OREANDA-NEWS. S&P Global Ratings said today that it had assigned its 'B' corporate credit rating to Hazelwood, Mo.-based Meter Readings Holding LLC. The company is the corporate parent and guarantor of AMI services company Aclara Technologies LLC.

At the same time, we assigned our 'B' issue-level rating and '3' recovery rating to the company's proposed $345 million senior secured first-lien term loan. The '3' recovery rating indicates our expectation for meaningful (50%-70%; upper half of the range) recovery in the event of a payment default. The existing $70 million asset-based lending (ABL) facility is unrated.

Aclara has a relatively narrow scope of operations and limited product diversity as a provider of AMI products and services to electric, water, and gas utilities. The company faces uncertainty regarding utilities' meter deployment cycles, somewhat high customer concentration, and the risk of technological change. These risks are partially offset by contract terms that provide some visibility on revenue, a solid order backlog, adequate geographic diversification, and growing profitability. Aclara is a portfolio company of financial sponsor Sun Capital Partners, and we expect the company to maintain an adjusted debt to EBITDA ratio that approaches or exceeds 5x.

With pro forma revenue of $474 million as of May 31, 2016, Aclara is a provider of AMI sensors, communications devices, and software (45% of pro forma revenue), electric meters (50%), and installation services (5%). AMI refers to a system of devices, networks, and data management systems that allow for two-way communication between utilities and their customers. The company anticipates that the growth potential of its industry is high and predicts that the global installed base of 564 million smart meters in 2015 may grow by 14% annually to 1.1 billion units by 2020. Industry participants compete based on their ability to offer low-cost and highly reliable integrated solutions that are specifically suited to a utility's objectives, allowing the customer to easily interpret and manage the data collected. Competition for new meter deployment projects, which may last from three to five years, can be intense when new opportunities arise because the timing and magnitude of new projects is uncertain and vendors may lower their pricing in order to win new work. Technological change is another risk that Aclara faces as the company and its competitors are continually seeking to introduce new products and software with improved capabilities that will make older products obsolete.

Aclara's 15% market share in the electric meters segment makes it the third largest company in the space. The company competes against firms like Itron Inc., Elster Group GmbH, and Landis+Gyr in this industry, which are larger, well-capitalized companies. The company enjoys the No. 1 and No. 2 positions in the gas and water AMI segments, respectively, but does not produce its own gas and water meter hardware.

Aclara's customer concentration is moderately high, as SoCalGas and Exelon account for 23% and 17% of its consolidated sales, respectively. Nonetheless, the company's overall market presence is solid, with over 60 million user endpoints in 36 countries. In addition, Aclara has broad AMI capabilities, including a fixed network radio frequency system that can communicate with electric, water, and gas utility systems, a 2/3 market share in the less-prevalent powerline carrier technology used for electric meters in rural areas, and a solid order backlog of almost $800 million as of May 31, 2016. The company's recent vertical integration efforts could also continue to yield operating benefits. Aclara acquired General Electric Co.'s global electric meters business in 2015 to provide it with a platform to integrate its AMI software into an electric meter housing and purchased Smart Grid Solutions (SGS) in March 2016 to help grow its installation and aftermarket services. The GE acquisition has already borne fruit, as in February Aclara was awarded a $310 million contract with Consolidated Edison Inc. to deploy five million meters starting in 2017, although the utility will be using a competitor's network platform.

During the next three years, we anticipate that Aclara's ability to achieve cost synergies, improve its operating efficiency, and secure new order wins will result in weighted average EBITDA margins of over 18% during our forecast period. This would compare quite favorably to the 10% margins the company was generating in 2014, prior to its recent acquisitions.

Financial sponsor Sun Capital Partners acquired Aclara in 2014 from ESCO Technologies and combined it with GE's electric meters business the following year. It will award itself and its minority shareholders a $66 million dividend distribution as part of this transaction. While the company's adjusted debt-to-EBITDA ratio following the transaction will be less than 4.5x, we believe there is a risk that aggressive financial policies from financial sponsor ownership could result in this ratio exceeding 5x. We would need to see the company and its owners commit to and abide by a financial policy consistent with debt leverage of below 5x before we would revise our financial risk assessment. We expect Aclara to continue to make debt-funded bolt-on acquisitions from time to time to fuel its growth.

The stable outlook on Aclara reflects our expectation that the company should see steady organic and inorganic growth supported by contributions from its recent acquisitions over the next 12 months. The company's good order backlog, new business wins, additional product offerings, and merger and acquisition synergies should support its operating performance going forward, though its good performance may be partially offset by operational expenses to grow its market share and typical customer churn. The company has a demonstrated track record of enhancing its growth via bolt-on acquisitions and we expect that it will continue to pursue small bolt-on acquisitions as part of its growth strategy. Given Aclara's ownership by financial sponsor Sun Capital Partners, the company may potentially provide debt-funded returns to its equity holders.

We could lower our ratings on Aclara if a significant decline in its earnings or a large debt-financed acquisition or similar shareholder return causes its total debt-to-EBITDA metric to exceed 6x without clear prospects for recovery. This could occur if the company faces operational challenges following unexpected volume declines from cancelled projects, the loss of key customer contracts, the substitution of its products, or an inability to effectively manage its highly variable cost structure. Based on our downside scenario, this could occur if Aclara's operating margins weaken by more than 300 basis points (bps) or its volume declines by over 15%.

Given our current assessment of Sun Capital Partners' financial policies, we view an upgrade over the next 12 months as unlikely. However, we could raise our ratings on Aclara by one notch if the company commits to--and demonstrates a track record of--operating with a debt-to-EBITDA metric of 4x-5x, a FFO-to-debt ratio of near 20%, and a consistently positive free cash flow-to-debt ratio with no prospects for near-term material deterioration. Any additional upgrades would likely depend on whether the company can meaningfully strengthen its business risk profile through enhanced scale, market share wins, improved pricing, and operating efficiencies.