DBRS Places Babcock International Ratings Under Review with Negative Implications

DBRS has today placed the Issuer Rating and Senior Unsecured Debt rating of Babcock International Group PLC (Babcock or the Company) Under Review with Negative Implications following the Company’s announcement on March 27, 2014, that it has entered into a conditional agreement to acquire the entire Avincis Group (Avincis) for GBP 920 million to be funded through fully underwritten rights issues representing approximately GBP 1.1 billion. However, Babcock will also assume Avincis’s net debt of GBP 705 million. The rating action reflects that the Company’s debt coverage ratios and the resultant financial profile, on a proforma basis, will be weaker than the current rating range, affected by the addition of Avincis’s existing debt, despite the issue of equity to fund the acquisition. In addition, the higher capital intensity and riskier operating environment at Avincis have also modestly weakened Babcock’s business risk profile. DBRS will downgrade Babcock’s ratings by one notch after the close of the transaction expected in May 2014.

DBRS notes that the use of equity to fund the acquisition is a positive. However, the impact of an additional GBP 705 million debt from Avincis would weaken the key coverage metrics materially. On a proforma basis, the adjusted cash flow-to-total debt (as defined by DBRS with debt including capitalized leases) would decline to about 16% and the adjusted debt-to-EBITDA would rise to over 3.5x compared with 35% and 2.15 times (x), respectively, for the 12 months ending September 30, 2013. These credit metrics are weak for the current rating. The Company has arranged a bridge facility to refinance the high cost debt at Avincis, a positive first step, lowering the interest expense of the consolidated group. (Babcock estimates a potential interest cost reduction of up to GBP 35 million per year.) However, Babcock needs to reduce the debt leverage and improve operating performance to restore its financial profile to near that in Fiscal 2012 levels to be compatible with the current rating. Moreover, the Company also faces the following challenges to strengthen its financial profile: (1) operating income at Avincis has been on a declining trend in the last three years; (2) ongoing investment to expand the fleet of helicopters to support growth pressuring the Company’s ability to reduce leverage; and (3) integration risk associated with a large acquisitioning, notwithstanding the Company’s good track record, notably the VT Group acquisition in 2010.
DBRS also notes that the acquisition of Avincis (with revenue of about 17% of Babcock’s) is modestly negative to the business risk profile of Babcock. The operating environment of Avincis is riskier as evident by recent accidents experienced by both Avincis and its major competitors. Furthermore, Avinci is a capital intensive business having to invest and maintain a large fleet of helicopters not to mention ongoing investments needed to support growth. Nevertheless, Avincis also has the following positive attributes: (1) Avincis has high revenue visibility with an order book of approximately Euro 2.3 billion at December 31, 2013, and pipeline opportunities of around Euro 7 billion. Contracts at Avincis are typically four to seven years in length with a high fixed revenue component, which adds to earnings stability. (2) The addition of Avincis will modestly diversify Babcock’s client base and geographical footprint. Longer term, Avincis is well placed to retain and build on its strong market position and to benefit from growth trends such as increasing outsourcing from governments and opportunities in new geographies.

Avincis is a leading supplier of helicopter and fixed-wing emergency services (medical, search and rescue, firefighting and civil protection in Europe and Australia) and a leading supplier of critical offshore crew-change helicopter services to the oil and gas industry in the U.K. sector of the North Sea. Avincis also has a growing presence in the Norwegian and Australian offshore oil and gas markets. Babcock will pay GBP 920 million (Euro 1,100 million) to World Helicopters (a company owned by funds advised by Investindustrial group and Kohlberg Kravis Roberts) for Avincis. The Company expects Avincis to be earnings accretive in Babcock’s first full year following the acquisition and that it will achieve a return on invested capital in excess of the current Babcock cost of capital in the second full financial year. Additionally, Babcock expects the net debt-to-EBITDA ratio at the end of fiscal 2014 (year ending March 31, 2014) to be approximately 2.5x* with a target net debt-to-EBITDA of 2.3x* at the end of fiscal 2015.

*This statement is not a profit forecast by Babcock.

In summary, DBRS notes that the acquisition of Avincis is modestly negative to the Company’s business risk profile. However, the assumption of Avincis’s existing debt has led to higher leverage and lower coverage ratios at the consolidated company level. The Company’s financial profile, on a proforma basis, is weaker than the current rating range. The weaker financial profile is the key reason that DBRS will downgrade the Company’s ratings by one notch at the close of the acquisition of Avincis expected May 2014.

Notes:
All figures are in U.K. pounds sterling unless otherwise noted.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Services Industry (July 2013), which can be found on our website under Methodologies.