Fitch Affirms BorgWarner's Ratings Following Remy Acquisition Announcement
Fitch's ratings apply to a $1 billion unsecured revolving credit facility, $1.7 billion (par value) in senior unsecured notes and a $1 billion CP program.
The Rating Outlook for BWA is Stable.
KEY RATING DRIVERS
The proposed acquisition will be an all-cash transaction, with an implied enterprise value for REMY of about $1.3 billion including net debt. The purchase price of $29.50 per share equates to a market capitalization of $950 million, about 44% above REMY's market capitalization at the close on July 10, 2015. The acquisition will add REMY's expertise in rotating electric motors, including stop/start technologies and hybrid motor systems, to BWA's existing powertrain technologies. There is little product overlap between the two companies, and Fitch does not expect any significant issues with competition authorities.
The acquisition will allow BWA to offer more comprehensive end-to-end powertrain systems, which Fitch expects will result in longer-term product synergies. As of now, BWA has announced that it expects to achieve at least $15 million in synergies from the acquisition, mostly related to purchasing efficiencies and redundant public company expenses, which suggests the figure is a conservative estimate. The transaction will also diversify BWA's powertrain offerings, which Fitch views positively. Currently, BWA's powertrain technologies are primarily tied to traditional internal combustion engines (ICEs), and although Fitch expects ICEs to remain dominant for many years to come, the company's lack of exposure to the growing electric propulsion segment had previously been a concern. Fitch believes the acquisition of REMY will significantly enhance BWA's exposure to the electric and hybrid vehicle segments over the longer term.
BWA plans to fund the acquisition through a combination of existing cash on-hand and revolver or commercial paper (CP) borrowings. As of March 31, 2015, BWA had $1 billion in cash on its balance sheet, including $423 million in the U.S. It also had $1 billion of revolver availability. REMY had $326 million of debt outstanding at March 31, 2015, primarily Term Loan B borrowings. Fitch estimates BWA's pro forma leverage post transaction will be in the mid-1x range, assuming a significant portion of the purchase is funded with cash on hand. By using its revolver or CP program for the debt-funded portion of the acquisition, BWA will retain financial flexibility to reduce its outstanding debt over the intermediate term, although the company did note that it could consider terming out any borrowings with long-term debt in the future. However, even if the debt is termed-out, Fitch expects leverage could decline to the low-1x range over the next two years. The company also mentioned that it will likely be above its 30% net debt to capitalization target following the acquisition, which suggests that a reduction in net debt will be a priority following the closing.
Outside of the acquisition, other fundamentals of BWA's credit profile and operating profile remain intact. The company retains a strong competitive position in the automotive engine and drivetrain segments, with significant free cash flow (FCF) generation potential, a solid liquidity position and relatively low leverage. In addition, efficient capacity utilization and a focus on cost control have resulted in profitability that is high for the industry, contributing to the consistent FCF that provides the company with significant financial flexibility.
Fitch's concerns continue to include BWA's ongoing interest in acquisitions and its heightened focus on shareholder-friendly activities. BWA recently announced a $1 billion three-year share repurchase program, and Fitch expects the company to continue repurchasing shares despite the REMY acquisition. The company has also paid a common stock dividend since mid-2013. Fitch's concerns regarding cash returns to shareholders are mitigated somewhat by the company's consistently positive FCF generation.
KEY ASSUMPTIONS
--Global economic conditions continue to improve at a modest pace over the intermediate term, leading to low- to mid-single digit growth in global auto production.
--In the near term, foreign exchange pressure from the strong U.S. dollar more than offsets revenue growth from higher business levels.
--The company funds the REMY acquisition with a combination of cash on hand and revolver or CP borrowings that are later termed out.
--Maturing debt obligations are refinanced.
--Capital spending is elevated in 2015, and then falls to more normalized levels in subsequent years.
--Dividends grow on an annual basis.
--Free cash flow is used to fund acquisitions or share repurchases.
--The company maintains about $700 million in cash on its balance sheet over the intermediate term.
RATING SENSITIVITIES
Positive: Given BWA's 'BBB+' IDR, a near-term upgrade of the company's ratings is unlikely. Typically, the inherent cyclicality and potential financial pressures of the auto supply industry result in a soft cap on IDRs at the 'BBB+' level, although in rare cases a supplier with a very strong business profile and unusually strong credit protection metrics could be considered for the 'A' category.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--An unexpected sharp drop in global auto production;
--An increase in leverage to above 1.5x for an extended period;
--A decline in the company's EBITDA margin to below 12%;
--A significant increase in long-term debt to support shareholder-friendly actions.
Fitch has affirmed the following ratings with a Stable Rating Outlook:
--Long-term IDR 'BBB+';
--Short-term IDR 'F2';
--Unsecured revolving credit facility 'BBB+';
--Senior unsecured notes 'BBB+';
--CP program 'F2'.
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