Fitch: Corning's 'BBB ' Ratings Unaffected by Acquisition of Alliance Fiber Optic Products
AFOP makes passive optical components used by cloud datacenter operators and leading datacom and telecom original equipment manufacturers (OEMs). The acquisition should expand Corning's access to cloud datacenter operators and OEMs and broaden its presence in Asia, adding roughly \\$80 million of annual revenues to Corning's roughly \\$3 billion Optical Communications segment.
Fitch estimates operating EBITDA margin for AFOP was more than 30% in each of the last two years and, in conjunction with undisclosed cost synergies associated with the deal, will drive operating EBITDA margin accretion for Corning's Optical Communications segment, which Fitch estimated in the high teens on a standalone basis. Free cash flow (FCF) margin also should improve although the deal's impact on nominal cash flow will be negligible, given AFOP's small size.
Corning announced this morning an all-cash tender offer to acquire all the outstanding shares for \\$18.50 per share, representing a transaction value of approximately \\$305 million (\\$270 million net of acquired cash) and a 12.5x multiple (10.8x net of acquired cash) of Fitch's estimated \\$25 million of 2015 operating EBITDA. The tender offer is expected to commence over the next week and will be followed by a merger, in which all shares of AFOP common stock not tendered will be converted into the right to receive \\$18.50 in cash per share.
Fitch expects the company will use available domestic cash (\\$1.3 billion at Dec. 31, 2015) to fund the transaction. Both boards of directors have approved the transaction, which is expected to be completed in the second quarter of 2016. The acquisition is subject to customary closing conditions, including the majority of AFOP shares are tendered and regulatory approvals.
KEY RATING DRIVERS
The ratings and Outlook are supported by Fitch's expectations for:
--Significant liquid crystal display (LCD) glass share leadership and strong market positions in fiber for telecom, and ceramic filters for automotive applications;
--Technology leadership from significant cumulative RD&E investments, resulting in strong operating EBITDA margin in the low- to mid-30s;
--Expectations for annual FCF over the longer term.
Concerns center on Corning's:
--Potentially limited headroom for operational shortfalls or sustained macroeconomic headwinds, given commitment to more aggressive financial policies;
--Significant ongoing investments in RD&E and capital spending requirements;
--Corning's need to offset meaningful annual average selling price (ASP) reductions in Display and Specialty Materials with manufacturing efficiencies.
--Organic sales growth flat in 2016, on a constant currency basis, followed by low-single-digit growth in 2017-2018.
--Acquisition spending is \\$250 million to \\$500 million annually and adds roughly 0.5% of inorganic growth to the top line per year.
--Operating EBITDA margins remain above 30% through the forecast period.
--Capital intensity remains in the mid-teens through the forecast period.
Negative rating actions could occur if Fitch expects:
--Total leverage sustained above 2.5x, from structurally lower profitability or debt issuance to pre-fund shareholder returns in conjunction with a significant macroeconomic slowdown; or
--Expectations for annual free cash flow sustained below \\$500 million.
A return to financial policies consistent with an 'A'-category rating is unexpected but could result in positive rating action.
Corning's liquidity as of Dec. 31, 2015 was solid and consisted of:
--\\$4.6 billion of cash, cash equivalents and short-term investments, 71% of which was located outside the U.S.;
--Undrawn \\$2 billion revolving credit facility expiring Sept. 30, 2019, \\$481 million of which supported outstanding commercial paper (CP) borrowings at Dec. 31, 2015. The facility includes a maximum 50% debt-to-total capital covenant (19% at Dec. 31, 2015).
Fitch's expectation for solid annual FCF approaching \\$500 million also supports liquidity.
As of Dec. 31, 2015, total debt was \\$5.3 billion (including the unrated \\$1.15 billion of convertible preferred stock after applying 50% equity credit to \\$2.3 billion of preferred shares issued to Samsung).
Fitch currently rates Corning as follows:
--Long-term IDR 'BBB+';
--Senior unsecured debt rating 'BBB+';
--Senior unsecured RCF 'BBB+'.
--Short-term IDR and CP at 'F2'.
The Rating Outlook is Stable.