 million. This concern is mitigated by the extended period over which future additional payments might be required, and by Tyco's financial flexibility to reduce future spending for share repurchases or acquisitions.
In addition to cash of \$473 million at Dec. 26, 2014, Tyco's liquidity included a \$1 billion bank credit facility that matures in 2017. The bank facility backs commercial paper issued under a \$1 billion program. The only material debt maturity scheduled prior to the end of calendar 2017 is a 3.375% note due October 2015. Debt totaled nearly \$1.5 billion at Dec. 26, 2014. Tyco also has substantial leases which Fitch considers in adjusted debt leverage metrics.
Rating concerns include potential tax liabilities. The IRS asserts the company owes income taxes of approximately \$1 billion for the 1997-2000 tax years. The amount includes penalties but not interest, which could be substantial. The IRS claim relates to intercompany debt on which the IRS has disallowed \$2.9 billion of interest and related deductions. If its claim is upheld, the IRS could demand additional income tax payments for similar deductions totalling \$6.6 billion in subsequent periods.
A resolution of the tax dispute could take several years, which would defer the cash impact. Any payments that might eventually be required would be shared with the other companies involved in both of Tyco's separations in 2012 and 2007. While not expected, an inability of the other companies to share in any future payments would increase Tyco's liability. If the IRS makes claims on all \$9.5 billion of deductions and ultimately prevails, Fitch estimates Tyco's share of the income tax liabilities could total approximately \$600 million, plus interest. An adverse outcome involving a larger payment is currently beyond the rating horizon but could lead to a negative rating action.
FCF after dividends totaled slightly more than \$300 million in 2014. Fitch expects FCF could increase toward a normalized annual level of at least \$500 million over the next two years or so after cash payments decline for special charges. FCF would also benefit from an increase in operating margins related to restructuring and as non-residential construction markets improve. Concerns about low FCF in the near term are mitigated by Tyco's conservative debt structure.
The cash impact of special charges was \$473 million in fiscal 2014 and included restructuring, environmental payments, and tax-related payments under Tyco's separation agreements. Cash charges will likely continue through at least 2015, but at declining levels.
At the end of fiscal 2014, pension plans were underfunded by \$374 million (US\$126 million; foreign \$248 million). Tyco estimates it will contribute at least the required \$36 million to its pension plans in 2015. More than half (63%) of Tyco's gross pension obligations are outside the U.S.
Tyco's ratings incorporate the company's geographic diversification, well-established positions in its fire and security markets, improving operating profile, and financial flexibility. Tyco continues to integrate and streamline operations to support higher margins. Margins are also supported by Tyco's increased selectivity around projects in the security business. Fitch estimates approximately 25% of revenue comes from recurring services which are relatively stable and help to offset cyclicality in the installation business.
Fitch's key assumptions within the rating case for the issuer include:
--Tyco maintains low leverage through business cycles, including total adjusted debt/EBITDAR below 2.5x;
--FCF increases to normalized levels near \$500 million or more during the next two years, excluding asbestos payments;
--Tyco makes \$600 million in cash payments during fiscal 2015 to fund a significant portion of its estimated asbestos liabilities;
--Tyco realizes further margin improvement from restructuring, a higher proportion of recurring revenue, and increased project selectivity;
--The resolution of contingent tax liabilities occurs over several years and payments are shared with other companies involved in Tyco's previous separations;
--In addition to asbestos payments in 2015, cash deployment over the long term is directed toward acquisitions and share repurchases.
Future developments that may, individually or collectively, lead to a negative rating action include:
--High spending for share repurchases or acquisitions leads to a sustained increase in leverage, including total adjusted debt/EBITDAR above 2.5x;
--FCF remains weak longer than expected due to operating results or high cash charges. The charges for asbestos liabilities are material, but Fitch believes cash funding during fiscal 2015 will be manageable. Fitch expects FCF, excluding asbestos funding, will increase to approximately \$300 million-\$400 million in 2015, depending on the timing of other cash charges, and FCF/total adjusted debt will improve above 10% over the long term;
--Liquidity is impaired by an adverse tax decision.
Future developments that may, individually or collectively, lead to a positive rating action include:
--Strong earnings or debt reduction lead to total adjusted debt/EBITDAR consistently below 1.50x-1.75x;
--FCF/total adjusted debt improves to around 20% or higher;
--Contingent tax liabilities are eventually resolved.
Fitch rates Tyco as follows:
Tyco International plc
--IDR at 'A-';
--Short-term IDR at 'F2'.
Tyco International Finance S.A.
--IDR at 'A-'
--Senior unsecured revolving credit facilities at 'A-';
--Senior unsecured notes at 'A-';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook is Stable.